Of Our Time: Constraining Capital, Liberating Politics

If, as widely predicted, the Social Democratic Party (SPD) wins the German election in September, there will be center-left governments simultaneously in every major European nation for the first time in history -- in London, Paris, Rome, and Berlin. Of the 15 nations of the European Union, no fewer than 13 will be governed by democratic-left parties. Liberal democrats also occupy the executive branch in Washington and Ottawa.

This stunning convergence entails a double irony. Supposedly, this is the supreme capitalist moment. Yet in nation after nation, voters evidently don't like the effects of capitalism in the raw.

At the same time, however, it is not at all clear that these very de-radicalized leftists can do much to temper the market. For the most part, their policies are slightly more benign versions of the same neoliberal policies put forth by their center-right predecessors. Indeed, many on the left have moved to the center not so much out of choice or even political tactic, but because globalized capitalism seems to leave them little alternative. Left programs can no longer deliver, absent a radical change in the rules of the global market economy.

The question, then, is whether they will muster the will and the strategy to change those ground rules, to reclaim space for national policy. Europe offers an alternative social model, but unless Europeans act in concert to challenge constraints of the global market, they do not have a viable economic model.

Intuitively, the recipe commended by neoliberals seems attractive: let markets set prices; let free trade and free movements of global capital work their efficient magic. If voters don't like the social consequences, use the state to temper the extremes and give the displaced new opportunities and skills. But this view is naive. Tempering the excesses of the market requires public outlays and regulations. Yet if the world is one big free market, capital tends to avoid nations that impose burdens on it. Moreover, as the founders of the postwar financial system at Bretton Woods grasped, leaving currency values and capital movements to financial speculators leads to competitive devaluations and deflation.

The collapse of the Bretton Woods system of managed exchange rates, in 1971-1973, ushered in a period of slow growth. Fran├žois Mitterrand learned painfully, as the first Socialist president of France during the early 1980s, that a nation which tries to grow faster than its neighbors is rewarded with a run on its currency. Since then, the market has only grown more powerful and the policy levers of nation-states more stunted. Even in a nation with fiscal discipline, tough regulatory strictures or generous social benefits and the taxes required to pay for them will frighten away investors.

As a result, most center-left governments are mainly reduced to accepting the discipline of the global market and tinkering around the edges. Their first priority is to reassure capital markets. In the United States, the Clinton administration is enjoying the effects of a modest and uneven boom based on very orthodox fiscal policy aimed at winning the confidence of the Federal Reserve and Wall Street. New social programs are off the table. Existing social programs such as Medicare and Social Security are in retrenchment.

In Britain, the highly popular Tony Blair is consciously emulating Clinton. Most of the energy in Blair's first year has gone toward modernizing Britain's institutions of government. Fiscal and monetary policy are entirely orthodox; indeed, Blair went the Tories one better by granting policy autonomy to the Bank of England. Privatization is accelerating, including even plans to partially privatize the London Underground. While Blair is modestly increasing social spending, he is selling off public assets in order to find money to spend on public investments that he can't finance with taxation or public borrowing.



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On the continent, where unemployment remains stuck around 12 percent, most left-of-center governments are placing their bets on conservative fiscal policies combined with heroic measures to improve education and training. They hope to partially deregulate labor markets and reform taxes that discourage job creation so that industry will take on more workers. Gerhard Schroeder, the SPD candidate for chancellor, speaks almost obsessively about the importance of education -- this in a country noted for high-quality schooling.

Everywhere, deficit reduction and relatively slow growth are the order of the day. In the United States, the slow growth takes the form of wage stagnation for the bottom half of the workforce. In Europe, where a variety of regulatory and redistributive policies still militate against U.S.-style inequality, the slow growth takes the form of high unemployment. The prevailing, feeble form of social democracy is not likely to change this economic trajectory very much. And if tinkering is their only contribution, the current spate of moderately left governments will likely be repudiated by the voters.

Is there no alternative? Is policy essentially dead?

There is certainly nothing wrong with "supply-side" policies aimed at improving the quality and productivity of the workforce. All Western nations can benefit from better-educated workers, lifetime learning policies, and other measures to make the labor market work better. It would also be smart to reduce payroll charges, which are now more than 20 percent in the United States and more than 60 percent in some parts of Europe. But these policies have their limits.

For example, the French Socialists under Lionel Jospin and the German SPD are promoting measures like a 35-hour workweek. Yet as European employers emulate their American counterparts and turn to temps and outsourcing, the assumption that the state can legislate a "normal" workweek is unrealistic. With slow overall growth, mandating a 35-hour week with 40 hours of pay will produce inflation. But a mandatory cut in both hours and pay will produce moonlighting, and defeat the whole purpose. Shorter working time is the fruit of higher growth, not the engine.

Labor market policies by themselves do not add up to higher growth rates. They can work as complements to a more expansionary macroeconomic policy, not as substitutes. The Swedish Keynesians figured this out more than four decades ago. You run as hot a macroeconomic policy as you dare without triggering inflation, complementing it with active labor market policies to match well-trained workers with employers. When unemployment gets down to a level that runs the risk of wage inflation, you enlist the unions in voluntary wage restraint, and soak up the remaining joblessness with retraining sabbaticals and public employment.

But Swedish Keynesianism doesn't work very well anymore. The culprit is the global economy. Global growth is held hostage to creditors and financial speculators. And countries with good wages and expensive social outlays find themselves priced out of the market.

There is, I think, an alternative to simply accepting a downward convergence of wages and benefits as an inevitable price to be paid for the "efficiency" of the global market. But this alternative will require a fundamental shift in how center-left governments view global capital. For the most part, American liberals and European social democrats have not challenged the neoliberal view that all prices are efficiently set by markets. Yet there is a surprisingly strong dissent being heard from mainstream economists who hold that there is one major exception to this rule -- the price of currencies and the flow of global capital.

In the May-June issue of Foreign Affairs, Jagdish Bhagwati, former chief economic advisor to the General Agreement on Tariffs and Trade and one of the most eminent and passionate of free trade economists, has a startling article contrasting trade in goods with trade in capital and currencies. "Only an untutored economist will argue," Bhagwati writes, "that free trade in widgets and life insurance policies is the same as free capital mobility." The reason is simple. Trade in ordinary goods and services tends to reach equilibrium. But global capital markets often tend to overshoot, pricing currencies wrong, pouring capital in and yanking it out, doing serious damage to the real economy.

A good case in point is the Asia crisis. Foreign capital seeking supernormal returns abruptly swamped these newly liberalized capital markets. When overbuilding ensued and returns began sagging, the capital rushed out, devastating the currencies and economies. Bhagwati writes, "When a crisis hits, the downside of free capital mobility arises. To ensure that capital returns, the country must do everything it can to restore the confidence of those who have taken the money out. This typically means raising interest rates. . . ." But higher interest rates only deepen local recession. Investors are "reassured" at a devastating cost to the real economy.

The International Monetary Fund, which comes in to "restore confidence" (and supervise a fire sale) often serves as a handy scapegoat. But the deeper problem is the neoliberal regime and its encouragement of short-term speculative capital flows to fragile economies in the first place. And those same speculative capital movements constrain the policy options of advanced economies.

Systemically, the effect of free capital mobility is not just periodic crises but a deflationary bias for the system as a whole, as nations competitively manipulate interest rates and exchange rates to reassure investors. In a downturn, this can take the form of competitive devaluations, as in Europe in the 1930s and Asia in the late 1990s. In an inflationary period, it can take the form of high real interest rates, as in Europe and America in the 1980s. The common effect is needless instability, creditor hegemony, slow growth, and pressure on nations to jettison high wages and decent social benefits.

Bhagwati's basic critique is shared by such mainstream economists as Jeffrey Sachs, Barry Eichengreen, and Joseph Stiglitz, now the chief economist of the World Bank. Paul Volcker has also called for a new Bretton Woods. And in a sense the critique is also tacitly shared by Robert Rubin and Alan Greenspan. For although global capital flows are more or less free and currency values are more or less set by market forces, governments and central bankers do recognize, if only through periodic ad hoc interventions, that the stakes are simply too high to let speculative capital and currency swings determine the fate of the real economy.

Five times in the past two decades, the United States and the other great powers have intervened in very significant ways to counteract the impulses -- and the damage -- of speculative forces in capital markets. These included the concerted intervention in late June 1998 to prevent the yen from crashing and taking the Asian economy with it; the Mexican rescues of 1983 and 1995; the Louvre Accord of 1988 to stabilize the dollar against the yen; and the Plaza Accord of 1985, which produced a period of coordinated reductions in interest rates.

Note that three of these occurred under the Reagan administration, which elsewhere was fiercely committed to free markets. Note also that the recent coordinated moves to shore up the yen were undertaken out of fear that a weakening yen would trigger a chain of devaluation throughout Asia and very serious recession -- more market irrationality. The Western powers have pressed the Chinese to continue pegging the Hong Kong dollar to the U.S. dollar and to continuing defending the Chinese yuan -- two more violations of the idea that currency values should be set by market forces.

But while Western governments are willing to engage in ad hoc interventions to contain crises, they are uneasy about returning to a more regulated regime for private capital flows and exchange rates. However, re-regulation of capital flows is precisely what is needed if left-of-center governments are to reclaim the capacity to pursue policies of high growth and social justice.

Casual students of U.S. history read of the centrality of the "money issue" in nineteenth-century American politics -- the fringe parties, the battles over gold, silver, and greenbacks -- and wonder whether our great-grandparents were afflicted by some kind of collective financial hysteria. In reality, the underlying issue was whether credit would be cheap or dear; whether capital markets would be run for the advantage of creditors or ordinary people; and whether periodic financial panics and depressions would be contained or seen as the inevitable side effects of progress and efficient markets. Precisely the same issues arise today globally.

By the same token, casual observers of the mid-century economy fail to appreciate the importance of the Bretton Woods system. Bretton Woods fixed exchange rates. But by committing central banks to collectively support the fixed rates, it also precluded speculative currency trades or capital movements. The latter was its more important achievement. Regulation of global capital thus created shelter in which it was possible for national governments to build high-employment, high-growth welfare states, free from the downward competitive pressure of global money markets. This is why liberals such as the New York Times's Thomas Friedman, who call for both totally free global markets and offsetting social outlays, have it wrong. Completely free global capital movements constrain both the economics and the politics of a social market economy.

The advent of the euro will likely move the world's financial system partway back toward Bretton Woods. It is probable that the relative values of the three major currencies -- the dollar, yen, and euro -- will be coordinated by their respective governments and central banks. The run-up to the euro has already resulted in lower interest rates and an associated economic boost for many of the European nations with historically weak currencies, such as Italy.

The bigger question is whether the concert of center-left governments will take the next step and pursue systematic strategies to limit speculative global capital flows. For example, Professor James Tobin's proposed tax on financial transactions, long ridiculed by free market economists, is getting a respectful second hearing, as analysts look for ways to stabilize private global money markets. Another good idea was devised by Chile, certainly no enemy of free markets. The Chileans require any foreign investor to place 30 percent of the amount of the investment on deposit with the Chilean central bank for a year, as insurance against capital flight. Such measures move the world back toward regulated capital markets. Removing currency values and capital movements from purely speculative swings and resulting recessions such as the current Asia panic would allow both higher growth and more managed national economies.

It would be salutary for the world's left-of-center governments to take this question seriously -- both to create more domestic room for policy and to allow the world a higher rate of growth. It would also be an ideological tonic to revisit the question, now a global one, of when and how market forces need to be tempered for the greater good of the economy and the society. This, after all, was the issue on which American progressives and European social democrats began. Either the irrationality of global capital flows will be tempered once again by democratically elected governments, or those governments will continue to be enfeebled by the world's money markets.




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