Why Globalization Works
by
Martin Wolf

Part I: Globalization of Market Systems

Page Contents

Define Economic Globalization

Capitalist Economic Markets

Government Economic Policy

International Trade

FUTURECASTS online magazine
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Vol. 6, No. 11, 11/1/04.

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Introduction to Parts I and II

Globalization and its critics:

 

&

  The vast benefits of globalization, and the deplorable ignorance of most of the critics of international trade, are set forth by Martin Wolf plainly and in detail in "Why Globalization Works." This book is required reading for anyone with a serious interest in globalization. Wolf fills it with detailed facts and cogent analysis, only a small fraction of which can be referred to in this overly long book review.
 &

  In this book, Wolf explains:

  "[What] a market economy is, why it has a close and supportive relationship with democracy, why and how it raises living  standards, in what ways it depends on support from the state, how the market moves naturally and beneficially across frontiers and, not least, how such a global market economy brings both great benefits and challenges for global political relations."

  There is much, of course, that Wolf does not cover in any depth - even in this wide-ranging book. For example, domestic social and political institutions will determine the extent of the benefits derived from liberal transformation of domestic and international trade. Inequality - especially unequal access to the factors of opportunity - factors like education and property rights and credit - determine not only the distribution of those benefits, but also the extent of a nation's benefits. The extent of legal, political and economic empowerment of civil society is another obvious factor.
 &
  However, even initial - very tentative and partial efforts at liberal economic transformation produce a cornucopia of benefits. China's recent history provides ample proof of the vast and immediate benefits that flow from any meaningful effort to initiate liberal economic transformation reforms, as long as basic infrastructure and political institutions are in place. Trade liberalization materially adds to those benefits - as long as basic infrastructure and political institutions are in place.
 &
  It should also be noted that Wolf uses the term "liberal" in its traditional 19th century sense - and that is the way it is used in this book review.

Free trade may not by itself be sufficient, but it is still necessary.

  The benefits of globalization - so clearly explained by David Ricardo two centuries ago - are as plain as the economic advantages of the U.S. federal union over the previous confederation of sovereign states - or the economic advantages of the European Union over the divided Europe of the first half of the 20th century. The collapse of the Soviet Union and all other attempts to administer non-market economies leaves systems of market capitalism as the only feasible economic systems, and it is axiomatic that the broader the market, the better the system.
 &
  Wolf readily acknowledges that trade liberalization is just one of many general policies needed to stimulate economic growth. Good governance, sound money and budgetary practices, infrastructure development, education, financial and legal institutions, and much more that he refers to but does not go into in detail in this book, are also necessary. However, that does not diminish the need for free trade. Free trade may not by itself be sufficient, but it is still necessary.
 &

Utopians have been "liberated" from socialist dogmas "to dream, no longer constrained by anything happening in the world."

  Nevertheless, opponents of "liberal capitalism" have proliferated. They make their voices heard and their influence felt. Among them are utopians who have been "liberated" from socialist dogmas "to dream, no longer constrained by anything happening in the world." More weighty are the many vested economic interests seeking shelter from import competition. These include trades unions, farm lobbies and industrial lobbies - particularly the steel and textile industries - "determined to protect their vulnerable economic positions" at the expense of the public interest as a whole. See, Wolf, "Why Globalization Works," Part II, "Criticism of Market System Globalization."

Defining Economic Globalization

The process of "globalization:"

  "Globalization," Wolf points out, is not an ideology - although opponents seek to present it as such. It is "a name for the process of integration, across frontiers, of liberalizing market economies at a time of rapidly falling costs of transportation and communications."
 &

  Wolf wisely avoids the trap of lumping economic globalization in with other broad categories of globalization. He thus avoids unmanageable breadth of subject. Although there are always natural connections and obvious dependencies between the three, social and political aspects of globalization are very different processes that Wolf leaves largely beyond the scope of this book. He accepts the view of the primacy of economic processes as "the driving force for almost everything else."

  Wolf here falls for an old fallacy most prominently adopted by Marxists. If it were true, then the opponents of globalization could be ignored. In fact, there are obvious mutual impacts. Economic processes are dependent on political processes that either facilitate or burden commerce, and both are broadly dependent on the cultural processes that support or suppress civil society. Even though economics may be the most prominent of the three, this multi-cornered chicken and egg problem is not that easy to unravel. It has recently been most prominently on display in Russia and other transformation economies.

Globalization is a process - a "movement in the direction of greater integration, as both natural and manmade barriers to international economic exchange continue to fall."

  Several cogent attempts at defining economic globalization are set forth by Wolf. He concludes that it is a process - a "movement in the direction of greater integration, as both natural and manmade barriers to international economic exchange continue to fall." As a consequence, economic changes in one part of the world have an increasing impact elsewhere.
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  Wolf cites Brink Lindsay, "Against the Dead Hand," where it is noted that globalization involves (1) the spread of market-oriented economic policies that (2) encourage the reduction of government-imposed barriers to international flows of goods, services, and capital, that (3) increasingly integrate markets across political boundaries.
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"If we want a better world, we need not a different economics, but better politics."

 

"The policies and capacities of states remain central to any understanding of how economic globalization works."

  Market driven globalization is far from perfect in practice or utopian in theory, Wolf readily concedes. Like democracy, despite its many flaws, it is merely by far the best practical alternative. As such, again like democracy, it is not that difficult to come up with valid complaints about various aspects of its actual operations. Wolf candidly deals with these.
 &
  However, he notes that the primary obstacles to improvement are political.

  "It is the deep-seated differences in the institutional quality of states that determine the persistence of inequality among individuals across the globe. The big challenge - - -  is to reconcile a world divided into states of hugely unequal capacities with exploitation of the opportunities for convergence offered by international economic integration. In short, if we want a better world, we need not a different economics, but better politics."

  There are natural limits to economic integration. The costs of transportation and communication continue to decline, but except for things that can be dematerialized - essentially, information - they will never come close to zero. There also will remain cultural obstacles to mobility. The vast majority of people will continue to work and go to school within a relatively modest radius of where they live, and they will strongly prefer to live in the culture with which they are familiar. This would remain true, Wolf asserts, even if all "policy barriers to movement" were removed.
 &
  Thus, distance - and states - will always matter. "Indeed, the policies and capacities of states remain central to any understanding of how economic globalization works."

Capitalist Market Systems

Freedom, property rights, & rule of law:

  The history and logical connections between individual freedom, property rights and rule of law are reviewed by Wolf.
 &

Only long term investments build prosperity, and these require reasonable safety and a web of abstract paper claims - all dependent on law.

 

Capitalism is freedom under laws that facilitate commerce.

 

A civil society of free individuals must be legally, economically and politically empowered by the rule of law established by government.

  A free society is an uncomfortable place for established hierarchies of power or opinion. Those who value "the unchanging and the traditional" experience insecurity in free societies.

  "Liberalism means perpetual and unsettling change. Most of its enemies have, at bottom, hated it for that reason."

  However, individual freedom is not anarchy. Indeed, they are polar opposites, since liberty is impossible under conditions of anarchy. The individual can be truly free only in a system of appropriate laws. He can build a prosperous life only if he can have confidence in his long-term rights and commercial arrangements. Markets - such as the Middle Eastern bazaars - are not enough. Only long term investments build prosperity, and these require reasonable safety and a web of abstract paper claims - all dependent on law.
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  Indeed, capitalism is dependent on ethical behavior. It requires "a high level of trust" not only in private commercial relationships, but also in the political authorities. There must be confidence that the fruits of enterprise will not be seized by government or private predators. Capitalism is freedom under laws that facilitate commerce.
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  Thus, individuals need protection from government - but are dependent on protection by government. A civil society of free individuals must be legally, economically and politically empowered by the rule of law established by government.
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Regulatory competition:

  But why should governments facilitate private commerce?  Why should they accord their subjects the individual liberty and protection of private property rights required for prosperity?
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Monopolistic governments have historically been anything but beneficent. It is only the pressure of competition that induces governments to facilitate private commerce and empower their civil societies economically, legally and politically.

  Competition between political entities provides one answer. For a variety of geographic and cultural reasons, Europe was politically fragmented among competing - often warring - political entities. Competition proved as beneficial a disciplinary force for governments and religions in Europe as for modern business entities. They needed the support of their peoples and the resources that could be provided by a flourishing commerce. Where such competition didn't exist - in China, India, Egypt, and other once advanced civilizations - monopolistic governments abused their powers and their peoples languished.
 &
  Today, globalization is criticized for undermining the beneficent plans of governments by threatening flight of productive capital and peoples. However, monopolistic governments have historically been anything but beneficent. It is only the pressure of competition that induces governments to facilitate private commerce and empower their civil societies economically, legally and politically.

  Today, third world governments that draw their revenues from oil or other mineral wealth are generally not dependent for their revenues on the commercial prosperity of their peoples. Such governments thus frequently don't give a damn for the prosperity of their peoples, and leave their peoples to languish in poverty. Great mineral wealth can be a curse for third world peoples.

The existence of property rights secure from both private and political seizure is essential for the establishment of securely democratic societies.

 

While not all market economies are in democracies, all democratic states permit the economic freedom of market economies.

 

"The market underpins democracy, just as democracy should normally strengthen the market."

  Constitutional democracy - political freedom under rule of law - provides a second answer. A benevolent despotism may be replaced by a despotism that is not so benevolent. To assure that government powers are suitably constrained, the various institutions of constitutional democracy and rule of law were developed in Western Europe and spread slowly about the world.
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  Wolf traces the course of these developments. He remains skeptical as to whether China and similar autocratic capitalist states will remain sufficiently committed to their beneficent reforms to indefinitely assure the prosperity of their peoples. He briefly notes some of the difficulties that threaten the existence of democracies and the factors that provide them with the strength to endure.
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  Securely democratic societies are the only ones where enforceable contract and property rights are secure against political influence - and where broad levels of economic prosperity are possible. In turn, the existence of property rights secure from both private and political seizure is essential for the establishment of securely democratic societies. (See, Hayek, "The Road to Serfdom")
 &
  As for autocratic capitalist states like China and Singapore, Wolf notes that such states tend to eventually become democratic. While not all market economies are in democracies, all democratic states permit the economic freedom of market economies.

  "Social democrats too often ignore this intimate link between economic liberalism and political democracy, between the values of the merchant and those of the citizen. The market underpins democracy, just as democracy should normally strengthen the market."

  Demagoguery is an inherent threat to market systems in democracies, as political parties compete to offer benefits from the public treasury. See, Heedless Government. Corruption is the primary threat in autocratic market systems. Although both demagoguery and corruption can be found in all systems, there are meaningful differences in degree.

  Moreover, only market economies broadly provide prosperity and economic growth and the broad contentment that support liberal democracy. Economic growth produces an educated middle class society from which an economically, politically and legally empowered civil society emerges to provide the essential support for both political and economic freedom - for both democracy and capitalism. The zero growth systems advocated by some environmentalists would inevitably turn autocratic as factions fought for benefits at the expense of other factions.
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  A substantial level of morality provides a third answer. "Values matter," Wolf affirms.
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  Judges, the police and the military must submit to civilian control. Good pay is an essential precondition for an honest government "service" sector. So is "a government made legitimate by popular consent." However, a high level of public morality is also required. There must be a "guardian culture" that serves the state.
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  Honesty in dealings must be the commercial norm. The essence of successful merchant societies has always been "voluntary agreement, honesty in dealings, openness to strangers, respect for contracts, innovation, enterprize, efficiency, promotion of comfort and convenience, acceptance of dissent, investment for productive purposes, industry, thrift and optimism."  The commercial culture must serve the market.
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  Both guardians and merchants are essential - and "each is suspicious of the other." This creates a permanent tension that has proven useful in damping the excesses of the other. It is a complex, tacit association that is unfortunately not easy to develop or promote in developing nations.
 &
  Wolf summarizes the characteristics of advanced liberal democracies:

  "They are constitutional democracies, subject to the rule of law; they respect private property and the ability to make contracts; they protect freedom of speech and inquiry; they recognize fundamental human rights; they have elected governments; and they have independent and honest judiciaries, rational bureaucracies and armies subject to civilian control."

Liberal democracy and market capitalism:

  The most fundamental role of governments in free societies is to protect the liberties of their citizens. However, increasingly, they have taken on a redistributionist function. Their revenues as a percent of GDP have increased in the 20th century - from about 10% at the beginning of the century to about 40% and sometimes as high as 50%.
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Capitalism is not dependent on territory - as small states such as Singapore and Denmark and Hong Kong prove so decisively.

 

Wealth based on industry is a "positive-sum game"

 

Even when unilateral, free trade policies "promote prosperity and peaceful relations with other countries." There is, in fact, a direct correlation - both current and historic - between open markets and prosperity.

  However, the great failed - often bloody - 20th century experiments with state socialism proved that "liberal democracy is the only political and economic system capable of generating sustained prosperity and political stability."

  Wolf here assumes facts not yet in evidence. States as different as vast China and tiny Singapore are currently intent on proving the viability and perhaps even the superiority of autocratic capitalist systems. That is the test for the 21st century.

  Liberal democracy also promotes peaceful international relations. Capitalism is not dependent on territory - as small states such as Singapore and Denmark and Hong Kong prove so decisively. Liberal democracies are more reliable treaty participants. Their treaties become a part of their laws and are internally enforceable. Their citizens increasingly associate across boundaries for civic as well as commercial purposes.
 &
  Although it took two centuries and several bloody wars to get the message across, Adam Smith was precisely correct in his criticism of mercantilist practices. The prosperity of a nation depends on the combination of internal development and international exchange. The broader the market for trade, the better. Conflicts and wars are bad for trade.

  "Mercantilism - the view that the aim of trade is the accumulation of treasure - was worse than bad economics. It was also lethal politics, because it led to conflict where conflict was unjustified. The rapid growth generated by industrialization should have helped instill Smith's lesson quickly. Unfortunately, it took two centuries."

  Nationalist and collectivist systems seek advantage through protectionism and imperialism. Such systems - involving trading blocs that seek advantages by discriminating against outsiders - are "self-fulfilling prophecies - they create the dog-eat-dog world their proponents believe justifies them."
 &
  Wealth based on land may be a "zero-sum game," but wealth based on industry is a "positive-sum game" - a reality obscured for two centuries by mercantilist and Marxist myths.
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  "Trade is far cheaper than empire, just as internal development is a less costly route to prosperity than plunder." Even when unilateral, free trade policies "promote prosperity and peaceful relations with other countries." There is, in fact, a direct correlation - both current and historic - between open markets and prosperity.
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Mercantilist policies benefit the politically influential at the expense of the nation as a whole.

 

The task ahead is, instead, not to halt global economic integration, but to make it work for more people than ever before."

  Unfortunately, special interests may profit from actions that impoverish the rest of the nation. Ruling classes may benefit from plunder and wars that impoverish the peoples of both the defeated and the victorious nation. Mercantilist policies benefit the politically influential at the expense of the nation as a whole.
 &
  The spread of democracy is inherently tenuous. Democracy is not expected to provide perfect or utopian governance, but new democracies have many fundamental flaws. They may lack rule-of-law or protection of minority rights. Nevertheless, the spread of democracy has been astounding. More than half the people in the world today enjoy some version of democracy.
 &
  This is what is at stake in the dispute over globalization.

  "If [its opponents] succeed in halting the movement towards international integration, much of this progress is likely to be lost, as prosperity falls, a corrupting web of controls on economic transactions grows, resentments over barriers to commerce increase and international ill will expands. The task ahead is, instead, not to halt global economic integration, but to make it work for more people than ever before."

Market systems:

  The history and essential characteristics of market systems is provided by the author. Wolf covers the basics, only a few of which are included in this review.
 &

  Four important aspects of modern market systems are highlighted: the limited liability corporation; innovation and growth; intellectual property; and the financing mechanisms - all functioning under laws designed to facilitate commerce. These are essential characteristics of the modern market economy without which it could not function. Yet, all four are under attack by the critics of globalization.
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  The industrial revolution was to a large extent a product of market economics. Industrial progress - a "Promethean revolution" involving the harnessing of fossil fuels - arose as a result of "a new way of organizing economic activities of society as a whole - a sophisticated market economy with secure property rights."

  "Unshackled from the constraints of tradition and driven by hope of gain, economic actors were tied by competition to the wheel of what the great Austrian economist Joseph Schumpeter called 'creative destruction.' - - - Within a market economy the hope of gain and the fear of loss drive inventors and innovators to apply new ways of doing things or to produce new products."

  Profit-seeking business people exploit and drive the economic transformation processes of market systems.

  "The market economy is, as a result, the only human institution that generates 'permanent revolution.'"

  The result in market economy nations was massive improvements in living standards and health at all levels of society. By the 21st century, all but the most dysfunctional states had received considerable benefits from the technological advances in the advanced market systems, but market systems had prospered far more than non-market systems.
 &

A sophisticated array of legal rules and government regulation and customary commercial practice have slowly evolved to facilitate market commerce. These rules of the game are essential to a properly functioning market.

 

Modern capitalism requires a high degree of ethics so that such functions as borrowing, lending and insuring can be carried out in confidence.

  The "magic of the market" delivers a cornucopia of economic benefits without anybody being in charge. "Self-interest, coordinated through the markets, motivates people to invent, produce and sell a vast array of goods, services and assets," just as Adam Smith pointed out.
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  However, markets are not anarchic. The analogy to a "jungle" is clearly false. A sophisticated array of legal rules and government regulation and customary commercial practice have slowly evolved to facilitate market commerce. These rules of the game are essential to a properly functioning market.
 &
  "The result today, in advanced economies, is a system of extraordinary complexity and efficiency."   "Externalities" - benefits and burdens created by commercial arrangements but ungoverned by market processes - are an increasingly recognized problem addressed by laws and regulations.
 &
  Markets arise naturally. Legitimate, gray or black, they are a hardy weed. However, they do not create modern prosperity unless transactions that take a long time are facilitated. Transactions that are not self-enforcing like an immediate purchase - that require trust and confidence - require more than a local bazaar. Modern capitalism requires a high degree of ethics so that such functions as borrowing, lending and insuring can be carried out in confidence.

  "In many developing countries, these longer-term or complex transactions are limited to dealings with family or close friends, where misbehavior carries credible sanctions."

  Wolf notes five problems that a market system must solve to work well.

  1. "Information must flow smoothly, giving people confidence in what they are buying;
  2. it must be reasonable to assume people will live up to their promises, even if these promises are to be executed decades into the future;
  3. competition must be fostered;
  4. property rights must be protected; and,
  5. the worst side effects on third parties must be curtailed."

"High levels of personal probity and honest dealing" are essential for efficient and effective markets.

  It is trust in commercial arrangements with strangers that elevates the modern capitalist society over the bazaar economy. A wide array of laws, regulations and commercial practices have been developed to assure the reliability of commercial arrangements, but "high levels of personal probity and honest dealing" are essential for efficient and effective markets.
 &
  Nevertheless, there are inevitably great incentives for abuse of trust.
Conflicts of personal interests and institutional interests are pervasive. Managers and other agents are under constant temptation to place their personal interests ahead of their broader obligations. This is the "principal-agent" problem. This is the abiding problem of "the vulnerability of the corporation to managerial incompetence, self-seeking, deceit or malfeasance." 

  For this reason, Adam Smith thought that the corporate structure - although useful for marshalling large amounts of capital - could not be trusted to perform anything more than the most routine functions in such fields as banking and finance.

  Market discipline is a powerful factor in enforcing proper conduct.

  The vast majority of economic transactions and relationships require repetitive activities - which will be impossible for parties that abuse trust. Other than the simplest transactions of the bazaar, nobody will do business with untrustworthy people. Notoriously untrustworthy are single transaction activities such as used car sales, roadside repairs, work offered by "fly-by-night" contractors, etc.

  The right to fail is a powerful cleansing mechanism for elimination of the untrustworthy and the incompetent. Government bailouts of failing companies short-circuit that mechanism.
 &
  Supplementing market disciplines for public corporations are internal accounting and managerial checks, stock exchange and government regulations, reporting requirements that enhance transparency, and a moral culture that supports "honest dealing."

  With each turn of the business cycle, the market sheds not only outmoded and incompetent organizations, but also the fraudulent houses-of-cards inevitably created during prosperous times. People are always shocked when these are revealed. Such fraud is unexpected because it is actually so rare. From the thousands of public corporations, perhaps a handful are revealed to have been fraudulently managed at any given time.
 &
  Far more serious, widespread and difficult to remedy is the lack of competence of top management. As with any large organization, internal politics are involved in getting ahead in corporations - and the best politicians are frequently not the best managers. Thus, there is the constant churning of the market, as corporations rise and fall with changes in the skill levels and dedication of their management. One of the most stupid and demonstrably false left wing propaganda myths is the notion that major corporations control the market instead of being controlled by the market.

  Without trustworthy conduct, "costs of supervision and control become exorbitant. At the limit, a range of transactions and long-term relationships becomes impossible and society remains impoverished." This applies not just to corporations, but broadly throughout the market system.

  Capitalism is the most inherently ethical of economic systems. It can't exist without high levels of trust.

  Innovation is also driven by market discipline. Innovation competition even more than price competition drives the market, and producers must compete or die. Fear of failure even more than hope of profit drives constant striving for innovation. That is an inherent feature of competitive market systems. It is "hard-wired" into competitive capitalism.
 &
  Intellectual property rights are uniquely dependent on government protections. Patents, copyrights, and trademarks are essential, but can easily go too far. Inherently, they also amount to government restraints of trade. Powerful vested interests seem to have pushed these protections too far in the U.S. at present. It is a delicate balancing act to support incentives for innovation without unduly inhibiting competition. (There ought to be a special Mickey Mouse copyright statute, so not all copyrights have to be overextended to protect Mickey.)
 &

There is a direct relationship between the sophistication of financing systems and the prosperity of nations.

  Financial intermediation is the "bloodstream" of modern markets. There is a direct relationship between the sophistication of financing systems and the prosperity of nations. Financial systems mobilize savings, allocate capital, monitor managers, and transfer risk to those willing to bear it.
 &
  Financial mechanisms can be notoriously unstable
and subject to abuse. Limitations on transparency make it difficult to evaluate performance. Operations inherently involve a variety of risks that periodically become manifest. Assets of banks are long term while liabilities are short term. Valuations are subject to wild swings. Financial market participants with incomplete information are prone to "herd behaviour." Financial markets are periodically subject to "self-fulfilling expectations" that increase instability.
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  "Financial markets are fragile because of the inherent challenge of orienting economic activity to an unknowable future." They are thus inherently imperfect, but absolutely essential.
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  Perfect competition and full information are illusions - not only beyond human capacity but also counterproductive in certain instances. (Fortunately, perfection in these virtues is not essential. A cornucopia of benefits flow from even imperfect competition and any substantial level of transparency.)

  "The modern corporation, perpetual innovation, intellectual property and sophisticated financial markets imply a substantial degree of monopoly and instability. But they also are what make the modern market economy astoundingly successful."

Criticism of market-directed capitalism:

  Challenges based on inequality, power and morality are quickly dispatched by Wolf.
 &

  Capitalist wealth does provide unequal power and wealth and is permeated with conflicting interests. However, this is far less so than for political position in pre-capitalist and modern non-market collectivist alternatives. No corporate plutocrat has as much power as the political leaders of pre-capitalist and non-market collectivist systems.
 &
  Only capitalism encourages people to build their own lives, supports the existence and facilitates the efforts of its own opponents, and induces moral standards on which essential levels of trust depend. "Trustworthiness, reliability, effort, civility, self-reliance and self-restraint" are values that are reinforced and rewarded in competitive market systems.

  Marx would be forced to argue stupidly that the values of such virtues were non-existent - "imaginary" - an "illusion" - since communism clearly could not reinforce or reward them, and his propaganda myth could not account for them. See six Economic Basics articles on Marx beginning with Karl Marx, "Capital (Das Kapital)" (vol. 1)(I).

Prosperous peoples in capitalist systems routinely engage in a vast array of civic activities and build the civil society that supports both democracy and capitalism itself.

  Even the much-maligned self-interestedness of capitalism is mitigated by the prosperity generated by capitalism. Impoverished peoples in non-capitalist states are perforce totally involved in their self-interested efforts of survival. Prosperous peoples in capitalist systems routinely engage in a vast array of civic activities and build the civil society that supports both democracy and capitalism itself. They also engage in a variety of noble causes - and in opposition to the economic system that makes it possible to engage in noble causes.

  Wolf asserts that only market economies provide sufficient wealth to support welfare states. This is true only as a matter of degree. Autocratic systems have been providing "bread and circuses" levels of welfare for millennia. Communist China had its "iron rice bowl." Only market systems provide both welfare and freedom - freedom, as Wolf notes, to even engage in opposition to the system that provides the benefits.

It was the supposedly benevolent state-socialist economies that created the worst environmental catastrophes.

 

Capitalist market systems provide the essential basis for political and individual freedom - encourage a wide array of moral virtues - and provide the wherewithal for a vibrant civil society active in cultural and moral activities.

  Even environmental criticism misses the mark. It was the supposedly benevolent state-socialist economies that created the worst environmental catastrophes.

  "The market economy has avoided these disasters for at least four reasons: first, it provides the means for independent critics of environmental abuses to flourish; second, it generates the prosperity that makes people concerned about the environment; third, it implies a separation between companies and the government that makes independent regulation possible; and, finally, companies are concerned about their reputations and will act to protect them."

  Capitalist market systems cannot provide utopian results, Wolf readily concedes. They are as inherently imperfect as the human beings active within them. They are simply by a considerable margin the best economic systems available. They provide the essential basis for political and individual freedom - encourage a wide array of moral virtues - and provide the wherewithal for a vibrant civil society active in cultural and moral activities.

  "Those who condemn the immorality of liberal capitalism do so in comparison with a society of saints that has never existed - and never will."

Government Economic Policy

Government facilitation of commerce:

  The stupidity of central planning - so popular in many intellectual circles just a few decades ago - is easily and irrefutably established by Wolf. (See, "Government Futurecast," Part II.) Faith in central planning - ("industrial policy" and socialist alternatives) - was, as Hayek stated, the "fatal conceit." (See, "Modern Advocacy Scholars" for some amazing examples of such "fatal conceit.")
 &

  Idealized concepts of local systems are equally stupid. The proponents ignore the limitations of such systems, their hardships, and their tendency to be dominated by oppressive social hierarchies.
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  That leaves market systems as the only alternatives.
 &

  However, governments have essential roles to play in capitalist market systems. Wolf demonstrates the importance and extent of the things governments must do and can do to facilitate competitive, market directed commerce. (See, "Government Futurecast," Part I.)
 &
  Wolf divides these activities into three categories.

  • "Public goods" - goods and services that the market cannot provide for itself.
  • The internalization of externalities and remediation of market failures.
  • Welfare support for people who for a variety of reasons cannot help themselves.

The quality of legal systems is another factor for which there is an observable correlation with the economic prosperity of nations.

  "Public goods" include protection of persons and their property, and enforcement of property and commercial rights as well as a broad array of civil rights. By providing rule of law and an independent judiciary, the government can also protect people from the predatory inclinations of government. The quality of legal systems is another factor for which there is an observable correlation with the economic prosperity of nations.
 &
  Public goods also include:

  • a reliable monetary unit - something governments have repeatedly failed to provide;
  • infrastructure and basic research;
  • education and - increasingly - health services;
  • competition and reporting policies and other aspects of market regulation;
  • regulation of public utilities and other monopolies;
  • appropriate regulation of financial markets and the other elements of the financing mechanism; (These are an inherent part of a modern monetary system, and thus are clearly a government responsibility.)
  • enforcement of health and safety standards for products and processes;
  • minimum wage and anti-discrimination requirements; and,
  • government itself - and the systems of taxation that support it.

  Internalization of externalities means preservation of the environmental commons.

  Even in the early days of capitalism - in the 19th century - there was never an overall "laissez faire" policy in market economies. There have just been practical choices as to whether or not - and how much - government should intervene in particular cases. See, "The 'Laissez Faire' Straw Man" in "Future Economic Myths."

    As the author points out, the roles of government are pervasive. However, such government activities - although far superior in advanced nations than in undeveloped nations - are attended by a multitude of weaknesses, inefficiency and often outright failure. For improving policy making in these areas, Wolf offers some suggestions concerning credibility - predictability - transparency and consistency - establishing precise objectives - working with market incentives - and establishing practical objectives that recognize the limitations of government instead of chasing ideal but unobtainable objectives.
 &

Inherent weaknesses of government management:

 

 

&

  "The mechanism of the state is at least as defective as that of the market," Wolf points out. Indeed, historically, "it has been far more so."

  "Often the most important violator of the conditions needed for markets to generate prosperity is government itself. It does not offer a remedy for market failures, but is a source of greater failures itself. This is not an accident. It is inherent in any political process, but it is truest, inevitably, in the poor countries that most need better government."

Modern governments have become hugely complex, largely opaque, subject to a wide array of conflicting narrow interests, hobbled by bureaucratic and political imperatives, to mention just a few of the obstacles to effective government.

  Today's advanced nations have "the most sophisticated, responsive and law abiding" governments in the history of the world. Nevertheless, they are hugely complex, largely opaque, subject to a wide array of conflicting narrow interests, hobbled by bureaucratic and political imperatives, to mention just a few of the obstacles to effective government.

  "[Policy] is made in a hugger-mugger of special-interest lobbies, self proclaimed 'public interest' groups, journalists, assorted experts, bureaucrats, politicians, particularly more influential ones, and anybody else with a big enough axe to grind."

  The results can be horrendous - and almost impossible to remedy. Agricultural policy and much trade policy, environmental policy, energy policy and labour market policy in many advanced nations contain such horror stories.

  "Government is essential. Of that there is no doubt. But to rely on it to do a sensible job of remedying so-called market failures when it busily introduces so many failures of its own is absurd."

  Yet, there have been clear improvements. Historically, it was much worse - and outside the advanced nations, it is much worse.

  "The notion that one can rely on governments, particularly in the developing world, to make an honest and disinterested effort to protect property, provide other public and merit goods and so raise national economic welfare, is mostly laughable. In the 1990s, at last, even the World Bank admitted the seriousness of bad government as a constraint on development."

  The author goes into some detail on the corruption and financial and management failure experienced by third world governments in recent decades. "In many countries, it has been easy to find examples of negative value-added production - enterprises whose inputs were worth more than their outputs." System wide levels of corruption are especially obstructive for economic development.
 &

Special interest influence is always greater in non-market systems, since every divergence from market results opens more inducements and opportunities for corruption.

  Privatization and deregulation materially reduce opportunities for government corruption and simplify government management tasks and responsibilities. Wolf provides a cogent explanation for this phenomenon. (See, Shleifer and Vishny, "The Grabbing Hand.")
 &
  Globalization forces governments to reform
by applying the forces of regulatory competition. Capital, businesses and talent will flee - (they "vote with their feet") - against inept and corrupt government. To keep pace, such governments will be forced to compete with regulatory reform or to descend into the autarky of N. Korea and Myanmar.
 &
  Those who are illiberal - who oppose market economics - and yet deplore state-capture by special interests, including corrupt politicians, are "incoherent," Wolf points out. Special interest influence is always greater in non-market systems, since every divergence from market results opens more inducements and opportunities for corruption.

International Trade

Advantages of international trade:

  The characteristics of national markets are described by Wolf. These characteristics exist in great variety for the different nations of the world, and give international trade its unique nature, and special advantages.
 &

  Comparative advantage - the brilliant insight of David Ricardo - assures that all nations can participate in and benefit from international trade, even if there is nothing that they produce that can't be produced more efficiently elsewhere. See, Ricardo, "Principles of Political Economy and Taxation."

  "Specialization makes sense, argued Ricardo, even if one country is more efficient at everything than its trading partners. Countries should specialize at what they are relatively most efficient at doing. Countries do not compete in trade, as companies do. Rather, industries compete inside countries for the services of factors of production. Opening a country to trade moves output in the direction of activities that offer domestic factors of production the highest returns. The shrinking import-competing industry is not competing with imports from foreigners, but with what its own domestic export industry can pay."

There are no examples in the last 50 years of any nation that succeeded in economic development with substantially protectionist trade policies.

  • International trade is equivalent to an increase in productivity. The immediate productivity increase for Japan when it was opened for trade in the 19th century is estimated at about 65%, with continuous benefits thereafter.

  •  Competition is also increased by removal of barriers to trade - with all of the immense productivity gains that competition brings. As stated above, it is competition that forces the pace of innovation.

  • The best technology in the world in every sphere is available through trade. Without trade, not even the U.S. can keep pace with all the technological advances. Developing nations that restrict imports fall behind the technological pace.

  There are no examples in the last 50 years of any nation that succeeded in economic development with substantially protectionist trade policies. Nations like India have "destroyed growth and the future of two generations" by closing their markets to trade.

  • Political freedom also seems to flow with the benefits of trade. South Korea, Taiwan, and Chile all began their rapid development under autocratic governments, and all have since become "stable and vibrant democracies." Even China has had to significantly reduce its level of repression as it slowly opens its markets.

  • Capital mobility offers a multitude of benefits - including as a check on government abuse of its people. Open capital markets offer people an escape route when their governments overtly or covertly grab their savings or abuse financial systems. It also enhances the traditional advantages of mature financial systems - allocating resources, enhancing returns and spreading risks.

  The vast majority of capital flows are within or among the advanced nations. Only a tiny proportion goes to developing nations since the possible high returns remain outweighed by the risks and other disadvantages.

  • Foreign direct investment not only adds technology to domestic production, but management skills as well. These are vital for developing nations.

Although clearly beneficial, free trade and capital mobility cannot by themselves equalize global incomes.

  However, undeveloped nations suffer from a multitude of disadvantages. They make finance "expensive, small in size and, worst of all, unstable."
 &
  Thus, although clearly beneficial, free trade and capital mobility cannot by themselves equalize global incomes. Wolf notes several of the reasons why poor nations remain poor.

  • Wealthy nations can invest more in developing the skills of their people.

  • "Agglomerations of skill" increase the returns of skill.

  • Wealthy nations offer better government - government that facilitates commerce.

  • There is a brain-drain, as skilled people leave impoverished nations and head for wealthy nations where they can earn more.

  Capital, too, can flee impoverished nations in favor of higher returns at lower risk.

Governance of trade flows:

  Governance is the key to reaping the benefits of globalization. While perfection is not necessary - and never even remotely achieved - getting the pertinent governance policies substantially right is a precondition for international commerce just as it is for domestic commerce.
 &

  Policies that block imports are among the most destructive. Wolf easily dispatches arguments based on:

  • Nurturing "infant industries" - protected infant industries almost never grow up.

  • Strategic trade policy designed to extract increased benefits from foreign trade partners - is almost always abused by domestic industries so that the costs outweigh the benefits.

  It is almost always better to deal directly with problems in the domestic economy than indirectly by obstruction of trade flows.
 &
  Free trade is clearly beneficial in its own right - unilaterally - even if imports are obtained from mercantilist states and even if open market policies are not reciprocated. Hong Kong and Singapore are tiny states that have benefited greatly from unilateral liberalization of trade.
 &
  However, the benefits are magnified if other nations reciprocate and open their markets. Moreover, establishing liberal trading regimes by treaty adds reliability to commerce. Thus, liberal internationalism is well worth the effort.
 &

Poverty stricken peoples remain in hopeless poverty because their governments refuse to open their markets to international commerce, and fail to establish conditions that facilitate domestic commerce and make trade attractive.

  Mercantilist practices are based on the view of trade as conflict, with exports the benefit and imports the cost. The U.S. has always had a mercantilist mindset, Wolf notes.
 &
  However, imports provide great benefits by increasing the efficiency of the entire economy. They are especially beneficial for the exporting entities in the economy. Exporting firms are handicapped if they are restricted to dealing with inefficient domestic suppliers, and have to compete for supplies with protected import-substitution industries. Protectionist measures always benefit the politically influential at the expense of the nation as a whole. It is these politically influential parties that sustain mercantilist myths.
 &
  International trade agreements inhibit such mercantilist tendencies. Wolf reports that there are now over 1300 trade treaties, with more than 160 nations participating in at least one. The poor and weak nations benefit the most from these treaties, since the treaties constrain the conduct of stronger nations.
 &
  The problem with globalization is that there is just too little of it, Wolf points out. Poverty stricken peoples remain in hopeless poverty because their governments refuse to open their markets to international commerce, and fail to establish conditions that facilitate domestic commerce and make trade attractive.
 &

  History of globalization:

   Globalization is nothing new. The difference for modern globalization is just one of degree.
 &

  People have always been engaged in trade, intermarriage, war, conquest, plunder, and the diffusion of culture, religion, and technology. Wolf stresses the expansion of political entities to encompass broadening commercial activities, and the moments of acceleration of these trends. The industrial revolution was the most recent of these moments.
 &
  However, while the technological advance continues and long term prospects for globalization seem assured, government policy has waxed and waned bringing short run advances and retreats. Wolf offers some major examples.

  • The silk road trade routes were opened and closed during several historic periods.

  • China's maritime trade extended world-wide in the 15th century, and then was dismantled.

  • European trade was liberalized world-wide in the 19th century but waned under protectionist pressures, ending in the trade wars of the 1920s and 1930s which played a major role in the catastrophes of the Great Depression and WW-II.

  Since 1945, under U.S. leadership, globalization has been slowly making up the lost ground. (See, O'Rourke and Williamson, "Globalization and History.") It accelerated greatly after 1989 with the collapse of the Soviet Union and of socialism worldwide. Details of these trends are provided by Wolf at some length.
 &

There has been an obvious correlation between prosperity - the growth of income per person - and the growth rates of trade - both for individual nations and worldwide.

  Will globalization and prosperity continue to expand, or will the forces of protectionism again impose restraints sufficient to impoverish peoples world wide? There has been an obvious correlation between prosperity - the growth of income per person - and the growth rates of trade - both for individual nations and worldwide. Nations that do not participate in globalization - that restrain international trade  - such as Argentina, Brazil and India - have been markedly less successful and less prosperous.

  "In the post-[WW-II] period, all successful developing countries have had faster growth of trade than GDP."

  While opponents of globalization grieve over jobs lost to imports, they ignore the surprisingly large percentage of U.S. merchandise production for export markets. The U.S. manufactures more than ever. It just does it more efficiently, with fewer workers. And, U.S. trade is predominantly with other advanced nations. International financial flows, too, are predominantly between the advanced nations. Even foreign direct investment goes predominantly - by 74% - to advanced nations.

  "The problem of the world's poorest countries, it appears, is not that they are exploited by multinationals, but rather that they are ignored by them."

  Today, there are significant differences in the character of capital flows when compared to a century ago. As a result, it is labor markets that are "certainly the world's most unintegrated," and the discrepancy in rewards to labor is "the world's biggest economic distortion."
 &
  Immigration restrictions - a lack of globalization in labor markets - are the primary cause of inequality. This is something the critics of globalization ignore.
 &

  Details of the rise and fall and restoration of global trade during the last two centuries are provided by Wolf. Nineteenth century globalization was made possible by technological advances in transportation and communications. It was furthered by policies of liberal trade and sound money pegged to gold that spread from Great Britain across Europe and thus to the world. It was supported by a growing middle class that sought peaceful international relations, the economic benefits of liberal trade, and the monetary security of the gold standard.
 &
  However, Wolf points out that the state and ruling elites were becoming increasingly dependent on the loyalty of the rapidly increasing working class. The Napoleonic Wars had demonstrated the need for mobilization of mass armies. To assure the loyalty of workers and soldiers, the state provided public education to - among other things - create literacy and spread the ideology of nationalism. To give the populace a stake in their nation, the suffrage was expanded and social security - the beginning of the welfare state - was established.

  "It was no coincidence that the starting-point was in Bismarck's conservative and nationalist Germany."

  Rising real wages and costly welfare programs "made it far less attractive to share the benefits of citizenship with outsiders." Extending the suffrage down the economic ladder provided political muscle for redistributionist ideologies like trade unionism, welfarism, socialism and communism. "It made control over immigration inevitable."
 &
  From nationalism flowed protectionism and the populist version of 19th century imperialism. The working class joined with industrialists to seek protection from import competition. The need to assure resources for long wars added to protectionist pressures for both industry and agriculture. As Germany industrialized along militaristic lines, Britain began to respond in kind with imperial preferences and industrial protection. The U.S. and other New World states adopted "infant-industry" arguments to support protectionist policies.

  "Bismarck's tariffs of 1879, which supported both industrial and agricultural products, were a decisive moment: the most dynamic and the biggest economy on the European continent had rejected liberalism."

  Tariffs thereafter rose throughout Europe and the Western hemisphere. They had been high in the U.S. since just after the Civil War, and they stayed high.
 &
  The spread of anti-liberal ideologies powerfully increased protectionist pressures. Nationalism and protectionism were mutually reinforcing and bred the view of nations in desperate struggle to dominate or avoid domination. This view, in turn, reinforced enthusiasm for centralized and top-down control.
 &
  Wolf describes this mix of attitudes and policies as "tribalism allied to modern science and technology." It reached its most extreme development in Germany. As other nations responded in kind, it became a self-fulfilling prophecy -- nations either would become dominant or would be dominated. The ultimate test of strength was WW-I.
 &
  However, declining costs of transportation kept trade growing until WW-I, and the gold standard worked well, with financial crises generally confined to peripheral nations.
 &

  World War I powerfully reinforced all the illiberal forces and left the European world awash in debts and financially enfeebled. Inflation became widespread. Only the U.S., Britain, and to some extent, France, remained financially stable.
 &
  The obligations owed to citizen-soldiers powerfully accelerated welfare state development. The intellectual community increasingly entertained doubts about free-market orthodoxies.

  "Capitalism was increasingly viewed as unjust, unstable and inefficient. The new achievements of the state in mobilizing resources for war could, it was argued, be as readily adapted to peacetime. Socialists and communists were not alone in believing this. Many on the right also accepted that collectivist solutions, which inevitably meant national solutions, were right for the new time."

  The Smoot-Hawley tariff in the U.S. "was the last straw." (U.S. tariffs were already higher than those of any other nation except Spain - and the U.S. was now the world's premier creditor nation.) Tariffs rose everywhere, and international trade collapsed. "This collapse in trade was a huge spur to the search for autarky and Lebensraum, most of all for Germany and Japan." The Great Depression seemed to confirm all the doubts about liberal capitalism.
 &
  The U.S. had replaced Britain as the "liberal hegemon," but the U.S. did not understand its new responsibilities and made a long series of egregious policy errors.  (See, "Great Depression Mythology" and the Great Depression Chronology Series beginning with "The Crash of '29.")

  "Britain no longer had the means or the morale. The U.S. lacked the will and the wisdom. The disasters of those years would have been avoided if the U.S. had understood in 1917 what it had learned by 1941."

  However, all that changed with WW-II. U.S. leadership provided peace treaties that were not vindictive. It provided processes supporting trade liberalization and currency convertibility. Trade agreements liberalized world trade between advanced nations, but excluded the labor intensive goods like clothing and agricultural products that developing nations depended upon for export earnings. With U.S. support and encouragement, a process of economic integration was begun in Western Europe. Prosperity followed.
 &
  But not for the communist and third world states that believed in the centralized planned economy. Failure, impoverishment and corruption were the inevitable result in socialist states.
 &
  The course of capitalist development, of course, never runs smoothly. Mistakes in government policies and private practices accumulate sufficiently to cause the periodic reversals of the familiar business cycle. The author provides an outline of the economic history of the last half of the 20th century, covering some of the broader factors involved in the economic swings. He explains how the world arrived at its current economic system.

  "The move to floating rates and domestic monetary stabilization made it easier to contemplate the abolition of exchange controls. But this move, which was to become universal among the advanced countries by the early 1990s, was also consistent with the advance of information technology and the general move towards reliance on market forces. For the high unemployment, high inflation and lower growth of the 1970s did more than destroy faith in naive Keynesianism; it also created increased interest in market solutions. There began what amounted to a market counter-revolution in the advanced economies."

  The result of the failures of Keynesian policies and the subsequent collapse of the Soviet Union and socialist alternatives "was a reunification of economic policy, as developing countries adopted regimes similar to those of the advanced countries -- trade liberalization, relaxation of exchange controls, fiscal stability and low inflation." Developing countries also increasingly abandoned fixed exchange rates in exchange for inflation targets and liberalized exchange controls.
 &
  Ultimately, even China joined the liberal trading regime of the World Trade Organization ("WTO"). Russia is expected to join sometime in the future. (Wouldst that it were that probable!) Wolf sums up.

  "The change in policies was, with very few exceptions, introduced by pragmatic politicians in response to experience. The stagflation of the 1970s discredited naive Keynesianism; the return of inflation discredited the view that monetary policy does not matter; the failure of nationalized industries discredited state ownership; the revolt of organized labour discredited wage controls; the distortions evident in the economy discredited price controls; the superior performance of outward-oriented, market-friendly developing countries -- such as Singapore and Taiwan -- and the equally evident relative failure of the inward-looking colossi of China and India discredited self-sufficiency; the high inflation and external debt cum fiscal crises of Latin America discredited populism; and, most important of all, the weakening and collapse of Soviet state-socialism discredited faith in allegedly rational central planning."

  The global market works. Globalization has brought widespread prosperity, but remains tragically limited. Wealthy nations unconscionably close their markets to the exports of underdeveloped nations. However, many underdeveloped nations shut themselves off from globalization and condemn their peoples to hopeless poverty. Development succeeds where globalization has been welcomed and implemented.

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Copyright 2004 Dan Blatt