Rely on markets to be unreliable

Governments still struggle with their economies

January 17, 1999|By Charles Wolf Jr.

In 1992, Francis Fukuyama optimistically forecast that the "end of history" was at hand. The collapse of Soviet communism and the demonstrated failures of command economies, he contended, had led to universal acceptance of market-based, capitalist democracies. The Manichean struggle between the two systems was winding down.

Fukuyama's optimism was premature.

Once again, the shortcomings of markets and the crisis of global capitalism are being sung by a politically diverse choir, including prime ministers Mohamad Mahathir in Malaysia and Yevgeny M. Primakov in Russia, Finance Minister Oskar Lafontaine in Germany and international speculator George Soros. This "resumption" of history has been spurred by a series of financial crises in international markets, Asia's financial turmoil, Russia's default on $15 billion of dollar-denominated Soviet debt and pressures on Brazil's debt-ridden, but otherwise promising, economy.

At bottom, critics have focused on "untrammeled" (i.e., unregulated) markets as the principal cause of all this turmoil, though they have diverged in their diagnoses and remedies. Mahathir blames global hedge funds for his country's plight, and he has acted to insulate Malaysia from international capital markets by governmental screening and control of capital movements into and out of the country.

Primakov and his aides have proposed to reverse Russia's economic decline by imposing selective price controls, restricting foreign-currency transactions and retaining a large state-enterprise sector in the economy. Lafontaine advocates larger government spending programs, while insulating German and European Union markets from import competition and international financial volatility. Soros proposes setting up an International Credit Insurance Corp., funded by the G-7 governments (therefore, their taxpayers), to protect economies and investors from excessive financial volatility.

On closer examination, these views are more reflective of the predilections of their protagonists than the reputed imperfections of market-based economies.

For starters, there are no untrammeled free markets; nor does the canonical free-market system presume that effective markets function without restrictions. For markets to operate effectively, clear and explicit rules of the game are essential. These include protection of property rights, legally binding and enforced contracts, established and reliable modes of resolving disputes, and free and open competition among producers, consumers, lenders, borrowers and investors. Without these rules, markets will malfunction.

Second, Asia's financial turmoil stems not from the operation of free markets but from a capitalism colored by personal or governmental excesses. In many of the affected countries, for example, there were excessive amounts of short-term lending and borrowing, and protracted support for overvalued exchanges rates underwritten by the assumption that governments or multilateral agencies would prop the currencies up if they came under attack.

Third, the story is similar in Russia. The absence of legal and other institutional restraints required for the smooth operation of markets, widespread fraud in the privatization of state-owned assets and an associated flight from the ruble all help explain Russia's economic predicament. Underlying and contributing to the Russian debacle has been a "moral hazard" stemming from International Monetary Fund lending practices. Because the IMF bailed out Indonesia with a $40 billion package, lent $60 billion to South Korea and lesser amounts to Thailand and the Philippines, should not Russian policy-makers expect more than the niggardly $15 billion to $20 billion that the IMF offered?

To blame the vagaries of free-market systems for these problems is to confuse the free market with aberrations from it.

Though the European Union, reinforced by its monetary union and single euro currency, differs from these cases, it, too, shows distinct signs of veering away from free, open and competitive markets. Having apparently rediscovered the attractions of Keynesian economics as a possible remedy for their chronic high-unemployment problems, the EU's finance ministers recently agreed on measures to insulate the union from potential external shocks by restricting outflows of capital and limiting import competition. If Lafontaine becomes the head of the European Commission, the executive arm of the EU, these trends are likely to be reinforced. Along this path lies a slower rate of growth in the EU's real gross domestic product and a depreciated value of the euro relative to the U.S. dollar.

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