Will the Trend to Economic Liberalism Continue?

PART 4:

Now as ever, predicting the course of change in economic systems and policies is a high-risk undertaking:  the process just described brought many surprises with it, while the current world financial turmoil, which came as a shock to the most experienced observers, has re-emphasised the limitations of economic understanding and the fragility of even short-term projections.  All the same, some indications for the future of economic liberalism can be gleaned from past trends, some current developments, and what appear to be established underlying factors.

CONSOLIDATION, MOMENTUM AND SPREAD

To start with, I believe that, broadly speaking, and despite some recent indications to the contrary, the main reforms of these past two decades have come to stay.  In particular, few governments, in any part of the world, are likely to take back into would-be permanent public ownership industries or enterprises that have been privatised;  to bring back either general price controls or the tight industry regulations and entry restrictions of the past;  to restore comprehensive exchange controls (at any rate as anything other than a temporary expedient);  to reintroduce prohibitions, or drastically tighten restrictions once again, on flows of direct foreign investment;  or, in the end, to repudiate in any substantial way the main commitments that they have made with respect to freeing cross-border trade flows.  This is not because they now have no effective choice in the matter -- as was seen above, "globalisation" has not deprived national states of freedom to decide their own policy régimes -- but because perceptions, and assessments of national interests, have changed.  In this respect the world has moved on.  Indeed, there are areas of policy, especially those just referred to, in which the ranks of the reformers may well be gradually reinforced as time goes by, with previously non-reforming countries responding to the pressure of events, the movement of ideas, and the influence of example.  There is likely to be a further momentum of liberalisation here, though just how much remains to be seen.  For reasons already noted, any such momentum is unlikely to be checked significantly by the coming to power of left-of-centre governments, as most recently in Germany and Italy.

Again, if one looks at individual countries, there are indications, or clear possibilities, of a still continuing reform momentum, provided that serious political instability does not develop.  In particular, this applies in cases where liberalisation is still in the early stages but some important corners, even though by no means all, seem to have been turned for good:  China, India, Brazil and -- even now -- Russia are the outstanding examples.  There is a good chance that, as in recent years, there will be a tendency across frontiers towards convergence in policy régimes, with the main steps towards convergence being taken, albeit often erratically, in a reformist direction, in the economies that are more heavily controlled.

Admittedly, all this applies mainly to those countries where political parties are free to compete for support and office, and there are accepted procedures by which changes of governments can take place without resort to force.  Where authoritarian systems persist, the range of possible outcomes is greater and the prospects for economic reform are generally, though not always, worse.  To take the more extreme cases, there is no clear prospect of economic reform in such countries as Cuba or Myanmar, while the coming to power of a Taliban or an Ayatollah Khomeini can bring with it, at least for a while, a wholesale onslaught on liberal ideas and freedoms of all kinds.  However, as noted already, some authoritarian régimes have taken the path of reform, and the influences which have been at work in these instances may well prevail in others.  In any case, the number of countries that can reasonably be called democratic has been growing in recent decades, and this trend seems likely to be maintained.  Because of its broadly positive implications for economic as well as political freedom, this can be viewed as a further source of momentum.

Generally speaking, therefore, it is reasonable to expect consolidation of the main reforms have now taken hold in most if not all the leading economies of the world, along with many others, together with a gradual though uneven further spread of much the same reforms elsewhere.  To this extent the prospects for economic liberalism appear favourable.  However, this is not the full picture.  Both immediate concerns and longer-established factors may work in the other direction.

THE IMPACT AND LESSONS OF RECENT CRISES

As from mid-1997, a new set of unforeseen and disconcerting events has extended the debate on economic reform.  The crises in a number of East Asian countries, together with more recent episodes of instability in financial and foreign exchange markets, have raised in an acute form some related issues of liberalisation versus control, including in particular the question of whether international capital flows should now be made subject to closer official regulation.  Broadly, two distinct morals have been drawn from these events, and though these are not incompatible they point in different directions.  They rest on different interpretations of the East Asian crises. ⁽¹⁰⁵⁾

The first interpretation can be labelled "externalist", since it views the crises as being primarily due to outside influences, rather than to weaknesses in the system or misguided economic policies within the countries affected.  A good illustration is to be found in an article by Steven Radelet and Jeffrey Sachs:

The crisis is a testament to the shortcomings of international capital markets and their vulnerability to sudden reversals of market confidence ...  The search for deeper explanations that attribute the entire massive contraction to the inevitable consequences of deep flaws in the Asian economies -- such as Asian crony capitalism -- seems to us mistaken. ⁽¹⁰⁶⁾

On such a view, the liberalisation of capital account transactions was a leading contributory factor in the crises, and this establishes a prima facie case against allowing the unrestricted transfer at any rate of short-term international flows of funds.  One leading economist with impeccable free trade credentials who has taken this line is Jagdish Bhagwati.  He argues that "the Asian crisis cannot be separated from the excessive borrowings of short-term capital as Asian economies loosened up their capital account controls and enabled their banks and firms to borrow abroad";  that the gains from full freedom for capital flows are often overstated, and in any case have to be set against the high costs arising from "the crises that unregulated capital flows inherently generate";  and that the pressure to abolish restrictions on all capital flows, in part through amending the Articles of Agreement of the International Monetary Fund, comes mainly from powerful Wall Street and Washington interests. ⁽¹⁰⁷⁾

It may be that some countries, influenced by such lines of thought, will follow the already-existing Chilean example in imposing precautionary restrictions on short-term borrowing from abroad, or even, like the government of Malaysia in September 1998, introduce wide-ranging exchange controls.  It remains to be seen, however, whether restrictions of the latter kind can be made to work and will yield benefits, real or perceived, which more than offset what are likely to be the substantial costs arising from the complexities and distortions involved and the effects on the confidence of investors both foreign and domestic.

In relation to this current debate, the earlier experience of the OECD countries is relevant.  Two morals in particular can be drawn from it.

The first is that country circumstances matter.  Generally speaking, and leaving aside the establishment in Europe of the Single Market, the process of freeing external capital flows in the core OECD countries was neither even nor uniform.  Countries accepted liberalisation as a goal while choosing for themselves -- albeit with provision for mutual consultation and surveillance -- the nature and timing of specific measures.  In the process, collective agreement on the freeing of short-term capital movements came last:  it was only in 1989 that the OECD Codes of Liberalisation were extended to cover all remaining capital flows "including short-term capital movements, such as money-market transactions, operations in forward markets, swaps, options, and other derivative instruments". ⁽¹⁰⁸⁾  When applications for OECD membership were made in the 1990s, adherence to the Codes of Liberalisation, together with an agreed negotiated timetable for further freeing of capital flows, was a condition of accession;  and all the five countries concerned have carried liberalisation further since they applied for accession, with the eventual abolition of exchange controls as one of the agreed objectives.  But as with other members, the choice and timing of changes is for each national government to decide, and in four of these five newcomers, the exception being Mexico, the controls on capital flows that remain are, generally speaking and for the time being, more restrictive than in the core countries.

This OECD experience suggests that the strength of the case for freeing short-term capital movements, and the timing of decisions as to how and when to move in this direction, depend on each country's situation.  This is in fact the approach adopted by (among others) the IMF, which so far from advocating total and immediate lifting of restrictions has taken the line that "there are important preconditions for an orderly liberalisation of capital movements". ⁽¹⁰⁹⁾

OECD experience in the last few years further suggests -- though this is more debatable -- that once the "preconditions" have been broadly met and controls have been removed, the change should be treated as permanent.  This view seems indeed to be widely though not always explicitly held, for it is noteworthy that few commentators, even among those most distrustful of international capital flows, have argued that, in the light of the East Asian developments, the core OECD countries should now reverse course and bring back their former controls.  So far at least, none of the governments concerned has considered this step;  and even for the five newer members, including Korea, it is not at present under serious consideration.  This suggests that the general case for closer restriction -- as distinct from arguments that may apply, and then perhaps only temporarily, to particular non-OECD countries -- has not been made out.

The Case of Korea

Aside from this particular issue, and more fundamentally, these recent crises have in fact reinforced the case for extending economic reform in East Asia, and indeed elsewhere.  Korea provides a good illustration.  Admittedly, there is little doubt that in the Korean crisis foreign short-term capital flows, as in many other episodes past and current, were destabilising;  but the reasons why they had such devastating effects are partly to be found within the Korean economy itself:  as with the other East Asian countries affected, a pure "externalist" explanation of the crisis is not adequate.

In this connection, the OECD Secretariat has made the point that in Korea there was "financial vulnerability stemming from highly-leveraged firms and a weak, poorly supervised financial system". ⁽¹¹⁰⁾  To this it can be added

• that many of the highly-leveraged firms had over-invested;
• that the extent of both the over-investment and their over-exposure to debt can be partly accounted for by their being specially favoured by government;
• that much of the debt financing was channelled through banks, some of which were government-owned, all of which were subject to official direction, and many of which were already carrying nonperforming loans;
• that the liberalisation of capital inflows which preceded the crisis was limited to "short-term inflows unnecessarily channelled through banks"; ⁽¹¹¹⁾
• that close connections between government, banks and favoured firms encouraged the idea that institutions which got into trouble would be rescued;  and
• that it was difficult or impossible to check from up-to-date published figures the financial viability of these institutions.

These weaknesses have been recognised, with the result that the response to the crisis in Korea has partly taken the form of a range of liberalising measures.  To quote the OECD Secretariat once more:

The government has taken a number of steps intended to open capital markets, restructure the financial system and strengthen prudential supervision, increase labour market flexibility and encourage corporate restructuring.  Additional steps to improve corporate governance practices and further open the product market are planned. ⁽¹¹²⁾

Broadly similar measures are being taken by governments in the other East Asian countries affected, aside from Malaysia, either independently or in the context of agreements with the international lending institutions.  In all these cases, and even if some new forms of restriction on short-term capital movements are imposed, whether temporarily or for a longer period, the result is likely to be a permanent move away from some long-accepted forms of interventionism.  It is not only in East Asia that such tendencies may appear. ⁽¹¹³⁾

Hence one effect of the East Asian crises and some related episodes may well be to reinforce on balance the already existing momentum of reform.  However, it would be wrong to draw the conclusion, from this and the previous section of the argument, that interventionism has entered into a terminal and irreversible decline.  Both domestically and on the international scene there are influences and tendencies which may set limits to further liberalisation, or give rise to a revival of interventionism in forms both old and new.

OLD LIMITS AND NEW THREATS

As to domestic policies, reforms so far have chiefly affected the production of marketed goods and services.  In the core OECD countries and others, the scope of markets has been extended, and their working improved, in areas where market mechanisms, while subject to numerous and diverse forms of often heavy-handed intervention, were already well established and taken for granted by virtually everyone.  In the former communist countries also, the main reforms have been in these same areas.  It is here that liberalisation has gone furthest across the world, through measures that are unlikely to be reversed and which may well spread to countries that have not yet adopted them.

Beyond this, the prospects for further and continuing economic reform are more doubtful.  On present indications, this is true in particular of three broad areas of policy where the case for greater economic freedom is still not widely accepted:  the provision of free or heavily subsidised public services, including health and education;  fiscal transfers, including state pensions and benefits of various kinds;  and labour markets.  Although in a growing number of countries these areas have been subject to reforming initiatives, there remains a wide gulf between the ideas of economic liberalism and current thinking and practice.

Two brief illustrations will serve to make the point.  In education, the argument was made by John Stuart Mill a century and a half ago that government financing need not, and probably should not, imply government provision of the services thus paid for.  In 1875 much the same case was put by Karl Marx, who then wrote:

"Elementary education by the state" is altogether objectionable.  Defining by a general law the financial means of the elementary schools, the qualifications of the teachers, the branches of instruction, etc., and ... supervising the fulfilment of these legal specifications by state inspectors, is a very different thing from appointing the state as the educator of the people! Government and church should rather be equally excluded from any influence on the school.

Marx goes on to assert that "the whole programme ... is tainted through and through by the Lassallean sect's servile belief in the state ..." ⁽¹¹⁴⁾

From a liberal viewpoint, this approach is equally relevant today.  In the provision of education services, as elsewhere in the economy, there is good reason to believe that consumers should be free to choose between alternatives, that individuals and businesses should be free to enter the industry and to advertise and supply services, and that competition between suppliers would not only widen the range of choice but also make for greater efficiency of operation, regard for consumers and readiness to innovate.  Almost everywhere, however, the provision of free schooling remains largely or wholly a public monopoly, nor -- though local experiments with greater freedom are to be found, perhaps increasingly -- is there any country in which this situation seems about to change.

In labour markets too, prevailing systems and practices, and the received ideas which lend support to them, remain far removed from liberal norms -- in some respects, as it appears, increasingly so.  There is of course room for debate as to just how these norms should be defined and interpreted.  But from a liberal standpoint it is natural to take freedom of contract as a general principle, a point of departure.  This implies a presumption against statutory restrictions or legal constraints, both on the freedom of employers and employees to make whatever deals may suit them, with or without the participation of unions, and on wages or conditions of employment including hours worked, paid holidays and age of retirement.  It is likewise inconsistent with general legal restrictions deriving from the notion of unfair dismissal, and with antidiscrimination or "affirmative action" clauses, or quotas whether formal or informal, that limit the range of possible bargains and arrangements for mutual benefit.  As Milton Friedman noted in Capitalism and Freedom nearly four decades ago:

"Fair employment practice" legislation, which aims to prevent discrimination by reasons of race, color or religion [and he would now have to add, by sex, age, national or social origin, political opinions, marital status, sexual preference, or absence of disability] interferes with the freedom of individuals to enter into voluntary contracts with one another. ⁽¹¹⁵⁾

At present, a non-restrictive legal framework giving expression to the principle of freedom of contract is not to be found in any country -- Hong Kong probably comes closest to it -- and there seem to be few cases in which the prevailing trend in labour markets, even in these recent years of economic reform, has clearly and consistently been in that direction.  Even in New Zealand after the Employment Contracts Act of 1991, there remain unfair dismissal laws administered by a specialist Employment Court, a statutory minimum wage and other legal provisions governing conditions of work, and anti-discrimination laws which as in other countries significantly restrict the freedom to hire and fire, and which have increased over time in scope and intrusiveness.  Nowhere is it widely accepted by public opinion that labour markets should be made substantially freer.

As to the international dimension, traditional protectionism is, as ever, flourishing all over the world, even though it has been losing rather than gaining ground in recent years.  Future advances towards freer trade are therefore likely to continue to be hard won.  Moreover, it is possible, indeed probable, that the process of international economic integration will be obstructed or partly reversed by new forms of interventionism.  In particular, cross-border trade flows may well become increasingly subject to provisions, whether internationally agreed on or unilaterally imposed by the richer countries, relating to minimum international labour standards and environmental regulations;  and it is likely that many of these, in so far as they are made effective, will have disintegrating consequences for the world economy.  It is often argued, not without cause, that the imposition of such international norms and standards is advocated for protectionist reasons, by employers and unions in the richer countries.  But this is not the main point.  Even if the motives that lay behind them were entirely disinterested, such measures could still be open to objection in so far as they restrict the freedom to enter into non-coercive bargains for mutual gain.  Protectionist or not, they are liable to be forces for disintegration. ⁽¹¹⁶⁾

New restrictive norms are not the only sources of risk to the open multilateral trading and investment system.  It could well be undermined also (1) by a spread of, and greater resort to, anti-dumping actions, and (2) by a growing propensity on the part of one or both of the two largest trading entities, the EU and the US, to adopt unilateral coercive measures, sometimes in the name of market opening.  Thus, despite the Uruguay Round agreements and the Bogor Declaration, ⁽¹¹⁷⁾ and the continuing momentum of decontrol in many developing and former communist countries, the further progress of cross-border liberalisation of trade and investment is far from being assured.  At the same time, it seems probable that the possibilities for international migration will remain closely restricted, often for reasons, and in ways, that are inconsistent with liberal thinking.

Hence it is not at all certain that interventionism will continue on balance to lose ground over the medium and longer term:  the reasonably predictable further gains for liberalism may prove to be both restricted in scope and subject to erosion of various kinds.  On the other side of the account, however, there are factors which are already lending support to the liberal trend, and which may well gain in strength.

A Continuing Impetus to Liberalisation

Under this heading, two widely felt influences making for reform can be identified, though their full effects are yet to be seen and are uncertain.  The first is internal.  For most of the present OECD countries, and probably for others too, pressures are likely to arise, or to grow more intense, from what has been called the fiscal crisis of the modern state.  Many governments will have little choice but to rethink their systems of public transfers and free or subsidised provision of services, if only because of the further ageing of their populations and the reluctance of voters to accept still higher levels of taxation.  By the same token, they will be looking, even more searchingly than now, for ways in which public expenditure programmes generally can be trimmed, run more efficiently, financed through charging, or run by private operators.  This will influence the direction and content of future reform programmes;  and it could well happen, as in the case of privatisation, that ideas for reform which were previously viewed as visionary, impracticable or hopelessly unpopular will progressively win acceptance -- in some cases, after they have actually been introduced by harassed or determined governments.  There is a case for far-reaching market-oriented reforms in relation to many areas of policy which have not so far been greatly affected by liberalisation:  in education, health, social welfare programmes, pensions, housing, town planning and land use, and transport including especially the use of roads, there is a wide range of possibilities -- in particular, through introducing or raising fees and charges, extending the scope for competition and private initiative, and making possible or establishing better pricing systems.  Hence an extensive though difficult reform agenda is to be found here, which may increasingly enter into practical politics.  Once such a tendency has emerged in a few countries, it may gather strength across the world in much the same way as privatisation has done.

A second factor, which is international rather than domestic, is the constraining effect of closer cross-border economic integration:  the impact of "globalisation", which up to now has been less marked than is often suggested, may become increasingly felt.  For example, it is likely that continuing pressures for tax reform will arise from a wish not to get too far out of line with the practice of other countries where rates have been brought down, and that governments will continue to accede to deregulation in order to help business enterprises within their borders to remain competitive in world markets.  More broadly, national governments are becoming increasingly aware of the need to maintain policy régimes which internationally-minded and potentially mobile enterprises will find acceptable.  At the same time, further developments in communications, and in particular the growth in transactions carried out via the Internet, may make it harder to enforce official restrictions on the ability of people and businesses to pursue their interests and make unregulated deals. ⁽¹¹⁸⁾

It is possible that in response to these and other developments, the liberal semi-consensus will gain further strength, and governments will continue to take the path of reform -- not solely, or even typically, from a belief in economic liberalism as such, but rather as a means to dealing with problem situations, or simply because they have lost the ability to enforce particular regulations which limit people's choices.  Hence there may well be a continuing impetus to liberalisation, not only in ways that have now become well established and broadly accepted by public opinion, but also in areas of policy where so far there has been much less to show.  Social changes, which in part arise from liberalisation itself, may contribute to its extension on these lines.  Rising average real incomes, wider share ownership, the growth of self-employment and contracting for labour services, the decline of trade unionism in the private sector, and the shrinking of the public sector where unionism and anticompetitive attitudes remain dominant, are likely to be influences on the side of reform. ⁽¹¹⁹⁾

Rather than trying to turn this brief review of possibilities into predictions or a set of scenarios, I conclude by setting the events of these last two decades in a much longer historical perspective.  In doing so, I draw together some of the main threads from the argument so far, while joining them up with one or two new ones.

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ENDNOTES

105.  The argument here draws on a paper of mine entitled "Industrial Policies Revisited:  Lessons Old and New from East Asia and Elsewhere", issued in Pelham Papers No. 3, published by the Centre for the Practice of International Trade at the Melbourne Business School, 1998.

106.  Steven Radelet and Jeffrey Sachs, "The Onset of the East Asian Crisis", paper prepared for the Brookings Institution, 1997.

107.  Jagdish Bhagwati, "The Capital Myth:  The Difference between Trade in Widgets and Dollars", Foreign Affairs, Vol. 77, No. 3, May-June 1998.  The quotations are from pp. 8 and 11.

108.  Pierre Poret, "Capital Market Liberalisation:  OECD Approach and Rules", paper presented to an IMF seminar, 1998.  The paper gives a good summary account of the whole history.

109.  World Economic Outlook, May 1998, p. 7.

110.  OECD, Economic Outlook 63, preliminary edition, April 1998, p. 205.

111.  OECD, Economic Outlook 63, Paris, 1998, p. 12.

112.  OECD, Economic Outlook 63, p. 104.

113.  Much the same diagnosis and conclusions as here are to be found in Pierre Poret, "The Case for Orderly Liberalisation in Emerging Market Economies", OECD Observer, No. 214, September-October 1998.

114.  Karl Marx, Critique of the Gotha Programme, written in 1875 though first published only in 1891.  The text quoted here is from p. 42 of an edition published in Moscow in 1947 by the Foreign Languages Publishing House.  The italics are in the original -- Marx was quoting from the text of the Programme.

115.  Milton Friedman, Capitalism and Freedom, Chicago:  University of Chicago Press, 1962, p. 115.

116.  Here again, Marx's views are worth recording.  At the end of the Critique of the Gotha Programme, he condemned not only the general prohibition of child labour, but also -- and in this case, with anger and contempt -- any denial of opportunity for prisoners to undertake productive labour.

117.  The Bogor Declaration of 1994 was signed by the member countries of the Asia Pacific Economic Cooperation agreement, which include the US and Japan.  It commits each of the signatories to establish "free and open trade and investment" by a specified date -- 2010 in the case of the richer members, and 2020 for those that are classed as developing countries.  Not surprisingly, there have since been signs that the notion of "free" trade is subject to varying interpretations by signatories.

118.  As noted above, an analysis on these lines is developed in Richard B. McKenzie and Dwight R. Lee, Quicksilver Capital:  How the Rapid Movement of Wealth Has Changed the World, New York:  The Free Press, 1991.  They argue (p. xi) that as a result of the growth of cross-border capital mobility and closer integration of national economies, "governments have lost much of the monopoly power that under-girded their growth in earlier decades" -- a process that is still under way.

119.  Arthur Seldon, in a recently-published study, has argued that in present-day democracies government "has lost the power to maintain its economic empire", because increasingly people are able to escape from the sphere of public tax-financed provision.  The means of escape are provided by new products and methods, higher incomes, the growing scope for work outside employment contracts, the "parallel" or "grey" economy, possibilities of barter, the development of electronic means of payment, the growth of transactions via the Internet, and the process of closer international economic integration.  (Arthur Seldon, The Dilemma of Democracy:  The Political Economics of Over-Government, Hobart Paper No. 136, London:  Institute of Economic Affairs, 1998.