Date: Thu, 5 Mar 1998 09:36:30 +0800
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From: Dion Giles <>
Subject: “Cool it”, megagrabber warns
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Towards A Global Open Society

By George Soros, Atlantic, January 1998

Let me start with the obvious. We do live in a global economy. But it is characterised not only by the free movement of goods and services but, above all, by the free movement of ideas and of capital.

This applies both to direct investments and to financial transactions. Both have been gaining in importance ever since the end of the Second World War, but the globalisation of financial markets, in particular, has accelerated in recent years until it [has] reached a point where movements in exchange rates, interest rates and stock prices in various countries are intimately interconnected. In this respect, the character of the financial markets has changed out of all recognition during the 40 years that I have been involved in them. So in talking about the global economy, it may be more appropriate to speak about the global capitalist system.

There can be no doubt that global integration has brought tremendous benefits. Not only the benefits of the international division of labour which are so clearly proven by the theory of comparative advantage, but also dynamic benefits such as the economies of scale and the rapid spread of innovations from one country to another which are less easy to account for by static equilibrium theory.

Equally important are the non-economic benefits, the freedom of choice associated with the international movement of goods, capital and people, and the freedom of thought associated with the international movement of ideas.

To appreciate the non-economic benefits we only need to remember what it was like to live in the Soviet Union or China when they were cut off from the rest of the world, or what it is like in Burma or North Korea today.

Global capitalism does not bring political freedom and prosperity to all parts of the world, but it certainly helps. There is a lot more freedom and prosperity in China today than there would be in the absence of foreign trade and foreign investment. So we can say that global capitalism has much to recommend it, even if it is not the be all and end all.

But global capitalism is not without its problems. I shall devote most of my speech to these problems because they are not well understood, and we need to understand them better if we want the system to survive. I want to make it clear, however, that by focusing on the problems I’m not trying to belittle the benefits that globalisation has brought. On the contrary it is exactly because I want to preserve those benefits that I should like to see the system work better.

I am firmly convinced that the present global capitalist system can be sustained only by deliberate and persistent efforts to correct and contain its deficiencies. That is where I am at loggerheads with the laissez-faire ideology which contends that free markets are self-sustaining and market excesses will correct themselves, provided governments or regulators don’t interfere with the self-correcting mechanism.

Let me group the deficiencies of the global capitalist system under five main headings. One is the uneven distribution of benefits, another is the instability of the financial system, a third is the incipient threat of global monopolies and oligopolies, a fourth concerns the role of the state, and a fifth rather nebulous category has to do with the question of values and social cohesion. Needless to say, the categories are somewhat arbitrary and the various problem areas are interconnected.

First, the benefits of global capitalism are unevenly distributed. Generally speaking, capital is in a much better position than labour because capital is more mobile than labour. Moreover, financial capital is better situated than industrial capital because once a plant has been built it is difficult to move it.

Multi-national corporations enjoy a lot of flexibility in transfer pricing and they can exert pressure at the time they make new investment decisions, but their flexibility doesn’t compare with the freedom of choice enjoyed by international portfolio investors. There is also an advantage in being at the centre of the global economy compared with being at its periphery. All these factors combine to attract capital to the financial centre and account for the ever-increasing size and importance of financial markets.

This brings me to my second point. Financial markets are inherently unstable and international financial markets even more so. International capital flows are notorious for their boom-bust pattern. During the boom period, capital flows from the centre to the periphery, but when confidence is shaken it has a tendency to return where it came from. During the 40 years I have spent in international financial markets I have seen many ebbs and flows and booms and busts. I fully recognise that international capital markets have become much more institutional in character and demonstrate much greater resilience, but I cannot believe that the present boom will not be followed by a bust until history has proven me wrong.

This risk of a breakdown is greatly increased by the fact that our theoretical understanding of how financial markets operate is fundamentally flawed. Economic theory has been built on the concept of equilibrium, and in my view that concept is quite inappropriate. In my view there is no such thing as equilibrium in financial markets because market participants are trying to discount a future which is itself shaped by market expectations.

This renders the outcome indeterminate and is only by accident that the actual course of events will correspond to the prevailing expectations. Market participants, if they are rational, will recognise that they are shooting at a moving target rather than discounting a future equilibrium. The theory of rational expectations makes a heroic assumption that market participants as a group are in a position to discount the future accurately. That yields a hypothetical equilibrium which has little relevance to actual market behaviour. But neither market operators nor the regulators have ever fully accepted the theory, exactly because they are rational people. And I am told that economic theory itself has gone a long way towards recognising and studying dis-equilibrium situations. Nevertheless, the laissez-faire idea that markets should be left to their own devices remains very influential. I consider it a dangerous idea. The instability of financial markets can cause serious economic and social dislocations.

The question poses itself: What should be done to preserve the stability of the financial system? Dr Mahathir's suggestion yesterday to ban currency trading is so inappropriate that it does not deserve serious consideration. Interfering with the convertibility of capital at a moment like this is a recipe for disaster. Dr Mahathir is a menace to his own country.

But the recent turmoil in Asian markets raises some thorny issues about currency pegs, asset bubbles, inadequate banking supervision and the lack of financial information which cannot be ignored. Markets cannot be left to correct their own mistakes, because they are liable to overreact and to behave in an indiscriminate fashion.

For instance, it is a grave mistake not to discriminate between Malaysia and Indonesia. At the same time I am not entirely in agreement with the prevailing opinion that the best remedy is to open up the domestic financial sector to international competition. Foreign financial institutions can play a useful role because closed financial systems tend to be inefficient, corrupt and bound up in politics. But foreign capital is notoriously fickle. So the best way to achieve stability is to mobilise domestic savings for domestic capital formation in an efficient fashion. That is the chief merit of privatising social security as it has been done in Chile.

The question of the appropriate exchange rate regime is far too complicated to be discussed here. The important point to recognise is that whatever regime prevails, it is bound to have its deficiencies which require constant vigilance.

Instability is not confined to the financial system. The goal of competitors is to prevail, not to preserve competition in the market. This brings me to my third point. There is a natural tendency for monopolies and oligopolies to arise and this needs to be constrained by regulations. The process of globalisation is too recent for this to have become a serious issue on a global level but, since we are dealing with a historical process, it is only a question of time before it will.

But whose job is it to prevent undue concentrations of power and to preserve stability in financial markets? This brings me to my fourth main point, the role of the state. Since the end of the Second World War, the state has played an increasing role in maintaining economic stability, ensuring equality of opportunity and providing a social safety net, particularly in the highly industrialised countries of Europe and America. But the capacity of the state to look after the welfare of its citizens has been severely impaired by the globalisation of the capitalist system, which allows capital to escape taxation much more easily than labour. Capital will tend to avoid countries where employment is heavily taxed or heavily protected, leading to a rise in unemployment. That is what has happened in continental Europe. I am not defending the antiquated social security systems on the continent of Europe, which are badly in need of reform, but I am expressing concern about the reduction in welfare services both in Europe and in America.

This is a relatively new phenomenon and it has not yet made its effect fully felt. Until recently, the state's share of the GNP in the industrialised countries taken as a group was actually increasing. According to Danny Rodrick, it has almost doubled since the end of the Second World War. Social spending began to decline in the 1980s under the influence of the Thatcher and Reagan governments but that was more than made up for by a rise in defence spending. But in the 1990s, defence expenditures have also declined while the pressures of globalisation have increased and the state has been in full retreat from the economy.

In many ways this is a good thing but if social services are cut too far while instability is on the rise, it may well engender popular resentment and lead to a new wave of protectionism both in the United States and in Europe, especially if and when the current boom is followed by a bust of some severity. This could lead to a breakdown in the global capitalist system, just as it did in the 1930s. With the influence of the state declining, the need for international co-operation is increasing. But this is contrary to the spirit of the times which calls for markets to be left alone.

There is another role that the state has played in economic development. In countries that were deficient in local capital the state has allied itself with local business interests and helped them to accumulate capital. This is against the theory of perfect competition but it has proved a successful strategy in countries like Japan, Korea and the various Tigers of Southeast Asia. While the model has worked, it raises some important questions concerning the relationship between capitalism and democracy. Clearly, an autocratic regime is more favourable to the rapid accumulation of capital than a democratic one and a prosperous country is more favourable to the development of democratic institutions than a destitute one. So it is reasonable to envisage a pattern of development which goes from autocracy and capital accumulation to prosperity and democracy. But the transition from autocracy to democracy is far from assured, for those who are in positions of power are likely to cling to their power. In this context, the emphasis on Asian values has served as a convenient pretext for resisting democratic aspirations.

Autocratic regimes which restrict free speech and foster corruption cannot last forever. The moment of truth comes when they fail to sustain prosperity. Unfortunately, economic dislocation and decline do not provide a good environment for the development of democratic institutions. So the political prospects for the Asian economic miracle remain cloudy at best.

This brings me to the fifth and most nebulous problem area, the question of values and social cohesion. If markets were self-sustaining, the question would not arise. We could take values as given and we could leave it to the markets to correct any excesses. But the laissez-faire argument is based on a misunderstanding of the nature of markets. Markets do not operate in a vacuum. They are intimately intertwined with politics and they are best understood as an irreversible historical process. In the 19th century, the global capitalist system was held together by the imperial powers and, eventually, it was destroyed by a conflict between those powers. But the days of the empires are gone. For the current version of the global capitalist system to survive, it must satisfy the needs and aspirations of its participants. In other words, you cannot have global markets without a global society. But our global society incorporates many different values, customs, traditions and religions. So, where can we find the shared values that could hold our global society together?

I believe that we should look for such values in the idea of an open society which is based on the recognition that our understanding is imperfect and fallible. Since nobody is in possession of the ultimate truth we need institutions which allow people with different opinions, different backgrounds and different interests to live together in peace. We need a market economy but we also need institutions that ensure political freedom and social justice. We have such institutions in individual countries but not in our global society. There are, for instance, people who argue that values are different in Asia. Of course they are different. Our global society is characterised by a diversity of values, religions and traditions. But fallibility is a universal human condition, therefore we ought to be able to find common ground in the open society, which celebrates this diversity. That is why I believe that the concept of the open society could serve as a unifying principle for our global society.

Unfortunately, time does not permit me to expound on this idea but I should like to stress one particular aspect of the open society which is of critical importance at the present moment—the freedom of information.

For example, I have been subjected to all kinds of false and vile accusations by Dr Mahathir. He is using me as a scapegoat to cover up his own failure. He is playing to a domestic audience and he couldn’t get away with it if he and his ideas were subject to the discipline of independent media inside Malaysia. The freedom of information is as indispensable in Asia as in the rest of the world.