TOPICS IN POLITICAL ECONOMY

CHINA, CONVERGENCE, AND MARKET CAPITALISM

Most of the noise coming out of this week’s meeting of the  G-20  heads of state in London will be about regulation,  “stimulation” and new barriers to international trade.   But there Is very likely to be one truly significant long-run political outcome: the functional acceptance of China by “the West” as a major financial and economic power.

This acceptance will take the form of communiqué  language that makes it clearer than ever that China’s share of voting power in the International Monetary Fund (and, perhaps, in the World Bank) will be increased substantially within the next two years.  This shift in voting power will be facilitated by a large increase in IMF resources contributed by member governments, most prominently the Chinese.  

The Death of Market Capitalism?  At the same time, noisemakers at the G-20 meetings will add decibels to the continuing funereal chorus from the chattering classes about “the death of market capitalism.” This, despite the fact that China owes its rise to global power thanks to its embrace of the key elements of market capitalism:  market prices to provide incentives to producers and letting individuals own the means of production and grow rich.

Market capitalism is not going to wither away just because financial regulators around the world decide to insist on less risk-taking by (government-supported) financial institutions, such as FDIC-insured banks, “too big to fail” investment banks, and government real estate lending agencies (FNMA and Freddie Mac). 

It was a form of market capitalism that lifted 400 million Chinese out of dire poverty in the fifteen years between 1990 and 2005, and which now makes some pundits muse about turning global leadership over to the “G-2” – the United States and China. 

Why Losing Market Share May Be Progress.  If market capitalism is not dying, then perhaps the U.S. is threatened by China because of a shrinking share of global economic output?  This notion surfaces in numerous discussions about China’s extraordinary economic achievements as well as international comparisons  of spending on research and development,  patents issued, educational achievements and a myriad of other measures.

But the emphasis on “market share” is simple-minded and incorrect, if the absolute level of economic well-being continues to improve.  In this situation, which certainly describes the past 15 years or so, a smaller market share for #1 simply reflects more rapid growth by lower-ranked countries. 

Furthermore, as Nobel prize winning economist Edward Prescott and Stephen Parente have suggested, if all countries would dismantle “barriers to experimentation”  (ranging from civil strife to monopolies to trade protectionism), “there is no reason why the whole world should not be as rich as the leading industrial country.”  In short, China’s progress over the past two decades is a strong argument in favor of what is known as the “convergence” hypothesis among economic growth theorists – as well as market capitalism.

Cut the Bad-Mouthing.  So, when China sits down in a much bigger chair at IMF board meetings in 2011, there is no reason to bad-mouth either the U.S. or market capitalism.  Instead, congratulate the Chinese and remind yourself that it was a form of market capitalism that got them there.

THE WORLD BANK REVISITED

As a former U.S. Executive Director at The World Bank, I am asked frequently these days if Paul Wolfowitz's messy resignation as President could be the "action forcing event" that leads to serious, sensible reform at this multilateral behemoth.  But first let's define what sensible reform needs to entail. 

I propose a simple three point initiative:

1. Stop lending to countries that have no problem borrowing in global financial markets.  This means especially India and China (which has its own $20 billion program for Africa!). These two countries accounted for 23% of the Bank's $12.4 billion in lending last year; Brazil, Mexico and Argentina accounted for an additional 34%.
2. Continue to provide technical assistance to countries that want it, but make countries like those listed above pay for it - as they presumably would, if the advice was worth it.  For poorer countries, advice can be provided gratis or at subsidized rates.
3. Continue worthy Bank research programs on key issues involved in economic development, such as the Doing Business initiative - perhaps the most effective effort of its kind, ever (visit the web site at http://www.doingbusiness.org/.

The argument that income from loans to relatively well-off countries is needed to pay for subsidized technical assistance and research is a red herring.  The Bank already has $38 billion in equity and a $26 billion portfolio of highly-rated investment securities and bank time deposits.  In 2006 this portfolio generated a billion dollars in income, more than enough to pay for a slimmed down (from 13,000) staff as a result of adopting the three-point program suggested above.

Is Serious Reform Possible?

The unlikelihood of serious reform at The Bank was reviewed in an earlier blog (9/17/2006). Even though U.S. Treasury Secretaries have frequently expressed the desire for substantive reforms, the need to spend a substantial amount of scarce political capital corralling other leading shareholders to go along has made such sentiments inoperative.  Entrenched bureaucratic interests in government ministries around the world are a formidable obstacle to any substantive reform effort.

Nonetheless, Paul Wolfowitz' controversial tenure - and messy departure - seem to have raised the reform question to unusual prominence.  Perhaps enough serious players in Washington, London, Berlin and Tokyo are really ready to reconsider doing business as usual, as yesterday's article in the NY Times suggests.  Let's hope that's the case.

WHY THE WORLD BANK AND THE IMF WILL ALWAYS BE WITH US

It’s annual meeting time again for The World Bank and the International Monetary Fund.  More than 10,000 people are expected in Singapore this week to rub shoulders and listen to an endless stream of finance ministers reading from scripts prepared by dutiful subordinates. Reporters will be looking out for colorful and maybe violent protestors railing against globalization and other favorite causes. 

But, barring some al Quaida spectacular, it should be very much like most other years: speeches and communiqués will discuss trade, debt, and the plight of Africa; China and India may get a few more votes on the Board of the Fund; calls for fiscal responsibility and “appropriate” exchange rate adjustments will be heard. TV cameras will record some scruffy marchers with placards and pithy slogans. Considerable wining and dining will take place, much of it at the expense of private bankers.

No one on an official podium is likely to ask, “Didn’t the main rationale for these institutions disappear some time ago?” The IMF was established to facilitate “fixed but adjustable” exchange rates; The World Bank was envisioned to function as a lender of last resort to countries seeking to restructure their economies.  But the collapse of the fixed exchange rate system in the 1970s obviated the primary reason for the Fund’s existence.  And the re-opening of international capital markets to most developing countries in the 1980s did the same for The World Bank.  Today, both institutions devote the bulk of their time and all their frequently overlapping financial operations on developing countries.

And both are still increasing their staffs: fiscal 2006 administrative budgets for the two multilateral institutions (which exclude their lending and grant programs) totaled over $3 billion. The two institutions do perform some useful advisory work, and their research programs provide a wealth of data for what works and what doesn’t in developing countries. But these activities require a fraction of $3 billion (most of which is paid by the developing countries).

Nearly a decade ago, with a view towards trying to build support for merging the two institutions, I wrote, “No serious effort at substantive reform for either institution has ever been mounted.”  (The Washington Quarterly, Spring 1999). The Congressionally mandated Meltzer Commission in 2000 developed some worthwhile (but certainly not dramatic) proposals.  However, with one partial exception, they were never taken up.  Proposals for serious reform continue to be made by academics and think tank types, some of whom cite my earlier papers.

I have reluctantly concluded that we would-be reformers should move on to projects with greater possibilities of success. The reality is that the political capital required on the part of major shareholder governments is far too great. The need to coordinate such a project with at least half a dozen other governments, with their own competing agendas and bureaucracies, would be daunting.  The likelihood that some new crisis would intervene and derail the extended campaign is high. 

As former U.S. Treasury Secretary George Shultz once reported, after he had suggested a major restructuring, such as merging the two institutions, to a leading central banker, the reply was, “You are probably right . . . but I am tired just thinking about the effort involved.”

Probably the best that can be done is to make sure that neither institution engages in counter-productive financial operations, nor receives another general capital increase requiring taxpayer funds or commitments.  So, if you are in Singapore this week, enjoy the party – and not to worry – there will be plenty more in the years to come.