Capital Rues

Capital Rules: The Construction of Global Finance, by Rawi Abdelal, Harvard University Press, 304 pages, $52.50

The Bridge at the Edge of the World: Capitalism, the Environment, and Crossing From Crisis to Sustainability, by James Gustave Speth, Yale University Press, 295 pages, $28.00


In the quarter-century after World War II, a unique social compromise thrived in the West. National governments assured rising incomes and social benefits for ordinary citizens; entrepreneurs enjoyed steady growth and reasonable profits -- but the prerogatives of financial capital were subordinated to the health of the real economy of goods, services, and wages. At the heart of this social settlement was an unprecedented set of controls on speculative movements of international money. The designers of these controls -- the fathers of the Bretton Woods Accord of 1944 -- understood that if speculative capital ruled globally, it would wreck the capacity of national governments to maintain balanced forms of capitalism domestically. Recent events have surely proved them right.

The most prescient of these architects was John Maynard Keynes. For most readers, Keynes' prime insight concerned the role of aggregate demand in the economy and the need for government deficit spending during slumps. But Keynes' even greater contribution and practical achievement was the construction of a global system of constraints on private finance; otherwise, private capital would flee from nations that pursued egalitarian or Keynesian policies.

The system of capital controls invented at Bretton Woods turned economic orthodoxy on its head. From about 1870 to 1914, totally free global movement of capital was both standard practice and conventional wisdom. The only regulatory mechanism was a largely private one -- the gold standard, which determined currency values and maintained confidence in them. But efforts to re-establish the gold standard after World War I turned into an economic straitjacket. Coming out of the Great Depression and World War II, Keynes and company realized that for a managed form of capitalism to work nationally, the regime governing finance had to operate globally.

Today, those controls on capital, and the stable, mixed economic system that they anchored, are a distant memory. What happened? This is the question that Rawi Abdelal addresses in his brilliant and authoritative book, Capital Rules. As Abdelal writes, "How and why did the world shift from an orthodoxy of free capital movements in 1914 to an orthodoxy of capital controls in 1944 and then back again by 1994?"

In the course of pursuing answers, Abdelal, a young professor at the Harvard Business School, spoke with nearly a hundred of the most-important players at senior levels of national governments, banks, and international agencies. His appendix of interviews reads like Alan Greenspan's rolodex. He also spent years in the archives of international and domestic agencies, and what he found is full of rich, often surprising insights.

The standard account is that "neoliberals" in the Anglo-Saxon countries, notably under Ronald Reagan, Margaret Thatcher, and their Chicago School allies, deliberately destroyed the more managed market system. This is either a triumph or a disaster depending on your view, but Abdelal's account is far less conspiratorial and more nuanced. By the time he finishes puzzling out the issue, Abdelal, who began as an agnostic, persuades himself and the reader that letting speculative global capital loose for the second time in a century was indeed a catastrophic and needless misstep. His story, however, is replete with paradoxes.

As Abdelal recounts the tale, the Bretton Woods system of capital controls started leaking as early as the late 1950s. In that era, because of the huge American trade surpluses -- those were the days! -- stateless dollars began piling up offshore, mainly in London. But the Americans and British adopted a policy of benign neglect. So, financial institutions could lend these "Eurodollars," exempt from the general system of capital controls.

In a variation on Gresham's Law (the weak currency crowds out the strong one), an unregulated parallel system undermined the official regulated one. This leakage, of course, required the acquiescence of governments. But two decades after Bretton Woods, in the era of Dwight Eisenhower and Harold Macmillan, governments were in a far less interventionist mood. Instead of updating the Bretton Woods system to constrain the latest innovations of private markets, governments mostly let financial markets alone. Cheered on by conservative economists, the United States then abandoned fixed exchange rates in 1971–1973 and let the dollar float, pulling out another of the key props to the Bretton Woods system. With the accession of Thatcher (1979–1990) and Reagan (1981–1989), the freest possible movement of money and goods globally and domestically became the new orthodoxy.

Where Abdelal deliciously complicates the story is in his account of the role of French socialists, of all people, in pounding the final nail into the Bretton Woods coffin. After the sluggish 1970s, the government of François Mitterrand, which took office in 1981, was determined to create social democracy in one country -- higher wages, faster growth, more social outlay. But by 1981, the ability of private capital to flee egalitarian societies -- the problem that had so concerned Keynes -- was already largely restored. After capital flight wrecked the first Mitterrand program, his architects shifted course and decided to fight fire with fire.

Mitterrand's key lieutenants, most notably Jacques Delors, later the father of the modern European Union, and Delors' chef de cabinet, Pascal Lamy, who now heads the World Trade Organization, concluded that if they couldn't have managed capitalism in one country, they could perhaps have it on one continent. Their bargain with the far more libertarian Germans led not only to a grander European Union, with a true single market and later its own currency and central bank, but also included the most un-socialist of ideas about global capital movements: Mitterrand's men sweetened the deal with a requirement that all member nations of the EU would have to abandon all capital controls, not just with other EU members but with all nations. They also pressed (unsuccessfully) to make totally free capital movement a universal requirement, through the Organization for Economic Co-operation and Development. In return, they hoped, international agencies would gain new global regulatory power over finance. They grandly termed this approach "managed globalization" -- mondialization maîtrisée. At the very least, they hoped, there would be more regulation of capital within Europe.

Alas, it didn't work out that way. The Anglo-Saxons had no interest in globalization managed by international bureaucrats, least of all French ones. As the sub-prime mess shows, private capital has overwhelmed regulatory constraints of all kinds, both domestically and globally. As Abdelal tells the story, one incremental liberalization logically led to another over a 40-year period. And though it is fashionable to assert that technological changes -- the Internet, electronic transactions -- made deregulation inevitable, Abdelal reminds us that similar global money movements were common, via telegraph, before World War I, but regulators nonetheless put the genie back in the bottle.

To choose just one example from his catalog of needless and heedless liberalization: The IMF, World Bank, U.S. Treasury, and private money markets gradually delegated increased power to private bond-rating agencies such as Moody's and Standard and Poor's. Through their power to rate government bonds, these private entities came to define which domestic economic policies were "sound." The sovereign bonds of nations that had no controls on capital got better ratings than the bonds of countries that attempted to manage their economies in the manner of the original Bretton Woods. This was, of course, an ideological preference, not a technical determination, but it constrained national policies. And these were the same bond-rating agencies that so disastrously misjudged sub-prime.

As Abdelal shows, the consensus on the genius of free capital movements has been largely proved wrong by events. Abdelal first came to prominence for his study of Malaysia, the one nation in the Asian financial crisis of the late 1990s that refused to abandon capital controls. He persuasively and bravely (he was untenured at the time) showed that this policy was far superior to the available alternatives. When he presented his findings as his maiden case report at the Harvard Business School, he was ridiculed by then Harvard president Larry Summers -- who later publicly apologized.

In Abdelal's account, the United States was largely a bystander to this unfolding process, mainly stepping in to veto efforts to combine liberalization with new forms of regulation. His study is prodigious and path-breaking, but I think this aspect of his interpretation is a bit misleading. He understates the prime role of the Anglo-Saxons in allowing the system of capital controls to collapse in the first place, and the libertarian shift only became more explicit with Thatcher and Reagan. By the 1980s, when the French got around to trying to restore the earlier rules, the damage had already been done. The French socialists were simply playing a very weak hand as best they could.

Though Abdelal is American (his father emigrated from Egypt), his narrative is told almost from a French viewpoint. It reads as if he spent a little too much time in Paris -- I can sympathize -- and almost none in London. Indeed, not a single British government official is on his interview list. Thatcher, who famously liberalized London's capital markets with a "big bang," gets one paragraph; Tony Blair, who sold financial Thatcherism to the center left and then used the EU as an instrument of banking deregulation in the interest of the City of London, doesn't even rate a mention.

Despite this one blemish, Abdelal's book is the definitive account of the politics of global financial deregulation -- and its increasingly disastrous consequences. It is instructive that a Harvard Business School scholar became increasingly radicalized the more deeply he looked into the process. Other experts are now having second thoughts about the wisdom of letting speculative capital dominate the real economy. Abdelal finds it ironic that while most casual observers believe the European Union to be the last bastion of managed capitalism, the EU is now the temple of financial liberalization: "The orthodoxy of capital's freedom seems to have been undermined everywhere except for Brussels, in part because the codified norm of capital liberalization for European states is literally not open to interpretation."

Though Abdelal's grasp of finance is sure, his elegant essay style is more in the genre of political history than in technical economics. How to make financial capital once again servant rather than master will dominate public debate for the next decade. And speaking of finance, Harvard University Press should find a way of selling Capital Rules for less than $52.50, for this book deserves the widest general audience of serious people.

If the need to once again harness finance in the broad economic interest is one pressing challenge of our young and turbulent century, another is surely the need to save the planet itself. James Gustave Speth, long a respected environmental leader, an adviser to President Jimmy Carter, and now a dean at Yale, has written a powerful account of his own radicalization based on his deepening examination of the environmental perplex. As Speth notes, environmental degradation is closely linked to the two other ills of our time: "growing social inequality and neglect and the erosion of democratic governance and popular control." (Had he been writing six months later, Speth would have added to this list financial collapse.) Like Abdelal, Speth concludes that the broader problem is the perversity of capitalism itself. "The fundamental question thus becomes one of transforming capitalism as we know it."

Speth begins The Bridge at the Edge of the World by providing a succinct, well-crafted, and thoroughly documented summary of environmental calamities. His subheads read almost like the biblical 10 plagues: Climate Disruption; Losing the Forests; Losing the Land; Losing Freshwater; Losing Marine Fisheries; Toxic Pollutants; Losing Biodiversity. We have heard much of this before but rarely as crisply summarized in one authoritative chapter. The writing is deeply humane, witty, uplifting, and modest rather than pretentious.

The dynamics of capitalism, Speth argues, are at the crux of these problems: "When prices reflect environmental values as poorly as today's prices do, the system is running without essential controls." He calls for a radically different set of economic policies to accurately price the true costs of environmental degradation and to harness new technologies. He goes on to link an out-of-control market system to the array of other social ills, drawing on his extensive knowledge of issues of global human development.

The book reads as if Speth, now in the fifth decade of a distinguished career, decided to take some time out and immerse himself in a small library of works on modern capitalism. The result is a superb synthesis of the great economic questions of our time: how to reconcile markets with environmental sustainability; efficiency with equality; and trade and global openness with socially defensible standards of living. These are ultimately political questions, not technical ones. Speth calls, first and foremost, for an invigorated democracy, at all levels, as the necessary counterweight to rapacious capitalism.

This allocation of central blame to capitalism might sound almost Marxian, but Speth writes less in the mode of Marx and more in the spirit of Karl Polanyi, a non-Marxist who composed a more persuasive account of capitalism overwhelming civil society. Speth observes, "It is true but too easy to say that the resistance will come from entrenched interests. It will also come from ourselves. We are the consumers and the employees, and we are easily seduced." But in the end, despite his depressing catalog of ills, Speth remains a warm-hearted optimist. There are, he concludes, "solid grounds for hope" -- in new scientific and technical breakthroughs that put sustainability and decent living standards on the same side and in the emergence of a global civil society.

There is historical precedent for this optimism. As Abdelal reminds us, during the quarter-century after 1944, the year both of the Bretton Woods Accord and the publication of Polanyi's masterwork, The Great Transformation, it was indeed possible to balance the dynamism of markets with other social imperatives. All it took was a far more robust democratic politics.

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