In the last column (BS, May 15) I had discussed the rise, fall and rise of a liberal international economic order (LIEO) over the last 200 years. What of the future? Is this new worldwide Age of Reform likely to be more permanent than its 19th century predecessor? There are auguries both favourable and unfavourable.
To take the latter first. The desire to view the state as an enterprise association still lingers on, as part of social democratic political agendas in many countries. It has ancient roots and is unlikely to die. It has now adopted a new voice, which has been labelled constitutional mania. It emphasises substantive social and economic rights in addition to the well-known rights to liberty freedom of speech, contract, and association emphasized by classical liberals. It seeks to use the law to enforce these rights based partly on needs, and partly on the equality of respect: desired by a heterogeneity of self-selected minorities differentiated by ethnicity, gender and/or sexual orientation. But no less than in the collectivist societies that have failed, this attempt to define and legislate a newly discovered and dense structure of rights (including for some activists those of non-human plants and animals) requires a vast expansion of the governments power over peoples lives. Their implementation
moreover requires at the least some doctoring of the market mechanism.
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In the international sphere this has led to demands by developed countries for the inclusion of environmental and labour standards in the WTO, as well as recent attempts to thrust Western moral values (democracy and human rights) down foreign throats using the threats of unilateral trade restrictions. All these inevitably poison international relations. The threat posed by a gradual erosion of the LIEO, from the nagging bad temper this generates, resembles that which led to its predecessors slow unraveling in the late 19th century. Whilst many voices are resurrecting the sceptre (particularly of the low skilled), and thence their social harmony from pauper labour imports.
This is particularly worrying as it echoes various fears in the late 19th century of the social disruptions and discontent caused by the Industrial Revolution. Another great structural change is taking place in Western economies, whose short term consequences could be painful and trigger another dirigiste reversal of the emerging LIEO.
It may be worth spelling this out. The late Sir John Hicks saw the substitution of fixed for circulating capital as the distinguishing feature of the Industrial Revolution.
But, as Ricardo in his chapter on Machinery noted, this structural change could be accompanied by a temporary stagnation or even reduction in employment and output whilst the adjustment was taking place; though at the end of the process the productive power and hence level and growth rate of output and employment would be higher. This explains why it took a long time in Britain for the Industrial Revolution to raise overall living standards, and why during the period of adjustment the older handicraft workers (using circulating capital in various forms of the putting out system) suffered, until they were eventually transformed into much richer industrial workers.
Today a similar process is underway in the West, with the increasing substitution of human for fixed capital in its newly emerging information age service economies. This process has been accelerated by the emerging LIEO as the unskilled labour rich countries of Asia particularly China and India go through their own industrial revolutions, and increasingly specialise in the production for export of those manufactures on which workers particularly the low skilled had depended in the past in the West. In California, for instance, much of the recent spurt in employment and growth is in what are termed virtual factories. These are design and wholesaling outfits whose production bases are scattered over southeast Asia. They take orders for virtually bespoke products whose production is contracted to the international source which is the least cost and likely to meet tight production deadlines. The head of the virtual factory is in California, and its body in labour rich Asia. But for India to
benefit from this emerging international division of labour it will have to undertake reforms on the two areas underlined in previous columns the provision of adequate infrastructure and the creation of flexible labour markets.
In the West, this ongoing substitution of human for fixed capital is an unavoidable means for maintaining and raising its living standards. But during the process of adjustment it is inevitable that initially the premiums of human capital should rise, as this provides the signal for workers to upgrade their skills. Rising skill premiums accompanied by stagnant unskilled real wages are evident in all Western countries. Those countries, mainly in Europe, which have prevented this signal from working have unskilled they have the much worse problem of high and rising unemployment rates. Despite the siren voices calling for protection from Third World imports to ease these problems, for the West to follow their advice would be a snare and a delusion. But, as the rise of protectionism based on the equally deluded infant industry arguments of Hamilton and List in the late 19th century demonstrates, such snares are not always avoided. At a time when the Third and Second worlds have enthusiastically embraced the LIEO
it is the temptation for harried Western governments for turning their back on the world they had created which constitutes the greatest threat to the future of the new global LIEO.
Against these there are many hopeful signs. The most important is that, as in pre-modern times, States are finding it more and more difficult to find the resources to continue (or increase) their enterprise. This is partly because of the worldwide growth in tax-resistance, and most important the virtually complete integration of international financial markets. The latter has strengthened the former. Nor is a reimposition of exchange controls to stop this process likely, if for no other reason than that it would now have to be adopted and enforced worldwide.
These provide the strongest grounds for optimism that the cycles in the rise and fall of the LIEO may be at an end. The instincts of the State through most of human history have been predatory. The integration of world financial markets provides a bulwark against these base instincts like tying Ulysses to the mast. Every government is now concerned about the rating of its country and its enterprises by world capital markets. Bad policies or at least those disapproved of by world capital markets can lead to an instantaneous reduction in a countrys wealth, and the terms on which it can acquire the means to increase it. The recent trend in fiscal rectitude is no longer a matter of choice but necessity. With massive global flows of capital triggered at the press of a button, governments are now faced with an instantaneous international referendum on their fiscal and monetary policies. The Central Bank or Treasury proposes but the money market disposes!
(The author is the James Cloeman Professor of International Development Studies, University of California , Los Angeles)