economic policies of the Western democracies, market capitalism began
quietly to displace those policies in much of the world. Central planning
was no longer a subject for debate. There were no eulogies. Except in North
Korea and Cuba, it was dropped from the world's economic agenda.
Not only did the economies of the former Soviet bloc, after some chaos,
embrace the ways of market capitalism, but so did most of what we previously
called the third world—countries that had been neutral in the cold
war but had practiced central planning or had been so heavily regulated
that it amounted to the same thing. Communist China, which had edged
toward market capitalism as early as 1978, accelerated the movement of
its vast, tightly regulated, then more-than-500-million-person workforce toward
the Free Trade Zones of the Pearl River delta.
China's shift in protecting the property rights of foreigners, while subtle,
was substantial enough to induce a veritable explosion in foreign direct
investment (FDI) into China following 1991. From a level of $57 million
12
I NTRODUCTION
in 1980, FDI drifted upward, reaching $4 billion in 1991, and then accelerated
at a 21 percent annual rate, reaching $70 billion in 2006. The investment,
joined with the abundance of low-cost labor, resulted in a potent
combination that exerted downward pressure on wages and prices throughout
the developed world. Earlier, the much smaller so-called Asian Tigers,
especially South Korea, Hong Kong, Singapore, and Taiwan, had showed
the way by engaging developed-country technologies to bring their standard
of living sharply higher through exports to the West.
The rate of economic growth of these and many other developing nations
far outstripped the rate of growth elsewhere. The result has been the
shift of a significant share of the world's gross domestic product (GDP)
to the developing world, a trend with dramatic ripple effects. Developing
countries typically have much higher savings rates than do industrialized
nations—in part because developing nations' social safety nets are weaker,
so households naturally set aside more money for times of need and retirement.
(Other factors also play a part. In the absence of well-established
consumer cultures, for example, households have less inclination to spend.)
The shift of shares of world GDP since 2001 from low-saving developed
countries to higher-saving developing countries has increased world saving
so much that the aggregate growth of savings worldwide has greatly exceeded
planned investments. The market process that equalizes actual
global saving and investment, we have to assume, has driven real interest
rates (nominal interest rates adjusted for inflation expectations) markedly
lower. Or to put it another way, the supply of funds looking for a return on
investment has grown faster than investor demand.
The apparent excess in savings, combined with globalization,
technology-driven increases in productivity, and the shift of workforces
from centrally planned economies to competitive markets, has helped suppress
interest rates both real and nominal and rates of inflation for all developed
and virtually all developing nations. It is why annual inflation rates
almost everywhere (Venezuela, Zimbabwe, and Iran being notable exceptions)
are currently in single digits—one of the few times, perhaps the only
time, this has happened since the abandonment of the gold standard and
the embrace of fiat, or paper, currencies in the 1930s. What is particularly
striking about this set of forces is that, largely serendipitously, they all came
13
THE AGE OF TURBULENCE
together at the beginning of the twenty-first century. Central banks' monetary
policy was not the primary cause of the persistent decline in inflation
and long-term interest rates, but we central bankers chose to alter our policies
to maximize the long-term benefits of these tectonic shifts in global finance.
Yet for reasons I will outline later, none of these forces is likely to be
permanent. Inflation in a fiat money world is difficult to suppress.
The decline of real (inflation-adjusted) long-term interest rates that
has occurred in the past two decades has been associated with rising priceto-
earnings ratios for stocks, real estate, and in fact all income-earning assets.
The market value of assets worldwide between 1985 and 2006 as a
consequence rose at a pace faster than that of nominal world GDP (the
2001-2002 period was the notable exception). This created a major increase
in world liquidity. Stock and bond prices, homes, commercial real
estate, paintings, and most everything else joined in the boom. Homeowners
in many developed nations were able to dip into their growing home
equity to finance purchases beyond what their incomes could finance. Increased
household spending, especially in the United States, absorbed
much of the surge of exports from the rapidly expanding developing world.
As the Economist put it at year-end 2006, "having grown at an annual rate
of 3.2% per head since 2000, the world economy is over halfway towards
notching up its best decade ever. If it keeps going at this clip, it will beat
both the supposedly idyllic 1950s and the 1960s. Market capitalism, the
engine that runs most of the world economy, seems to be doing its job
well." Such developments have been on the whole both sweeping and positive.
The reinstatement of open markets and free trade during the past
quarter century has elevated many hundreds of millions of the world population
from poverty. Admittedly many others around the globe are still in
need, but large segments of the developing world's population have come
to experience a measure of affluence, long the monopoly of so-called developed
countries.
If the story of the past quarter of a century has a one-line plot summary,
it is the rediscovery of the power of market capitalism. After being forced
into retreat by its failures of the 1930s and the subsequent expansion of
state intervention through the 1960s, market capitalism slowly reemerged
as a potent force, beginning in earnest in the 1970s, until it now pervades
14
I NTRODUCTION
almost all of the world to a greater or lesser extent. The spreading of a commercial
rule of law and especially the protection of the rights to property
has fostered a worldwide entrepreneurial stirring. This in turn has led to
the creation of institutions that now anonymously guide an ever-increasing
share of human activity—an international version of Adam Smith's "invisible
hand."
As a consequence, the control of governments over the daily lives of
their citizens has lessened; the forces of the marketplace have gradually
displaced some significant powers of the state. Much regulation promulgating
limits to commercial life has been dismantled. Throughout the early
post-World War II years, international capital flows were controlled and
exchange rates were in the grip of finance ministers' discretion. Central
planning was widespread in both the developing and the developed world,
including remnants of the earlier dirigiste planning still prominent in Europe.
It was taken as gospel that markets needed government guidance to
function effectively.
At the meetings in the mid-1970s of the Economic Policy Committee
of the Organization for Economic Cooperation and Development (OECD),
made up of policymakers from twenty-four countries, only HansTietmeyer
of West Germany and I were pressing for market-based policymaking. We
were a very small minority on a very large committee. The views of John
Maynard Keynes, the great British economist, had replaced those of Adam
Smith and his classical economics when the Great Depression of the 1930s
failed to follow Smith's model of the way economies were supposed to behave.
Keynes offered a mathematically elegant solution to why the world
economy had stagnated and how government deficit spending could bring
prompt recovery. Keynesian interventionism was still the overwhelmingly
dominant paradigm in the mid-1970s, though it was already on the cusp of
decline. The consensus within the Economic Policy Committee was that
letting the market set wages and prices was inadequate and unreliable and
needed to be supplemented by "incomes policies." These differed from
country to country, but generally set guidelines for wage negotiations between
unions, which were very much more widespread and powerful than
today, and management. Incomes policies fell short of all-out wage and
price controls in that they were ostensibly voluntary. The guidelines, how
15
THE AGE OF TURBULENCE
ever, were generally backed up by the regulatory levers of government
which were employed to "persuade" transgressors. When such policies
failed, formal wage and price controls were often the response. President
Nixon's ill-fated, though initially immensely popular, wage and price controls
of 1971 were among the last vestiges of postwar general wage and
price interventionism in the developed world.
In my early schooling, I had learned to appreciate the theoretical elegance
of competitive markets. In the six decades since, I have learned to
appreciate how theories work (and sometimes don't) in the real world. I
have been particularly privileged to have interacted with all the key economic
policymakers of the past generation, and to have had unparalleled
access to information measuring world trends, both numerical and anecdotal.
It was inevitable that I would generalize on my experiences. Doing
so has led me to an even deeper appreciation of competitive free markets
as a force for good. Indeed, short of a few ambiguous incidents, I can think
of no circumstances where the expanded rule of law and enhanced property
rights failed to increase material prosperity.
Nonetheless, there is persistent widespread questioning of the justice of
how unfettered competition distributes its rewards. Throughout this book
I point to the continued ambivalence of people to market forces. Competition
is stressful because competitive markets create winners and losers. This
book will try to examine the ramifications of the collision between a rapidly
changing globalized economy and unwavering human nature. The economic
success of the past quarter millennium is the outcome of this struggle;
so is the anxiety that such rapid change has wrought.
We rarely look closely at that principal operating unit of economic
activity: the human being. What are we? What is fixed in our nature and
not subject to change—and how much discretion and free will do we have
to act and learn? I have been struggling with this question since I first knew
to ask it.
As I've traveled across the globe for nearly six decades, I have found
that people exhibit remarkable similarities that by no stretch of the imagination
can be construed as resulting from culture, history, language, or
chance. All people appear motivated by an inbred striving for self-esteem
that is in large part fostered by the approval of others. That striving deter
16
I NTRODUCTION
mines much of what households spend their money on. It will also continue
to induce people to work in plants and offices side by side, even though
they will soon have the technical capability of contributing in isolation
through cyberspace. People have an inbred need to interact with other
people. It is essential if we are to receive their approval, which we all seek.
The true hermit is a rare aberration. What contributes to self-esteem depends
on the broad range of learned or consciously chosen values that people
believe, correctly or mistakenly, enhance their lives. We cannot function
without some set of values to guide the multitude of choices we make every
day. The need for values is inbred. Their content is not. That need is
driven by an innate moral sense in all of us, the basis upon which a majority
have sought the guidance of the numerous religions that humans have embraced
over the millennia. Part of that innate moral code is a sense of what
is just and proper. We all have different views of what is just, but none can
avoid the built-in necessity of making such judgments. This built-in necessity
is the basis of the laws that govern every society. It is the basis on which
we hold people responsible for their actions.
Economists cannot avoid being students of human nature, particularly
of exuberance and fear. Exuberance is a celebration of life. We have to perceive
life as enjoyable to seek to sustain it. Regrettably, a surge of exuberance
sometimes also causes people to reach beyond the possible; when
reality strikes home, exuberance turns to fear. Fear is an automatic response
in all of us to threats to our deepest of all inbred propensities, our will to
live. It is also the basis of many of our economic responses, the risk aversion
that limits our willingness to invest and to trade, especially far from home,
and that, in the extreme, induces us to disengage from markets, precipitating
a severe falloff of economic activity.
A major aspect of human nature—the level of human intelligence—
has a great deal to do with how successful we are in gaining the sustenance
needed for survival. As I point out at the end of this book, in economies
with cutting-edge technologies, people, on average, seem unable to increase
their output per hour at better than 3 percent a year over a protracted period.
That is apparently the maximum rate at which human innovation can
move standards of living forward. We are apparently not smart enough to
do better.
17
THE AGE OF TURBULENCE
The new world in which we now live is giving many citizens much to
fear, including the uprooting of many previously stable sources of identity
and security. Where change is most rapid, widening disparities in the distribution
of income are a key concern. It is indeed an age of turbulence, and
