Worth 5 minutes!
Steve
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Toronto Globe & Mail
Thursday, September 3, 1998
The End of Pop Economics
By Robin Bienenstock and Thomas Homer-Dixon
Toronto -- The current crisis in international markets highlights
inadequacies in the way economists and other analysts think about the
global
economy.
The crisis began with the devaluation of the Thai baht in the summer of
1997. It spread through Southeast Asia, battering one economy after
another,
and is now rolling through Russia and Latin America. Lately, many analysts
have concluded that economic recession in the world's emerging economies
will affect the industrialized countries of Western Europe and North
America; some even speak of impending global depression.
This crisis is far from over, yet it is already rich with ironies. Three
stand out:
Only days ago, Stanley Fischer, first deputy managing director of the
International Monetary Fund, attacked billionaire financier George Soros
for
causing panic when he called for the devaluation of the Russian ruble. How
strange to hear a senior IMF official echoing the sentiments of the
belligerently anti-Western Prime Minister of Malaysia, Mahathir Mohammad.
When Mr. Mahathir himself attacked Mr. Soros last year, he was condemned by
Western commentators for scapegoating speculators and Western-style
capitalism instead of focusing on economic mismanagement closer to home.
Since Aug. 14, the government of Hong Kong has spent billions of dollars
buying stocks on the Hong Kong stock exchange. Today, the government of
this
bastion of free enterprise owns about 6 per cent of the stock market's
entire value. Moreover, it is proposing curbs on stock and futures trading.
When Mr. Mahathir introduced similar curbs last year in Malaysia, he was
once again roundly criticized.
The non-convertibility of the Chinese currency, the yuan, is now a critical
bulwark against a deepening of the crisis. The country's policy of
insulating its economy from global capitalist pressures is thus helping to
protect the capitalist system from itself.
These developments are not only ironic, but instructive. They reveal
internal contradictions in the standard economic analysis that guides
policy-makers' responses to the crisis.
Briefly, the standard analysis runs as follows. The boom cycle of the early
1990s in the East Asian economies was powered by cheap labour, government
commitments to export-industries, close co-operation between government and
business leaders, and liberal lending by domestic and foreign banks. All
these factors generated strong optimism among investors about prospects for
economic growth. But the pendulum swung too far. Many of these Asian
economies had weak institutions, especially those governing the banking
sector. As a result, lenders opened the spigots too widely, co-operation
between government and industry became collusion and corruption, and
optimism became unbridled greed. Once a series of relatively small events
such as the baht devaluation revealed the deep weaknesses of these
economies, panic ensued. Foreign lenders and investors fled, contributing
to
a credit squeeze that choked off growth.
Such explanations are fine to a point, but they miss many things. First,
they suggest that North American and European investors are largely
blameless in the creation of this crisis or even that they are victims of
developing-country profligacy. Thus, a recent Globe and Mail editorial
argued that "even provident members of the world community pay the price
for
their wayward neighbours."
Second, they imply that economic analysis alone gives us an adequate grasp
of key social processes. Economic factors are assumed to trump all others
in
the shaping of our societies' destinies.
Finally, and most important, these explanations are, at base, mechanistic.
Conventional economic analysis assumes that economies work much like
clocks:
They are finely crafted machines that exhibit clear cause-and-effect
relations among their parts. In such machines, the twist of a screw here or
the turn of a nut there, whether an increase in interest rates or a cut in
government spending, produces predictable and easily calibrated results.
Reality, as the current crisis shows, is much more complex and not at all
machine-like. The global economic system now resembles, rather than the
closed and predictable mechanism of a clock, something closer to the open
and chaotic system of the weather. In the world of international finance
and
trade, modern computer and communication technologies have sharply
compressed time and space, and boosted traders' ability to move vast
amounts
of capital instantaneously. Market-relevant information, both fact and
rumour, also moves at the touch of a button. These changes have produced
market forces far stronger than any single government.
Researchers in the field of "complexity theory" are developing new ways of
thinking about such phenomena. They have found that economies, ecologies
and
the Earth's weather have certain common features. For instance, in complex
systems a small event like the baht devaluation can trigger an avalanche of
consequences that is both entirely unpredictable and far larger than the
original event. As these consequences cascade into one another -- as, for
example, one Southeast Asian economic collapse precipitates another --
people trying to steer the system have little opportunity for analysis,
reflection or intervention. Key components of complex systems are often
tightly "coupled," or bound together.
In today's global economy, this means that no single actor or group of
actors can be held either entirely blameless or entirely responsible for
the
current debacle. Just as the Russian, Japanese and Indonesian governments
are guilty of poor economic management, so are German, British and American
banks guilty of too-liberal lending.
Partly because of the characteristics mentioned above, complex systems can
behave one way for a long time and then, quite unlike clocks, suddenly
cross
a threshold and start behaving entirely differently. In East Asia, we see
that a self-reinforcing cycle of investment, profit, consumption and more
investment has suddenly flipped to a negative cycle of falling investment,
failing banks and crashing consumer demand.
Lastly, complex systems are invariably composed of many separate
subsystems.
There is more to the current crisis than economics; the world's economic,
political and even ecological subsystems are tightly interlinked. Yet
standard economic analysis has little to say about the political gridlock
in
Japan, Russia and the United States that is powerfully contributing to
inaction, even paralysis, on the economic front in these countries.
Standard
analysis has even less to say about the ecological disasters -- such as
last
year's wildfires in Indonesia and the recent flooding in China -- that
exacerbate economic problems. China's flooding alone may knock several
percentage points off the country's growth this year, which could tip the
balance against its struggle to maintain the value of the yuan.
Policy responses to the current global crisis are grounded in a standard
interpretation of how economies work. But the standard interpretation
cannot
adequately explain some of the events we see; what's more, it produces the
kinds of policy inconsistency we highlighted at the beginning of this
article. National governments and international agencies like the IMF are
sending contradictory signals by, for example, praising the salutary
effects
of free markets on the one hand and condemning the activities of
speculators
on the other. These inadequacies and inconsistencies not only make it
difficult to resolve the crisis, but may lead us deeper into it.
Theories about the behaviour of complex systems are still in their infancy,
but researchers around the world are pushing back our frontiers of
understanding. A better understanding of today's complex, interlinked
global
systems cannot arrive too soon.
Robin Bienenstock is writing her doctoral thesis on complexity theory at
the
University of Toronto. Thomas Homer-Dixon is director of the Peace and
Conflict Studies Program at the University of Toronto.
