In the End, the Forces of Wealth Creation Will Dominate Those of Wealth Redistribution

This commentary is based on a paper delivered at the Cato Institute on Oct. 21. This article appeared in Bridge News on November 2, 1999
Economic forces constitute an irresistible force, while some political institutions tend over time to become immovable objects.

Even those political institutions that are intended to improve the workings of markets tend to become immovable objects through institutional obsolescence.

The ultimate implication of a conflict between irresistible economic forces and immovable political institutions (which could be organizations or rules) is that institutions must change, or they will fail.

In other words, there must be an effective political and economic regeneration in which various institutional arrangements, especially organizations, take on the characteristics of living organisms—that is, they must be adaptable to a changing environment.

The institutions that define the parameters of our global economy are evolving. Propelled by technological change and chance economic events, these institutions undergo a continual process of change. Those qualities that enhance economic well-being tend to survive, and those that do not eventually disappear.

People adopt institutions—laws, rules, conventions and customs—to define and enforce property rights and, more generally, to reduce the costs of economic exchange.

Just as tangible manufactured goods must compete in the global town square, institutional arrangements are also tested against others in the international arena.

Ideas must face the competition no less than goods and services, and politicians must now appease two sets of voters: citizens at the local ballot box and financial managers in global capital markets.

Domestic ballot-box voters respond well to politicians who pander to their craving for wealth-sharing programs. Capital-market voters survey the world for those who pursue the best wealth-creation policies.

Gaining the support of one is almost surely to diminish support from the other.

The spread of democracy reduces the possibility of the even more perverse outcome in which governments redistribute wealth away from their own citizens toward foreigners, via various subsidies or guarantees.

In the end, just as trade barriers cannot permanently withstand the competition of better goods produced elsewhere, so too exchange and capital controls cannot serve as permanent obstacles to pressures of capital-market voters who constantly search for the best wealth-creating environment.

To prosper, every economy needs sound money.

Changes in the money prices of goods and assets convey information. If an economy’s monetary unit is known to be a stable standard of value, then changes in money prices will accurately reflect changes in the relative values of goods and assets.

That is, price fluctuations signal changes in the demand for, or supply of, goods or assets. Resource utilization then shifts toward more valued uses and away from those less valued.

During the Asian crises of 1997, broad macroeconomic policies (fiscal policies, monetary policies and balance-of-payments accounts) did not raise any warning flags.

Instead, the less obvious underlying flaws in the domestic financial markets (especially the banking companies) were revealed to be pervasive.

Undercapitalization, connected lending, inadequate supervision, duration mismatches, uncovered exchange-rate exposure and other flaws were exposed in the post-mortem of the financial duress of the so-called currency crises.

It is tempting to say that what is needed is an international organization responsible for working toward global adoption of sound banking and other financial market practices.

However, the idea of empowering a “conditionality enforcer of first or only resort” is troublesome. Some combination of carrots and sticks will always be present. Whether carrots or sticks dominate will change over time, depending on personalities and political environment.

I doubt anyone would defend a view that what is needed is a “global financial policeman-prosecutor-judge-jury and executioner” all rolled into one.

To some people, the world’s capital markets may seem, at times, like the wild, wild West, but they would still stop short of a call for a financial Judge Roy Bean.

Instead, we might think that a “financial night watchman” would better serve as the role model for the professional staff of any international organization that is empowered to work on behalf of creditor nation states.

A common element of all financial crises of recent years was the existence of government guarantees—to pensioners, producers, intermediaries and so on—that were revealed to be unsustainable.

The sooner the revelation, the better the countries were equipped to eliminate the distortions without a crisis, and to this end an international organization might truly add value.

There is little doubt that recent crises reflect the increased scrutiny of financial discipline imposed on a country’s policies and institutions by foreign investors and lenders.

Global market participants have become a class of stateless voters, roaming around the world’s economies in search of the best wealth-creating institutions. They represent an irresistible force.

There is, however, a core tension between the interests of market participants and the incentives of local politicians to redistribute, rather than create, wealth.

In the end, the forces of wealth creation will dominate those of wealth redistribution. The adjustment process has not been, and will not be, a smooth one.

Achieving discipline, though painful, will have a positive effect. As the president of Korea said earlier this year, there is a “silver lining” to the Asian currency crisis. The restructuring and reforming of the banking institutions now occurring in Asia will leave it better off in the long run.

This final decade of the millennium has seen considerable financial market turbulence. At the end, though, we have already evolved toward a more stable global monetary order.

Jerry L. Jordan is president and chief executive officer of the Federal Reserve Bank of Cleveland.