At a time when many countries are struggling, the debate over government’s involvement in the free market is becoming more prominent. Jules Gray looks at the different active and passive options the public sector can consider, and how globalisation can help
Around the world, governments are exercising different degrees of fiscal and monetary meddling in response to the financial crises. As the world recovers from the 2008 economic meltdown, the question of how much intervention a government should exercise has reared its head, and has been based on ideology, economic input, and panic.
The effect these economic changes have on international trade are phenomenal, and businesses operating in new and existing markets must be aware of the atmosphere they will encounter. Does the government heavily tax FDI in order to curb imports? Does the central monetary authority allow interest rates to fluctuate rapidly? These are questions executives working to an international remit must consider.
Around the world, countries have developed different ways of operating, but over the last few decades a prevalence of free-market thinking has dominated developed countries, promoted in the US by Milton Friedman and the Reaganomics that shaped that economy during the 1980s, and by Margaret Thatcher and later Tony Blair in the UK.
However, doing business in these jurisdictions has become strained, as the free-market pushed freedom too much and regulatory bodies have failed to limit rogue growth plans, the result of which we are experiencing now in light of the subprime mortgage crisis. China, on the other hand, has traditionally taken a more controlling role in their economy, with the communist state carefully managing output and becoming more and more of a viable option for international business – and their balance sheets.
However, much of the soaring growth that the Chinese economy has seen over the last few decades was instigated by the reforms of leader Deng Xiaoping between 1978 and 1992. Indeed, it was Xiaoping who moved away from the ideological restrictions of communism to a more pragmatic system, welcoming international trade and opening its doors to corporate integration.
Global trade frowns on interventionism
International business is often put off by the idea of an interventionist government, for many reasons. That said, the lessons of a free-roaming system with little regulation are becoming all too clear in Europe and North America, where, in particular, negligent banking systems have forced economies to a state of paralysis.
Opponents of interventionism argue that the central planning of an economy will be threatened by the law of unintended consequences, as well as preventing the market from correcting itself. Some argue that banks considered too big to fail should not have been propped up by the state, and instead allowed to collapse, providing a far harsher lesson to the people that caused the crisis than has otherwise been felt.
However, in practise, the decisions rest on how serious the consequences will be for the economy. For example, Lehmann Brothers, on the one hand, was allowed to file for bankruptcy in 2008, while just a few days later AIG was given state aid as it was felt it would have too severe consequences for the US economy were it to collapse. The set back to international trade in the US hasn’t still fully been worked out yet.
The monetarist school of thought that emerged from the University of Chicago in the 1940s claimed that free markets could best allocate resources within an economy, and encouraged minimal government intervention other than controlling the interest rate through the money supply. The main proponent of the Chicago School was economist Milton Friedman.
Friedman strongly believed that governments should allow the market to be free to operate naturally, without excessive intervention from politicians. Known for his disdain of wastage of centralised governments, he said of the US federal government: “If you put the federal government in charge of the Sahara Desert, in five years there would be a shortage of sand.” He also felt that a free market was the fairest way for an economy to operate, adding: “The most important single central fact about a free market is that no exchange takes place unless both parties benefit.”
Monetarists offer cash, Keynesians step in
As monetarists step in to toy with a currency and the flow of income, international businesses involved with a nation with a monetary-heavy doctrine might find themselves struggling in a crisis. It’s often argued that a liquidity gap can be caused by too much monetary meddling, and its roundly agreed by economists that fiscal policies are required to lift an economy from the current Great Recession. For those executives considering working in countries infatuated with monetary policy, it’d be wise to look into fluctuating interest rates.
Strict government control over both monetary policy and intervention in the marketplace is often cited as the best way to grow a stable economy and aid international business. Keynesian policies believed that in order to mitigate the effects of recessions and depressions, governments should take control of fiscal and monetary policy to stimulate growth. Global trade is said to benefit from a well-considered Keynesian approach, in which imports and exports benefit from better growth plans. In recent years for instance, the Australian government has encouraged growth with the country’s neighbours being welcomed into the country by healthier domestic fiscal planning.
However, businesses looking to expand into new markets should be wary of
governments attempting to operate too much with the private sector. John Maynard Keynes, the author of Keynesian economics, said: “The important thing for government is not to do things which individuals are doing already, and to do them a little better or a little worse; but to do those things which at present are not done at all.”
As economies around the world suffered from the financial collapse in the US and Europe during 2008, much of the blame has been pinned on this light touch regulation that allowed financial institutions to operate in such cavalier ways. It is argued that had restrictions remained, such as the Glass-Steagall Act that prevented banks from excessive speculation that was repealed in the 1999 US banking reforms, much of the difficulty the banking industry has seen would not have occurred.
Tighter regulations on banking practices have emerged, such as Basel III and Solvency II, which are designed to maintain realistic capital levels and restrict speculation.
Governments have also been encouraged to stimulate growth by embarking on massive investment in the state, propping up employment. This has provided multinationals with more options, allowing them to better provide for their customers and seek out regions in the global marketplace perceived as having friendlier attitudes to bigger growth potential.
On the flipside, many governments have been reluctant to sanction such high levels of spending, seeing a better opportunity for growth in investment from the private sector, which they hope will take advantage of better business environments such as highly trained local workforces. Austerity measures promoted by the governments of Britain and Germany have called for a cutback in public spending and a stabilisation of debt levels.
These strategies have had mixed results, with growth in the UK stalling and a double-dip recession being blamed on the government’s commitment to cutting back on expenditure.
Calls for an influx of infrastructure spending have received cautious reactions from the UK government, who have attempted to get foreign sovereign wealth funds and large institutional pension funds to build the projects, although with limited success. Last November UK Chancellor George Osborne set a target of £20bn to be raised from pension funds th help with infrastructure, but so far only £2.5bn has been raised as regulations limit what local government pension funds can do with their money.
Addressing speculation in financial markets is seen by Keynesians as an important way to control the private sector from harming the rest of the economy. France recently introduced a financial transactions tax, which will take 0.2 percent off every share purchase. Analysts must wait to see the results for international commerce of the new tax. Keynes himself felt it would be the best way of preventing speculation damaging the economy, saying: “The introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise in the United States.”
US writes global cheques
Following the Great Depression at the beginning of the 1930s, Franklin D Roosevelt set about a series of reforms that would reshape the American economy and propel the country towards global economic dominance. The free market, as Roosevelt saw it, would reshape domestic commerce and welcome trade with other market economies, namely, Germany, France,the UK, Spain, the Netherlands, and Canada.
Roosevelt’s New Deal was based upon the principles of the ‘Three Rs’, which encouraged relief for the unemployed and poor, recovery of the economy, and the reform of the financial system to prevent another catastrophic slowdown. This would become the founding principals of global trade.
Many of the characteristics of the New Deal were designed to bolster the role of the state in supporting the economy and acting as a safety net for the poorest in society. Throughout the 1930s, Roosevelt implemented a series of acts, including the Economy Act of 1933 that proposed to balance the federal budget, initially pleasing deficit hawks. There was also banking reform – including the Glass-Steagall Act – as well as monetary reform, regulation of securities, and the Social Security Act.
It was this act, in 1935, that was the centrepiece of the entire programme, providing pensions, unemployment insurance and welfare benefits for the most needy, greatly improving the living conditions of much of the population (see fig 1). Although it took some time to kick in, as employment grew, business travellers flocked to the newly resurgent US, in an attempt to align business with the growing new world. While there was a great deal of reform in the financial system, there was also huge investment in infrastructure, with the railways and roads getting significant upgrades, while the Second World War provided the manufacturing industry with a massive boost in demand.
During the 1980s, President Ronald Reagan set about a series of reforms that drastically cut back the states involvement in the market and reduced taxation on businesses. This further generated direct investment, allowing a period of sustained growth both at home and abroad. Friedman himself was enthusiastic about the principles of Reagan’s policies, but felt that he could have gone further: “Reaganomics had four simple principles: Lower marginal tax rates, less regulation, restrained government spending, noninflationary monetary policy. Though Reagan did not achieve all of his goals, he made good progress.”
Free markets encourage globalisation
Economic liberalisation occurred in a number of countries that had previously practised firmer control over their economies. Although China still has a relatively tight grip on their economy, the reforms implemented by Deng Xiaoping in 1978 resulted in a soaring growth of the economy. Reforms included an end to the collectivisation of agriculture, a new openness to foreign investment and the encouragement of entrepreneurs to start new businesses.Throughout the following two decades, many state owned institutions were privatised, and protectionist policies were removed. The impact of these reforms can be seen from the fact that nearly 70 percent of GDP in China is from the private sector. This liberalisation can be witnessed today in the sheer volume of exports leaving Chinese soil, as well as the amount of multinationals keen to do business with Beijing.
One consequence of liberalisation that emerged from the debt crisis and hyperinflation that afflicted Latin America during the 1980s was democratisation. When stakeholders including the IMF and the World Bank set about liberalising Latin American economies, and restricting the input that governments had on economic policy, liberalisation and democratisation occurred, according to economist Nikolaos Karagiannis in his book ‘Key Economic and Politico-Institutional Elements of Modern Interventionism.’ In particular, Argentina emerged from their financial crisis because of increased privatisation and an opening up to foreign investment, making business a far more palatable option on those shores, something it has strayed from in recent years.
With a need to address the economic troubles of many western economies in recent years, the arguments about how much input governments should have in the running of the market have become louder. On the one hand, governments have been encouraged to cut back on their national deficits, with the best way to do this as a retreat of the state. However, in order to stimulate growth, these economies have been encouraged to sustain employment by investing in the same institutions.
International business must bear many of these considerations in mind when an
expansionary policy is on the cards. Both long and short term, executives stand to lose heftily should they venture into territory governed by a central body with too much input, or too little.