The astounding worldwide stock market turmoil of the past week signals a watershed in global economic development. It is a demand by global investors that all countries adapt their economies to the dictates of free markets.
Just as the fall of the Berlin Wall in 1989 marked the triumph of the American political system over communism, so the latest crisis marks the triumph of the American economic system of open markets over state-run economies.
We have seen examples of free-market triumphs in recent years. Japan, an economy that traditionally limited outside investment and competition, has been forced by seven years of recession and continual international pressure to begin opening its financial system to foreign competition and to the free-market rule that investments earn a return.
This year, smaller nations, notably Thailand and Malaysia, have felt the lash of free-market pressure. Global investors, in effect, objected to the way those countries took in the world’s investments in their infant stock markets and then poured the funds into grandiose state projects or real estate developments of dubious economic value.
Now even China has been attacked by investor skepticism. This latest crisis began in Hong Kong, where investors saw the stock exchange increasingly introducing shares in Chinese companies that were not businesses in any traditional sense of the word.
Rather, these so-called Red Chip companies were corporate shells designed to raise capital through Hong Kong so the Beijing government could inject assets into state-owned corporations and give them the appearance of private companies.
They were popular with investors with the approach of the July handover of Hong Kong to Chinese control, and such Red Chips had risen to a market value of $60 billion before the current crisis. But now Red Chips have tumbled in value along with other shares on Hong Kong’s market.
It was the most dramatic demonstration yet of the new power of global stock market investors to dictate terms to ostensibly powerful governments.
“This crisis will one day be seen as a milestone in the evolution of a truly global capital market,” said Jeffrey Garten, dean of the Yale School of Management and a former U.S. undersecretary of Commerce.
“Free markets can be great levelers. They say to every country, if you want the world’s money, we want investments that are reasonable, open, transparent and producing real returns,” Garten adds.
The battle for markets
That model of open companies, reporting to shareholders, making decisions on sound economic principles rather than national favoritism or because the project’s developer is brother-in-law of a government official, is one that the United States has long championed and largely lived by.
Its opposition in recent decades has come from the so-called Asian model of Japanese companies. They operated behind a wall of trade and investment restrictions to take advantage of access to open markets in the U.S. and other countries. But they do so without letting U.S. companies enjoy access to its huge markets. U.S. policy has fought for years to open up Japan’s system, and that battle continues.
But China presented a new and even larger Asian model. China’s policy - announced in September by President Jiang Zemin, who meets President Clinton in Washington this week - was to create 1,000 large state-owned companies. Some of them, Chinese officials declared, would qualify for the Fortune 500.
But they wouldn’t be like IBM or other companies on that list of the largest corporations. If IBM wishes to raise money from stock investors, it must issue a detailed prospectus explaining what it is going to do with the funds and how it plans to earn a return on investment. And government regulators must verify the claims in the prospectus.
China’s companies, state-controlled in a system that does not believe in full disclosure, would not have to go through such explanations. Rather, say numerous Western business negotiators in China, officials there seem to think the world’s capital should be forthcoming simply because they want to build their planned infrastructure projects.
This crisis has come about because the world’s investors have declared such terms unacceptable.
The markets’ challenge to state economies has been met with howls of protest. Malaysia’s ruler, Mahathir Mohammed, and others in Asia have charged that their currency devaluations were coerced by a conspiracy of speculators.
But the pension funds and mutual funds of the world are not speculators. By and large they are patient investors seeking to earn returns with which to pay pensions and social benefits to their clients.
The pension and mutual funds, now grown to trillions of dollars in size, represent something relatively new in the world. Each day enormous sums whirl across the globe ceaselessly investing in currencies, stocks and bonds of every nation. They make up the investment flows that ultimately determine everything from the interest rate on your mortgage to the the living standards of its citizens.
To be sure, Malaysia, Thailand and other countries might well be genuinely puzzled by the workings of those investment flows. After all, Thailand and Malaysia scarcely had a stock market 10 years ago.
Investment capital in developing countries was allocated by the central state government or, as in most cases, it didn’t exist at all. But the global spread of technology, which has given workers in developing countries training to work on sophisticated machines making products for the world markets, has changed all that.
Suddenly, ancient societies became involved in the global markets for goods and services, and global markets for capital. The new money pushed up living standards very fast, making people believe they had discovered a new way to mine gold.
But in this crisis, those new nations in the world economy are learning that access to global capital carries with it rules and responsibilities - to use the capital efficiently and in ways that produce a return for investors.
Built on exports
Yet developing countries are not the only ones being taught lessons in this crisis. France, and other countries of Europe, have suffered economic setbacks because their customers in Asia have had to devalue their currencies and throttle back their economies.
According to Joanne Perez, Paris-based economist for Merrill Lynch, “Europe has built its whole recovery scenario on exports. A lot of the potential European export markets are at risk.”
The very unison with which markets fell precipitously in Asia and then around the world, and now seem to be recovering in concert, testify to that interconnectedness.
Indeed, the United States, too, can anticipate fallout from the crisis. Many economic experts are predicting that the low labor cost countries of Asia, their costs reduced even further by currency devaluations, will now try to regain economic health by pouring out exports to the big and open U.S. market.
It’s not news that the U.S. economy endures competitive pressures because it does largely play by the free market rules of free trade and open disclosure. But in the world economy emerging for the 21st century, the spread of free markets will support U.S. interests which lie with a world where investments can earn returns and trade can be on rational terms.
Ultimately, the reason free markets are triumphing in the world is not ideological, but practical: They work to provide returns to investors and small depositors and to allocate capital efficiently to create jobs and wealth in industry.