International Capital Liberalization : The Record

A liberalized, sophisticated financial system, with a premium placed on the possibility of exit, is a fragile financial system. That fragility is manifest in liquidity crises, some of which have substantial reverberations in reduced real output; in risk aversion in the private sector which produces a bias toward the short-term and a corresponding reluctance to invest for the long-term; in risk aversion in the public sector, producing a bias toward deflationary policies; and in persistent demands for greater "flexibility" to increase the possibilities of exit. It is often argued that nothing can be done to change the present system, since capital flows can overwhelm the actions of any one government. This is certainly true. But it is equally true that the foundation stones of the world financial system are the monetary instruments issued by a small number of major governments. Ultimately, those governments acting together have the potential to control capital flows. But that potential will only be manifest if governments themselves have a different theory of economic policy than the theory which currently dominates economic and political debate. As Peter Temin has made clear, the Depression of the 1930s was a product both of the loss of international financial control and the fact that governments were convinced of the necessity of deflationary policies. They had no alternative theory. Without a change of theory by governments, without an active willingness to pursue expansionary monetary and fiscal policies, no formal structure of financial controls would deliver recovery. It took the experience of the Depression and of World War II economic management to change the theory. In the same way, it is unlikely today that a significant reassertion of control over international financial structures is possible without an equally major change in priorities and analyses by all major governments. Such seismic changes have historically been associated with the aftermath of world-wide economic and political disruption