Jan 10, 2009

Columnists - Fareed Zakaria;Writing the Rules for a New World

If you want to know what the post-American world will look like, just reread the coverage of the November G20 summit in Washington, D.C. First, there was the event itself. Every prior financial crisis had been handled by the IMF, the World Bank or the G7 (and, later, the G8). But this time, the big boys realized they couldn't tackle the problems alone and had to bring in world's top emerging markets too. For an effective response in a highly connected global economy, all the world's major players needed to participate. To supply cash, countries like China and Saudi Arabia were crucial. As for legitimacy, the old Western clubs were archaic, relics of a bygone world and could no longer provide it on their own.

Of course, not everything has changed. The meeting was still held in Washington, and President George W. Bush got to play the major role in setting the agenda. America has vital relations with key countries like China, Japan and Saudi Arabia, as well as good ties to old allies like Britain, France and Germany. And it seemed entirely possible that this larger and more representative group of nations could actually do some of the policy coordination needed to begin to solve the crisis. So it's a new world, but not necessarily one from which America has been ousted, nor one where common actions are impossible.

Historians will probably look back on the meltdown and see it as one largely caused by success. I realize it seems odd to say that of events characterized by panic, a credit crunch, slowing growth and falling stock markets. But consider the conditions that created this state of affairs. Over the past two decades, the world had enjoyed political stability, low inflation and a massive expansion of the global economy by almost 3 billion people. Countries around the planet grew at unheard-of levels—124 of them expanded at 4 percent or more in 2006 and 2007. Wars, civil conflicts and terrorism caused less political turmoil than they had in decades—or, by some measures, in centuries.

All this produced a new set of problems. As some countries grew in strength and resources they became more assertive and nationalistic. The emergence of Iran, Venezuela and a revived Russia is in good measure a product of the price of petroleum. So is Islamic jihad. Fueled by vast amounts of money, Wahhabi ideas found their way into almost all Muslim countries, shifting the tone of Islam everywhere and giving resources to radicalized young men.

In the world of economics, prosperity and low inflation unleashed two massive forces. The first was cheap credit, and the second, vast new pools of capital. Surplus savings piled up in the emerging economies of Asia (and then in the oil-producing countries of the Middle East) on a scale never before seen in history. Add to these two new forces two old ones—greed and stupidity—and you begin to understand how it all came apart.

At one level, the problem is that the United States and some other Western economies consumed too much—much more than they produced—and made up the difference by borrowing. But if America overspent, Asia oversaved. All those savings—some $10 trillion—had to go somewhere, and for two decades most of it was funneled back into the United States, which was seen, with some justification, as the safest and best place to invest. This led to easy credit and multiple bubbles in the United States—in technology stocks, bonds, real estate.

As bad as it looks, the current financial crisis will end. I don't know when or how, but the combination of government interventions will eventually work. Why do I say this? Because governments are more powerful than markets. They can close markets down, nationalize firms and write new rules. And Washington has one other, unique power: it can print money.

Government intervention has stabilized capitalism before. No modern society could accept the downswings that were routine in the 19th century, an era of much less intervention. The average length of a recession between 1854 and 1919 was 22 months. In the past two decades, by contrast, recessions have averaged eight months. Between 1854 and 1999, the U.S. economy went into a contraction every 49 months. In the past two decades, it has been 100 months between contractions. Many factors have contributed to these changes, but the chief explanation has been Washington's monetary and fiscal policies. Of course, the financial industry—the center of the current crisis—is unusual if not unique, since it is the lifeblood of the economy. As a result, it should be monitored especially carefully. In almost all the financial crises of the past 30 years (and there have been dozens of them) the government has had to intervene to restore trust and confidence. And it's succeeded.

Does this round of intervention mark a return to socialism, or even the old mixed economy? Well, 35 years ago governments in most countries controlled the value of their national currencies. They owned steel companies, car manufacturers, the telephone company and banks. They set the price of airline tickets, phone calls, stock commissions and cement. Tariffs in the industrialized world were several times higher than they are today. Does anyone really think we're returning to this era? Does anyone believe that governments would be any better at owning and running economies than they were in the past? There will be a return of regulation. But regulation is not socialism.

Capitalism is now a global phenomenon. It is being powered by the actions of companies and governments and individuals all over the world. And in the search for growth and higher standards of living, countries will continue to use free markets and free trade to power their rise. Governments have not liberalized their markets because Treasury Secretary Henry Paulson or his predecessor Robert Rubin ordered them to; they did so because they could see the benefits of moving in that direction (and the costs of not moving). This process will continue to be halting and episodic, depending on political pressures. But I suspect that over the next 20 years, most countries will try to free up their markets (in a controlled fashion) to get more growth rather than nationalize bits of their economies. Certainly the history of past economic crises shows that in their wake countries have conducted more-aggressive economic reforms to bring greater credibility to their systems, attract new capital and jump-start growth.

As all this suggests, the current debate about government and markets is sterile. Every serious thinker understands we need both. The question is how to balance the two to achieve growth, innovation, stability and social equity. The crucial need is not for big government or small government but smart government. How can we make government work for the vast majority of people, for future generations, for the broad welfare of society?

The real problem we face today is not a crisis of capitalism. It is a crisis of globalization. The new world coming into being is not going to go away. We will not return to a system dominated by a handful of countries around the North Atlantic. The factors powering the rise of the global economy, and thus the rise of the rest, are broad structural forces that have been at work for decades. They are not ephemeral and will not vanish in the face of one financial crisis or recession. They will endure, and in the process shift power away from established centers in the West.

But will this lead to a more stable world?

There is, of course, the age-old worry: that in times of transition, the world will get messy. Ever since Thucydides observed that the shift in power from Sparta to Athens was the fundamental cause of the Peloponnesian War, scholars have watched such moments with apprehension. But this time, if properly managed, the rise of the rest needs to be destabilizing. America is not sinking fast, about to be replaced by a single country. The Chinese economy remains one fifth the size of America's, and its military is even smaller. Most major powers share some basic interests and ideals with the United States. The real danger remains that Washington will overplay its hand, leading other countries to seek to balance it. The management of U.S. political and military power remains the single most important task for global stability. The United States must provide rules, institutions and services that help solve major global problems.

But common action—to create public goods—has become much more difficult today. Economic and social activity is global, but political power is local. Economic, social and political problems often spill over borders, yet the solutions tend to lie with national governments that jealously guard their sovereignty. Unless we solve this basic problem, we should expect more crises of various kinds. And we should expect responses that are ad hoc and ineffective. Eventually such clumsy responses may make countries approach things narrowly and nationalistically, creating more global instability and less peace and prosperity.

To illustrate this point, consider almost any serious problem; chances are it implicates more than one country. Terrorism, financial contagion, infectious diseases, energy, security—all these challenges require coordinated responses, and in some cases institutions that can implement them. Take a simple example like infectious disease. An outbreak today is almost guaranteed to quickly spread far and wide. That means we all have an incentive to determine the nature of the pathogen as quickly as possible, isolate the victims and work toward a cure. Ideally, the World Health Organization would be able to step in, require samples of the virus to be sent to it, make a definitive determination and set protocols to be followed. Unfortunately, it is underfunded, undermanned and lacks the authority to make rules that everyone must follow.

This mismatch between problem and solution has been remarked on by me and others for a while now. Somehow it has yet to move up the international agenda. Yet that may finally be changing.

Sometimes a crisis provides an opportunity. This past fall, several Western governments initially responded to the financial meltdown by trying to handle it on their own. They seemed to forget about globalization—and nothing is more globalized than capital. Money flows around the world with no barriers, demanding international policy coordination. Belatedly recognizing this, leaders held the G20 meeting in Washington, a good first step. But to seriously address the crisis, we must move beyond this one event to a systemic fix. The IMF, for example, needs to be revamped and funded far more generously to handle such panics in the future.

It has become conventional wisdom, even a sport of sorts, to blame the United States for a lack of leadership on these issues. There is some truth to this, and I certainly hope that President Obama will be far more engaged than his predecessor in tackling this agenda. But the problem is not limited to Washington. The problem also lies with Paris and Moscow and Beijing and New Delhi. European governments have been reluctant to cede power to the IMF and other forums. The United Nations is becoming increasingly irrelevant and antiquated, unable to adapt its structure to accommodate rising powers. Many emerging-market countries guard their sovereignty as jealously as does the United States, often even more so. Yet what alternative is there?

The point is that unless we find ways to expand and enhance the rules and institutions of global cooperation, the world will experience more and more crises and the government responses will be hasty and ad hoc, too little, too late. If, on the other hand, we come together and work together on the common problems of humanity, imagine the extraordinary opportunities it could create for everyone. Imagine if we created new rules of the road that allowed this extraordinary process of globalization and growth to persist and spread to every section of society, raising standards of living and health for the poorest of the poor, allowing more and more people to develop their potential.

Citizens and governments the world over have worked wonders during the past few decades. Now it's time for their governments to match this ingenuity with new forms of cooperation. The great project of the 21st century should be a new architecture—one that helps to ensure growth and peace for the world

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