In his new book, and in subsequent interviews, Alan Greenspan has provided a lucid analysis of the driving forces of global economic change during the last two decades. The end of the Cold War, in this telling of the story, freed up savings, lowered interest rates, and fuelled a major, almost uninterrupted global expansion. The disinflationary effects of access to a global labour pool made Greenspan?s monetary management task easier, perhaps even trivial, except for pumping in liquidity to stave off the occasional crisis. Greenspan argues that asset price bubbles under his watch were driven more by this global excess liquidity, and could not really be controlled by the US Federal Reserve Board. Perhaps the most intriguing view expressed by the former Fed chairman is that ?Turbulence is, as we get into the 21st century, probably a necessary condition to maintain an economy worldwide as high-powered as the one that now exists.?
The analogy used by Greenspan is that of millions of computerised adjustments that keep a modern plane flying steadily. Certainly, financial markets can provide that kind of flexibility to the real economy, absorbing shocks, and smoothing their effects so that economic activity proceeds on course. And when financial markets are in danger of seizing up, the role of central banks becomes that of an ?ber-computer, to provide a higher level of adjustments to control lurches. Or perhaps the Greenspans of the world are the human pilots who take over from the computers when necessary.
So there are two key ideas in Greenspan?s book that can frame thinking about the future. One is the impact of long-run demographic trends. The other is the role of financial markets and how to manage them. It does not appear that the potential to absorb the world?s surplus labour is anywhere near its end. Despite the recent increase in China?s inflation rate, and booming commodity prices, the scope for training workers around the world, giving them capital and technology, and raising their productivity remains substantial. As many others have noted, the rapid growth in countries like China and India is being helped by catching up with the technological frontier at a pace not seen before for such large countries. Also, the nature of recent IT innovations has speeded up technology transfer by enhancing communications, and by reducing the minimum efficient scale of many activities.
All this is good. Greenspan?s worries about the US, in this regard, apply to a small fraction of the world?s population, albeit its richest component. Lagging school education, burdensome social security arrangements and political pressures for relaxed inflation targets will put the US at a relative disadvantage, but not slow down the world?s growth appreciably. Pushing this view to the extreme, even terrorism, as long as it is contained in scale and frequency, cannot injure growth. High oil prices mean that Middle East petrodollars are now adding to the global savings and investment mix, and this should keep interest rates low and liquidity high. Even long-struggling countries such as Egypt are seeing investment and growth. Soon, the subprime crisis will fade into the past, as the capitalist juggernaut keeps going for decades.
If the lubricant of this growth is global financial capital, then its continued flow will be crucial to the process just described. Going back to Greenspan?s computer metaphor, however, the problem is that the computer is subject to manipulation by other humans besides benevolent central bankers. And there is not even one computer, but many of them, acting only on parts of the system, with feedback loops that can magnify deviations more than stabilise them. Herd behaviour, seen often in financial markets, is not something that is captured well by the metaphor of computerised adjustments.
Perhaps central banks realise that they may be called upon more and more to prevent or manage panics and crises. This is one explanation for the accumulation of foreign reserves that is gaining favour among academics. Even developed countries may need larger reserves now that global capital flows and financial trading have skyrocketed. Global market movements can swamp individual countries? abilities to deal with them. In this scenario, the current lull in the demands on the IMF may be temporary: its role as liquidity provider to countries may still be needed on occasion.
To sum up, high growth may be here to stay for a while. High growth needs mobile private capital. Mobile private capital is inherently turbulent. Therefore, one needs large precautionary accumulations of liquid financial assets by public entities to smooth out this turbulence. This is quite different from the world according to Greenspan, in which financial market turbulence smoothes the real economy. Instead, it is active public policy, representing societal preferences delegated to agents such as central bankers and other policymakers, which manages turbulence in financial markets and prevents its disruption of real economic activity. The real challenge is to structure the institutions of public policy so that this desirable end is reached, rather than the capture of the fruits of growth by those who control policy. Ultimately, Greenspan does not tell us much about these deeper questions of political economy, which tackle how ?individual rights and economic freedom? are balanced with beneficial collective action.
?Nirvikar Singh is professor of Economics at the University of California, Santa Cruz