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Die Krise des Globalen Kapitalismus

The Crisis of Global Capitalism. By George Soros

George Soros: Die Krise des Globalen Kapitalismus. Offene Gesellschaft in Gefahr, Alexander Fest Verlag, ISBN: 3828600972, Fischer Verlag (TB), ISBN: 3596147360

The Crisis of Global Capitalism: Open Society Endangered, Public Affairs (US Edition), Little & Brown (UK Edition)

02.05.2000 · Reviewed by Richard Resch

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Several years ago, Francis Fukuyama proclaimed the "End of History." With the demise of communism, the times of ideological conflict seemed to have finally gone. Over the centuries, liberal-democratic ideas have stood their ground with a vengeance, and freedom, democracy and pluralism are the winners. However, according to George Soros, generous philanthropist, free spirit and one of the world's most successful financial market investors, they now have a new enemy. This time, they are "threatened from the opposite direction - from excessive individualism."

In his best-seller "The Crisis of Global Capitalism: Open Society Endangered," lauded by the New York Times as "brilliant and persuasive" and published in more than thirty-five foreign editions, Soros attacks what he calls "market-fundamentalism," the belief in self-regulating markets as the optimal form of socio-economic organization. In his opinion, this belief is misplaced, as free markets are inherently unstable, can cause intolerable inequities and on their own cannot sustain social goals like political freedom and social justice: "We can have a market economy, but we cannot have a market society." For Soros, the popular line of reasoning that free markets equal more economic growth and thus necessarily lead to greater prosperity and more democracy seems too simple and dogmatic in the light of empirical evidence: "If there is any lesson to be learned, it is that the collapse of a repressive regime does not automatically lead to the establishment of an open society. An open society is not merely the absence of government intervention and oppression. It is a complicated, sophisticated structure, and deliberate effort is required to bring it into existence. Since it is more sophisticated than the system it replaces, a speedy transition requires outside assistance. But the combination of laissez-faire ideas, social Darwinism, and geopolitical realism that prevailed in the United States and the United Kingdom stood in the way of any hope for an open society in Russia. If the leaders of these countries had had a different view of the world, they could have established firm foundations for a global open society."

Soros' analysis of the problem starts with a fundamental critique of social science. Natural science has an independently existing world as object of enquiry, against which hypotheses can be tested. If a theory is not congruent with the laws of the material world, it will be falsified by the course of events. Still, according to Heisenberg's uncertainty principle, there is a factor of indeterminacy in natural science concerning the position and momentum of particles, but that relates only to the viewer and the process of viewing. The same is not true for social science, whose subjects and objects both are thinking beings with imperfect knowledge and understanding. This adds a totally new quality of indeterminacy. In such a setting, cognition and actual outcomes are not functionally independent, but subject to what Soros calls "reflexivity." Predictions will affect the expectations of people, who adjust their behavior according to their expectations in line with their idiosyncratic interpretations. The outcome in turn is based on the actions of people and, again, influences their expectations. Thus, social science may function like a kind of "alchemy." This is of course not an entirely new idea, not even in economics. Take for example Keynes' accelerator theory of investment: if producers expect that demand will expand, which may or may not be true at this point in time, they will invest more. This in turn will increase total income, consumption and aggregate demand. As a result, producers will find their expectations partly justified. Soros' merit is that he very concisely outlines the immense general practical relevance of reflexivity. A previous review of his book by the Economist mocked: "...here is the principle in its most general form. Let x be any human activity: then perceptions of x affect x, and (wait for it) x affects perceptions of x. Here is a challenge for some future Quantum Research Fellow of Soros Studies: find anybody who ever denied it." However, that is exactly it: the man has a point. And if he has one, what about his conclusions?

Now, the problem with market-fundamentalism is not that it is fundamentally flawed - according to Soros, all theoretical constructs of social science are necessarily more or less so, because of the inherently imperfect nature of human understanding (by which he does not imply that they are useless). The problem is that most of the times market fundamentalism is not recognized as an ideology, but rather presented as the absence of ideology, due to its firm basis in orthodox economics. Nevertheless, it rests upon three metaphysical assumptions: individuals are utility maximizers with rational expectations, there is perfect information and most importantly, demand and supply are independently given. If nobody interferes in the price mechanism, prices will adjust until demand and supply equilibrate. In equilibrium, resources are deployed most efficiently. Any interference in the price mechanism - for example by governments - will result in inefficient distributions of resources and thus suboptimal outcomes. The first two assumptions are contested in economics; the third one is not. According to Soros, that is a mistake. Markets with known quantities behave as if supply and demand were independently given; however, there are other markets of immense relevance, which do not: "Buyers and sellers in financial markets seek to discount a future that depends on their own decisions. The shape of the supply and demand curves cannot be taken as given because both of them incorporate expectations about events that are shaped by those expectations. There is a two-way feedback mechanism between the market participants' thinking and the situation they think about." In consequence, free financial markets are inherently unstable; they naturally tend to exaggerate developments and thus are subject to boom-bust patterns. More importantly even, they do not always automatically self-correct their excesses according to some underlying "fundamentals" as orthodox economic theory would predict, but the "fundamentals" themselves can to a certain extent be a function of the market prices. For example, a hyped company can use its inflated stock price to take over companies in other sectors, thereby creating new realities. "If we look at the behavior of financial markets, we find that instead of tending toward equilibrium, prices continue to fluctuate relative to the expectations of buyers and sellers. There are prolonged periods when prices are moving away from any theoretical equilibrium. Even if they eventually show a tendency to return, the equilibrium is not the same as it would have been without the intervening period."

Here comes the twist: if free financial markets are inherently unstable, introducing more market discipline means introducing more instability. However, how much instability can societies handle? Soros' major concern is that the global economic system as it exists now may eventually be subject of a major home-made collapse destroying a lot of the wealth previously created. It is held together by flows of goods, services and most importantly credit. Credit, however, is a reflexive phenomenon. Having credit is a function of being creditworthy and vice-versa. Countries can use international flows of credit to invest in projects with high returns they otherwise could not pursue. These leveraged returns are the basis for future wealth and creditworthiness. If funds contract in a credit-crunch, the money to pay back debts in the future may not be created. In global boom times, money shows the tendency to flow from the center of the system to the periphery, in search for higher returns. In times of crisis, it flees back to the secure havens of the center, thereby exacerbating the problems for the periphery. If the opportunity costs of staying within the global system become too high, countries may opt out, as Malaysia did in the course of the Asian crisis by re-introducing capital controls. If such behavior proves an example for other crisis-ridden countries, the whole system may disintegrate. According to Soros, the major problem is that the international institutions are underdeveloped and underequipped in comparison to the well-functioning institutions regulating the national markets in the developed world. The IMF lacks the necessary funds and authority to prevent and efficiently manage big crises, and its policies may even incur harmful side effects by distorting the expectations of speculators about what risks they may have to take in the future.

Unfortunately, as in-depth and compelling Soros' analysis is concerning the problems, so sketchy and less precise are his proposals to solve them. In a handful of pages, the whole boils down to the creation of a global credit insurance and a global central bank as lender of last resort on the basis of the existing institutions. He seems reluctant to be more specific: "This is about as far as I want to go in prescribing solutions. Perhaps I have already gone too far." Nevertheless, Soros offers a thorough analysis of why global financial markets behave as they do with impressive ease and common sense. "The Crisis of Global Capitalism" makes a fascinating read. It is not written by somebody only throwing hypotheses and numbers at the audience; rather, the reader is given a full story of how and why certain ideas have grown with the author in the course of historical events, and why he has dismissed others. Strikingly, in the face of lacking orthodox explanations, the mainstream arguments begin to increasingly sound like Soros: "The Euro is weak as all believe it is weak." (Süddeutsche Zeitung, "Viele Theorien, aber keine Erklärung," 08.09.2000).

Obviously, the book will not make too many friends among the proponents of laissez-faire, especially being written by an exceptionally successful practitioner like Soros, indeed, the prototype hero of laissez-faire capitalism. One of the latest criticisms of Soros I have come across is that it is somewhat inconsistent and unethical to first make a fortune as a currency speculator at the expense of whole countries, and then to come along and proclaim something like "you should not have let me." Such a perfidious charge implies two alternatives. Either, exploit the opportunities and shut up, i.e. do not criticize a system which has made you rich. Depending on the view of things, this might be more consistent, but I cannot see how it could be ethically superior. The other alternative would be that you are allowed to openly criticize a system, but only if you do not exploit it yourself. This tastes of hypocrisy. After all, the very fundamental mechanism of laissez-fare capitalism is indeed that rational individuals, may they be consumers, workers, entrepreneurs, company managers, shareholders or fund managers will exploit all given opportunities to create added value, i.e. to make money for themselves and their investors (as long as making money for one's investors is sufficiently connected to making money for oneself). If you approve of this rationale wholeheartedly, on what grounds can you advocate some but condemn other manifestations of the very same principle? If we herald free markets and efficiency, can we at the same time really expect shareholders to not accept a generous takeover bid if they know that it will cost many jobs? Remember, we are talking about rational individuals, not saints.

The book makes it clear how ideologically contaminated the international debate on social organization still is, and how far we still are from a pragmatic view of things. Markets are undeniably very powerful tools to create wealth, and they have served the world well. Societies that have put their bets on central planning have fared dramatically worse and practically ruined themselves. Soros rightly observes that this has wrongly given way to the interpretation that "since regulations are faulty, unregulated markets are perfect." Markets are valuable tools indeed, but they are only tools, not ends in themselves. And as such, they cannot be the universal answer to all problems. In markets, money is the sole measure of value; the value of anything is the price market participants are willing to pay for it. This means that "markets reduce everything, including human beings (labor) and nature (land), to commodities." As for commerce, this principle is indeed sensible and useful. However, it is hard to believe that extending market values to all aspects of the world will increase total utility. There is more to society and human interaction than transactions made by self-interested individuals: "As market participants we are bound to serve our own best interest, but it is not in our own best interest to be only market participants." A world based solely on market values would be cynical in the sense of Oscar Wilde: "A cynic is a man who knows the price of everything, and the value of nothing."

Also quoted:
George Soros, "The Capitalist Threat," The Atlantic Monthly, February 1997
George Soros, "Toward a Global Open Society," The Atlantic Monthly, January 1998

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