Mr. Greenspan discusses the ascendance of market capitalism  (Central Bank Articles and Speeches, 2 Apr 98)
Central bank: fed | Type: speech | Date: 1998-04-02

Mr.

Greenspan discusses the ascendance of market capitalism Remarks by Chairman of the Board of Governors of the US Federal Reserve System, Mr. Alan Greenspan, be the Annual Convention of the American Society of Newspaper Editors held in Washington, D.C 2/4/98.

## The Ascendance of Market CapitalismThe current turmoil in East Asia is easy to categorize as one of many such cri the

decades.

Nonetheless, it appears to be an important milestone in what evidently ha significant and seemingly inexorable trend toward market capitalism and political systems t the rule of law.

The shifts have been gradual but persistent.Markets today are responding far more rapidly to subtle changes in consum values and choices than ever before.

While advancing technology has always been a sensitizing markets to changing consumer tastes, what is so striking in recent years is ho that force has become.

Just-in-time inventory systems have enabled production to more adjust to changing consumption.

Satellite coordinated trucking moves goods to destinat optimal use.

Bar coding has facilitated a major revolution in retailing.

For superma example, checkout scanning devices have facilitated the creation of a variety of wares ref most current consumer wants.Those producers who cannot keep up with this technologically driven surge efficiency fall by the wayside.

Those exceptionally skilled in advanced engineering and programming, for example, are rewarded with significantly higher levels of income relativ less facile.

It is difficult to prove, but arguably luck, the great random leveler in th appears to play an ever smaller role in determining success and failure in today's just-i quality, productive systems.

Those systems appear to be especially rewarding to financial advent of computer and telecommunications technology has spawned a vast proliferation o financial derivatives products crafted by mathematicians and finance technicians who ha previously found favor on either Wall or Lombard Streets.

The above-average earnings they reflect the increasing value added created by financial institutions, which, in turn, resu enhanced ability to marshal savings to support investment in the most productive physical cNot unexpectedly, as the share of Gross Domestic Product has shifted persiste conceptual products and services from those requiring physical brawn to produce, the wage p for skills and education has risen significantly, especially during the past two decades. surmise, the shift arguably has led to the sharply higher college enrollments that we see United States and elsewhere.

But the resulting increased supply of skills has apparently ge been sufficient to offset the increasing demand, as net returns to education, at leas recently, have continued to rise.Left to its own devices, this new high-tech competitive system appears to exhib leeway for inefficiency.

Inefficiencies expose potential unexploited profit opportunities, open, and effectively competitive markets induce new resources to be brought to bear to bottlenecks and other, less than optimum, uses of capital.Of course, little of this is new.

Market economies have succeeded over the ce by thoroughly weeding out the inefficient and poorly equipped, and by granting rewards t who could anticipate consumer demand and meet it with minimum use of labor and capital reso But the newer technologies are goading this process.

For good or ill, an unforgiving capita is driving wealth creation.

It has become increasingly difficult for policymakers who practice, as they put it, a more 'caring' capitalism to realize the full potential of thTheir choices have become limited.

To the extent they block themselves or portions o population from what they perceive as harsh competitive pressures, they must accept a lower standard of living for their populace.

As a consequence, increasingly, nations appear to b open themselves to competition, however harsh, and become producers that can compete in markets.

Not irrelevant to the choice is that major advances in telecommunications have troublesome for politicians and policymakers to go too far in pre-empting market forces material affluence of market-based economies has become so evident to ubiquitous tele watchers, their constituents, around the world.It was not always thus.

In the first decades following World War II, before th of significant advances in computer and telecommunications technologies, market econo appeared less daunting.

Adjustments were slower.

International trade comprised a far smal of domestic economies.

Tariff walls blocked out competition, and capital controls often co cross-border currency flows.

In retrospect, the economic environment appeared less comp more tranquil, and certainly less threatening to those with only moderate or lesser ski before computer technology automated many repetitive tasks, the unskilled were able to co significant value added and earn a respectable wage relative to the skilled.In this less demanding world, governments were able to construct social safet and engaged in policies intended to redistribute income.

Even though such initiatives o recognized as adding substantial cost to labor and product markets, and thereby reduci flexibility, they were not judged as meaningful impediments to economic growth.

In economi broadly subject to international trade, competition was not as punishing to the less effi today.

To be sure, average standards of living were less than they could have been, composition of output was far less sensitive to changing consumer tastes than is the case high-tech environment.

There is clearly a significant segment of society that looks back at with affectionate nostalgia.But maintaining the kind of safety net that, for example, is prevalent i continental European countries where high unemployment appears chronic is proving increas problematic in today's altered environment.

Governments of all persuasions still may choos people acquire the skills they need to utilize new technologies.

And they generally en support the incomes of those who have been less able to adapt.

But technology and competi extracting a high price for the more intrusive forms of intervention that impair market i work, save, invest, and innovate.International competitive pressures are narrowing the choices for economies broad safety nets:

the choice of accepting shortfalls in standards of living, relativ burdened economies, or loosening the social safety net and acquiescing in the greater conc of income that seem to be associated with our high-tech environment.

Erecting trade barrie off cross-border competition leads to the loss of the great advantages of the internationa labor and cannot be considered a realistic alternative for societies choosing to realize th of technological advances.

Fortunately, for the moment at least, there appears limited se Europe or elsewhere to move in that direction.Clearly, the synergies of transistor, laser, and satellite technologies have computer and telecommunications revolution over the last half century that is altering the interact with each other and with their institutions.

We are adding to our knowledge economic and political systems contribute to welfare and wealth and which do not.

This pr course, has been ongoing especially since the advent of the Industrial Revolution w emergence of significant wealth creation first offered meaningful alternatives.

But in the War II years most of what had been open to conjecture and debate throughout the nineteenth and first half of the twentieth, is gradually being settled by the sharp realities of recen˝I am not alleging that the human race is about to irreversibly accept market ca as the only relevant form of economic and social organization and that this great debat There remains a large segment of the population that still considers capitalism and its e materialism, in all its forms, degrading to man's spiritual nature.

In addition, even some seek material welfare, view competitive markets as subject to manipulation by mass promot advertising that drives consumers to desire and seek superficial and ephemeral value governments even now attempt to override the evident preferences of their citizens, by lim access to foreign media because they judge such media will undermine their culture.

Final remains a latent protectionism, in the United States and elsewhere, which could emerge as force against globalization should the current high-tech world economy falter.Moreover, I certainly have no doubt that in the event of problems in today' more Spencerian, form of capitalism, governments would increase their interventions in an to alter market results.And, as history amply demonstrates, most recently in East Asia, market -- or market -- systems can produce crises that tempt government intervention.

Such crises occasion when confidence unexpectedly fails and is replaced by fear and a loss of trust, vicious cycle of retrenchment in economic activity and government endeavors to count Nonetheless, in light of the record of failures of intrusive intervention over recent difficult to imagine such activism persisting much beyond any immediate crisis.The history of the twentieth century has been a testing ground for innume theories of social and economic organization that have been tried and found wanting.

T people respond to incentives and rewards persists from generation to generation suggesting imbedded set of stabilities in human nature.

We see this, for example, in remarkable consi the behavior of markets over time.

Nonetheless, history is strewn with examples of econo social systems that have tried to counter, or alter, human nature and failed.Despite an unrelenting effort over more than seven decades, the system in the Union was unable to mold human responses to fit the Soviet view of human destiny and how s should be organized.

The post mortem of what went wrong clearly exposed the fatal flaws as to the system, and not the result of external forces, although the arms race may have ha process.

The lesson that appears to be emerging is that only free market systems exh flexibility and robustness to accommodate human nature and harness rapidly advancing tech to consistently advance living standards.To get a better sense of the forces that are driving the world's economies, e in the second half of the twentieth century, it is useful to understand why the Soviet e central planning failed.

Indeed, it is not an exaggeration to state that from this fai learned as much about why our free capitalist systems work, as about why central planning The Soviet economic failure was so unambiguous that it proffered a new set of standards gauge alternative economic paradigms.

It, for example, afforded us a far better understandi some of the mercantilistic capitalist economies of East Asia worked for awhile but then didCentrally planned economic systems, such as that which existed in the Soviet U had great difficulty in creating wealth and rising standards of living.

In theory, and to in practice, production and distribution were determined by specific instructions -- often of state orders -- coming from the central planning agencies to the various different establishments, indicating from whom, and in what quantities, they should receive th materials and services, and to whom they should distribute their final outputs.˝Without an effective market clearing mechanism, the consequences of such paradigm, as one might readily anticipate, were both huge surpluses of goods that were no by the populace, and huge shortages of products that consumers desired, but were not pro adequate quantities.

The imbalance of demand over supply of these latter products in required rationing or its equivalent -- standing in queues for limited quantities of goodsOne might think that the planning authorities should have been able to adjust distortions.

They tried.

But they faced insurmountable handicaps in that they did not have the immediate signals of price changes that so effectively facilitate the clearing of capitalist economies.

Movements in prices give incentives to adjust the allocation of resources to accommodate the changing technology of production and the shifting tas consumers.Among the key prices central planning systems lacked were the signals of fina equity values and the broad array of interest rates.

In a centrally planned system, fin decidedly minor role.

Since the production and distribution of goods and services are e driven by state orders and rationing, finance amounts to little more than a system for rec While there are pro-forma payment transfers among state-owned enterprises, few if any act driven by them.

Payment arrears, or even defaults, are largely irrelevant in the sense t essentially intra-company transactions among enterprises owned by the same entity, that is,Under central planning there are no credit standards, no interest rate risks, value changes -- none of the key financial signals that determine in a market economy w credit and who does not, and hence who produces what and sells to whom.

In short, none financial infrastructure that converts the changing valuations of consumers and shifting of capital equipment into market signals that direct production for profit is available. matter in the Soviet-bloc economies.

Few decisions in those centrally planned systems were by the lack of a developed financial system.Regrettably, until the Berlin Wall was breached in 1989, and the need to de market economies out of the rubble of Eastern Europe's central planning regime became app little contemporary thought had been given to the institutional infrastructure required of the West, that infrastructure had developed pragmatically, interacting with, and facil evolution of, the markets themselves.In the years immediately following the fall of the Berlin Wall, many of the s the former Soviet bloc did get something akin to a market system in the form of a rapid black markets that replicated some of what seemingly goes on in a market economy.But only in part.

Black markets, by definition, are not supported by the rule There are no rights to own and dispose of property protected by the enforcement power of t There are no laws of contract or bankruptcy, or judicial review and determination again en the state.

The essential infrastructure of a market economy is missing.Black markets offer few of the benefits of legally sanctioned trade.

To know t state will protect one's rights to property will encourage the taking of risks that crea foster growth.

Few will risk their capital, however, if there is little assurance that the are secure from the arbitrary actions of government, or street mobs.Indeed, the presumption of property ownership and the legality of its transfer deeply embedded in the culture of a society for free market economies to function effec capitalist societies, and especially under British common law and its derivatives, the mo of property rights is accepted, or at least acquiesced in, by virtually the whole of th˝Accordingly, a negligible proportion of commercial contracts has to be adjudicated thr courts.

If it were otherwise, the system could not function.Most other rights that we Americans and others cherish -- protection against legal violence or intimidation by the state, confiscation of property without due process freedom of speech and of the press, and an absence of discrimination -- are all essentia effective, functioning market system.Indeed a list or bill of rights enforced by an impartial judiciary is, and I he the analogy, what substitutes for the central planning function as the guiding mechanism market economy.

It is these 'rights' that enable the value judgements of millions of consu converted through a legally protected free market into prices of products and financial i and it is, of course, these market prices that substitute for the state orders of the ce economies.The increasing recognition of a rule of law and its associated rights a indispensable to an effective functioning market system, is pressuring political leaders acceptance of that framework.

Economic necessity appears to be functioning, but not in the Marx contemplated.

The broad acceptance of market economics -- and the political rights as with it -- is impressive.Clearly, not all states protect the right of private property with the sa Indeed, they vary widely.

Nor is it the case that all societies with firmly protected pr bend invariably to the majority will of the populace on all public issues.

But the press democracy and property rights appear persistent.Centrally planned economies tend to be frozen in time.

They cannot rea accommodate innovation, new ideas, new products, and altered specifications.In sharp contrast, market economies are driven by what Professor Joseph Schumpe a number of decades ago, called 'creative destruction'.

By this he meant newer ways of doin newer products, and novel engineering and architectural insights that induce the co obsolescence and retirement of factories and equipment and a reshuffling of workers to different activities.

Market economies in that sense are continuously renewing the Innovation, risk-taking, and competition are the driving forces that propel standards progressively higher.The bold, if unintended, experiment in economic and social systems, which b after World War II in Europe, did not come to a full resting place with the fall of the B 1989.

Despite the ebb and flow of governments of differing persuasions, the face of t economy continues to edge evermore toward free market-oriented societies.

It is true in Europe, Latin America, and Asia.

Even many of the socialistic economies of Africa are emb free market capitalism.The current crisis in East Asia is likely to hasten that trend as hard-learned economic structure lead to significant reform.

The economies in crisis did not use central the pervasive Soviet Union style.

They relied on markets in most respects, but they a elements of central planning in the form of credit allocation, and those elements, in my v out to be their Achilles heel.The crises have their roots in the endeavor of some East Asian countries to o their economies to world competition, while still mandating a significant proportion of t through government directives.

It is, of course, possible for a time to clear a market th planning, albeit at a lower standard of living, by restricting alternatives available to˝the Soviet system demonstrated.

It is also possible to clear the market through the fr competitive forces with consumers' choices governing what is produced.

A market will not clear and achieve stability, except by chance, however, if consumers are largely free to production is set significantly by government directives.For it is only by chance that governments, meaning planning agencies, successfully gauge the rapidly changing tastes of consumers and evolving technologi production.

It is much too difficult a task.

Only sophisticated market mechanisms can do th planning of the sort practiced by some East Asian countries can look very successful fo because they started from a low technological base and had sufficient flexibility to all units to borrow the more advanced technology of the fully market economies.

But there are this process as economies mature.Many Asian policymakers are learning that government-directed investments, bac by government inducements to banks to finance them, can lead to substantial gains in out number of years in economies with low real wages and low productivity (as it did in th Union).

Eventually and inevitably, however, such a regime leads to establish facilities t goods and services that domestic consumers and export customers apparently no longer want consequent losses to companies, and the resultant buildup of nonperforming bank loans, financial intermediation and the economy.There has been, to be sure, much pain and periodic backtracking among a number the nations that discarded the mantle of some forms of central planning or mercantilist There will doubtless be more.

But as a consequence of the experience of the last half centu capitalism has clearly become ascendant, at least for now.

Advancing technologies have spu competitive forces of the market to accelerate the rise in consumer wealth and living sta long as material well being holds a high priority in a nation's value system, the per technological advance should foster this process.

If we can continue to adapt to our new fr tech economy, that is not a bad prospect for the next century.˝