Fortunately for the New Economy, Larry Summers - Clinton's point man on trade and international finance - not only gets it, he's actually being helpful.
An outsized figure both physically and mentally, Summers is known as a man whose regard for his own candlepower is almost as impressive as the candlepower itself. "Larry Summers is to humility what Madonna is to chastity," Wall Street Journal columnist Paul Gigot once wrote. On two occasions recently, Summers sat down with Wired's John Heilemann to talk about everything from the aftermath of Mexico and the volatility of a financial system gone cyber to the question of whether the global economy is rendering policymakers like him more or less irrelevant. Summers was, as ever, confident to the point of cockiness, but the quality of his conversation made complaints about his arrogance seem ... well, small-minded. Besides, he has a fine sense of humor about himself. After reading Gigot's barb, Summers quipped to his wife, "Well, it's not as bad as it could've been: he could've said that I'm to chastity what Madonna is to humility."
Wired: In the past few months, the critics of global economic integration - people like William Greider and Richard Gephardt - have been making their case quite forcefully. You've been trying to take them on. Explain the debate as you see it.
Summers:
The place to start is with a comparison of the 1920s and the late 1940s, two periods that were in many respects similar to today. Both times America was coming off the end of a conflict. Both times people were weary. Both times people were internally preoccupied. Both times there was some resistance to foreign entanglements. Both times there was some sense that middle-class families were not doing as well as they would like to have been doing. Sound familiar? In the 1920s, what the United States did was move away from internationalism. We were party to the punitive collection of debts in Germany. We didn't join or support the League of Nations. We passed the Smoot-Hawley Tariff. And we made no effort to provide global leadership. What followed was maybe the 20 darkest years in modern human history - the Depression, hyperinflation in Germany, World War II, the Holocaust. But after World War II, we learned a very different lesson. We focused on leadership. We passed the GI Bill and the Marshall Plan. We created the architecture of international financial institutions. We worked as a consistent force in favor of world markets and more international integration for 50 years. And despite all the terrible things that have happened, it's been 50 years of remarkable peace and prosperity.
The overwhelming historical lesson is that progress requires American leadership. History also gives an indication of the stakes involved, which go far, far beyond questions of the mercantile advantage and really go to America's role in the world, and to the prospects for the world to stay at peace. Asia today is in many ways like Europe before World War I, with a number of rising powers that are wary of one another. Europe still has tremendous tension over unification that has yet to be resolved. Who would have thought there would be ethnic slaughter in Europe in the 1990s? There are profound challenges that depend on US leadership, and US leadership in the economic area is a part of US security - just as it was in the 1940s and the 1920s.
That's what I like to call the integrationist position. On the other side, you have what I call the separatist position, which offers, I think, three broad arguments against the integrationist position. The first is that somehow this will impoverish Americans; that basically the economic success of others comes at our expense. But the evidence is overwhelming that this is wrong. The reason wages are lower in other countries is because productivity is lower. We have much more to worry about economically from Germany, where wages are higher than here, than we do from Bangladesh, where wages are lower. If you ask what the change has been in the content of trade that comes from less developed countries, it's only 1 percent of GNP in the last 15 years, so it's hard to believe that this has a lot to do with the tectonic shifts that we have seen in our wage structure. In any event, whatever changes have been associated with globalization have not been due primarily to trade agreements. The country where people have the greatest economic fears is China, and we haven't had any trade agreements with China. Meanwhile, in every trade agreement we have entered, foreign trade barriers have come down by far more than American trade barriers; with Nafta, the ratio was five to one. There just isn't evidence to suggest that trade agreements have had an adverse effect on the prosperity of individual Americans. And if you look around the world, you see that those with protectionist policies have not prospered, to put it mildly.
The second argument that separatists make is that capitalist economics is a Western affectation, and that we have to understand that cultures are different, and that the attempt to export the Western economic consensus will produce a backlash. But I think it's extraordinarily difficult to rely on cultural arguments. It was only a quarter of a century ago that many sophisticated cultural observers, including Nobel prize winner Gunnar Myrdal, were certain that Asia would suffer a Malthusian famine by the late 1980s; a judgment had been made that a Confucian culture was fundamentally inimical to economic growth. Careful studies comparing rapidly growing countries in Asia with less rapidly growing countries in South America and Africa reveal that what's common to sustained economic growth are economic fundamentals: saving, a price system that works, an outward orientation, the availability of capital for entrepreneurs, the existence of a secure system of property rights, education.
There is a tremendous receptiveness around the world to Western economic thinking. It would be a tragedy, just at the moment when these ideas are gaining currency, if there were to be some kind of pullback. There is every bit as much potential ethnic hatred between the Chinese and the Malays in Malaysia as there is between ethnic groups in Africa. The reason that has not resulted in mass slaughter in Malaysia is that people have seen their living standards double in 10 years, and then double in 10 years, and then double in 10 years, and look forward to vastly better lives for their children. It's that, and not some mythical cultural solution, that offers the best prospect for stability and peace. Now, all you have to do is to look at the savings-and-loan crisis, or at rising wage inequality here, or at the Japanese banking failures, or at levels of unemployment in Europe, to understand that we by no means have all the answers. We're not at the end of economics. We're not at the end of the business cycle. But I think there are some directional tendencies for this era that we have identified and are fairly universal.
The third separatist critique is that America can't afford to be globalist. George Bush was never more wrong than when he said, "We have more will than wallet." We're saving nearly a hundred billion dollars because the Cold War is over, relative to what we were spending on defense. It's hard to believe we couldn't have invested $3 billion in responding to forward challenges in the international arena, like AIDS, or the global environment, or narcotics. But in fact, nonmilitary foreign affairs spending has fallen nearly by half in real terms in the last 10 years. I think the greatest challenge for all of us is to build a constituency for American leadership and internationalism in a world where we no longer have the Communist threat as a rationale.
You say that the integrationist position is "under siege" by separatism. In what sense?
You see globalism under siege in the United States' failure to meet its obligations to the international financial institutions and the UN; in the questions that are raised as to whether the president will be able to get the authority to negotiate further trade agreements; in European attitudes toward foreign television and movies; in the reluctance in some quarters in Japan to permit the stationing of American troops in Okinawa; in the strengthening nationalist movements in Russia and a number of other countries in the former Soviet Union. And the list could go on. What are the stakes? It's very difficult to lay out the scenarios. But I think it's worth remembering how remote a prospect World War I would have looked in 1910, and how remote a prospect World War II would have looked in 1934.
It's now more than two years since the peso crisis. At the time, you guys in the administration - and you personally - took a lot of heat for the Mexican bailout. Do you feel vindicated by history?
I think if we had not acted and Mexico had been allowed to default, there is a real chance you would have seen the same kind of effects that followed the Mexican default in the early 1980s. It would have meant a cessation of flow of capital for many years to many developing countries. It would also have meant - and this may have been the more profound point - a renunciation of the kind of market-based model that developing countries were adopting. Mexico had become an exemplar of that model, and if Mexico had been allowed to fail, you would have seen that model coming under political attack in India, in Russia, in China.
Rubin explained the crisis in terms of his "theory of interconnectedness." What does that mean?
Capital markets are becoming more and more connected. There are many more investors involved with emerging markets. There are much more liquid markets in emerging-markets securities. The Mexican cri-sis came at a particular moment when emerging markets were a big but new idea - when people had first started grouping them all together. Frankly, one of the consequences of the Mexican crisis is that people now take a more differentiated view of emerging markets, looking at each of them separately. In the early stages of development of stock markets, there is often a "nifty 50" or some such, and money goes into all of those stocks en masse and moves out of them en masse. But then, over time, there comes to be a more differentiated view. I think something similar is happening in the global capital market.
Could there be another Mexico?
The circumstances of Mexico were very special, but I certainly don't think we've seen the last financial crisis in a developing country. The four most dangerous words in markets are, "It's different this time." That said, one of the salutary effects of the Mexican crisis was that it became an important object lesson in what can go wrong when there's loss of confidence from abroad and countries don't respond by taking the steps necessary to restore confidence. Policymakers around the world have realized that if they don't respect the pressures the capital markets bring, they can get in serious trouble.
Earlier this year, Thailand seemed to be on the brink of a Mexico-style financial crisis, and lots of people in government and in the markets were watching it very closely. Would a Thai meltdown - or a meltdown in Pakistan, or any other nation cited as "the next Mexico" - carry the same systemic risks?
Thailand's policies were on a path that, without adjustments, could easily have been unsustainable, and could have called the health of its financial system into very serious question. But by making strong and dramatic policy adjustments - in terms of budget policy, in terms of policy toward financial institutions - the Thai authorities appear to have contained the situation. Mexico was special to the United States because of the 2,000-mile border, because it was a large share of the total flow of capital into emerging markets at that time, and because it was a poster child of the Bretton Woods institutions (the IMF and World Bank). I don't think if the problem came in another emerging market it would have those three elements, and therefore I am inclined to think the danger it would spread throughout the emerging-market sector is slightly less than it was at the time of the Mexican situation. Crises will happen, capital can flow very quickly, spillovers are important. But there has been a maturing of the markets, and a reduction in those kinds of systemic risks.
After the bailout of Mexico, you and your boss started working on a series of policy changes at the international level - at the G-7 level, at the IMF and the World Bank level. Tell me about the kinds of policies you put in place to lessen systemic risk.
We've gone from a small-numbers problem to a large-numbers problem. In 1982, the chair of the Fed could get 20 major bankers in a room, remind them that he is their regulator, and they'd work something out together. You can't do that with thousands of separate holders of emerging-markets mutual funds. There were two types of policy changes. The first was to try to prevent crises from happening, and the other was to deal with them if they happened. In terms of trying to prevent crises, the most important thing we did was, with the IMF, to put in place financial disclosure standards that countries can voluntarily submit to. Disclosure is at the heart of our own regulatory system in many respects. If investors in Mexico had understood, on a real-time basis, what was happening in Mexico, you wouldn't have had a crisis, or at least not a crisis of the same magnitude. Establishing these disclosure standards can have a large effect. One advantage is that there's more information for investors and they'll send warning signals. Equally important is that when you know you're going to have to publish everything, the temptation to slip and slide through is reduced, and this acts as a discipline on policymakers not to use their reserves in irresponsible ways or pursue inconsistent monetary and exchange-rate policies.
What about the other category - dealing with crises if and when they happen?
There, the main policy change is something called the "new agreements to borrow." This agreement brings about two dozen countries into an inner group of the international monetary system that provides a supplemental fund - a spare fuel tank, if you like - to help the IMF address a crisis, if it comes.
Given interconnectedness and globalization, many people argue that governments don't possess the policy leverage they used to. Do you think multinational approaches to economic policy are becoming not just desirable but unavoidable?
In some ways what the world economy is going through now is a little bit like the process the US went through in the early part of this century, when increasingly states had to cooperate, and increasingly there were responsibilities that had to be taken on at the federal level. While there are important differences, that analogy does say something about the direction in which the world is moving on everything from environmental questions to questions of financial regulation.
Not long ago, Wired did an interview with former Citicorp CEO Walter Wriston ("The Future of Money," Wired 4.10, page 140), who said something provocative. He was talking about the Eurodollar market, and he said, "The Euromarkets are now the greatest mobile pool of capital in the world. Money goes where it is wanted, and stays where it is well treated, and that's all she wrote. This annoys government to no end. This huge pool of 'stateless money' is destabilizing. It can move instantly, and it does."
Is Wriston right? Is interconnectedness a force for instability and volatility, or the opposite?
Your question poses a dichotomy that's much too simple. The invention of superhighways made transportation better and safer, overall. But it certainly also increased the risks of spectacular smash-ups. I think the development of modern financial markets and greater connectedness is very much like the development of the superhighway, or the inven-tion of the jet airplane. A positive force. A force that overall increases safety and stabil-ity. But a force that has its own fragility associated with it, and one that carries certain risks.
Wriston went on to say that all of this is "annoying to governments because the market isn't in any one place, geographically. It resides in cyberspace. London today is the center of the Euromarket trading. But if the British put on reserve requirements or other controls, Bahrain is waiting. In just a couple of keystrokes the whole market could be gone. Technology has overwhelmed public policy." True?
Policy is more potent for good or for ill than it used to be. Good policy is more richly rewarded because more capital comes in. That's why this is the first time in human history that you see significant numbers of countries growing at over 5 percent a year. Countries like those in East Asia - that have focused on investment, on exports, and on educating their populations - have been richly rewarded with foreign investment that has carried with it large amounts of knowledge. They have been richly rewarded with investments in technology that have spread technological prowess to their citizens. And they've therefore been able to benefit more directly from things that the globe knows. At the same time, bad policies are punished more severely than ever before, because capital can move out more easily. So I think that public policy is more potent, not less potent, than it used to be. I am confident there are more Fed watchers than there were 15 years ago, and that suggests, in some sense, that what the Fed does may be even more important than it used to be, or at least as important as it always has been. The range of sound policy choices may be more constricted, but making those choices wisely is even more important than it used to be.
Implicit in what you're saying is the notion that there is an agreed understanding about what "good" economic policy is.
The laws of economics are more like the laws of physics than many people once supposed. You can't wish them away, and they don't change because of politics. If governments print too much money, they will have inflation. If they expropriate - if they steal - they won't have foreign investment. If they lack well-developed financial markets, savers will earn low rates of return, and will therefore stay away. These are the realities that all countries, whatever their culture, have to confront if they want to prosper in today's world.
The rise of global capital markets has been the most profound change to the world economy in the past 20 years. The rise of emoney could be the most profound change in the next 20. There's heated debate about what government should do, if anything, about it. How much regulation do you think is necessary?
In many ways there is a lot to learn from the spread of credit cards, which are a profound innovation in the use of cash, in that basically you have the notion that you can give someone a plastic card and at the end of the day they will get credited money. Credit cards have raised important issues in the area of consumer protection and the area of fraud, and the credit card market is a much, much healthier market today because the Secret Service is involved in protecting against fraud; because there are restrictions limiting how much it can cost you if you lose your credit card. I think this is instructive, because it would have been easy to have either substantially underregulated or substantially overregulated credit card technology, and denied people its benefits. Like most things in public policy, the truth lies between the extremes.
Taxation is one of your academic specialties, and it's an area you and others at Treasury have been thinking about with respect to ecash and e commerce. You've put together a report on this in preparation for the discussions at the G-7 summit.
The first thing the report says is that we are not going to introduce Internet taxes, or treat the Internet as a golden goose to be plucked. It does touch on three areas where the Internet requires us to think through traditional tax concepts, if we're not going to impede the development of this technology. One is the definition of property. In traditional economic thinking there is a very strong difference between a tangible good and an intangible property on which you can acquire royalties. When you think about software, there's nothing importantly different about a diskette versus a program that is downloaded through a modem. In each case it's really the information content that's crucial. Designing appropriate rules that can maintain neutrality in that situation is essential. The second area is the question of international taxation - taxation where more than one jurisdiction is involved. Cyberspace resides in no one country, so you have to design appropriate tax concepts. What we favor are approaches that are residence-based, because with residence-based approaches you know who gets the income and you know where they reside. So one of the things being discussed in the international forum is, with intellectual property transferred from one country to another, how the profits should be taxed.
The third area that the paper touches on is the whole area of tax evasion. Just as we've got a variety of requirements and restrictions on the use of cash, we will also need ways, as various electronic funds transfers proliferate, to ensure that they don't become vehicles for escaping or avoiding tax. One of the things I've been struck by since I came to Treasury is the link between financial issues and law enforcement issues. Our IRS commissioner, Peggy Richardson, likes to say it took an accountant to catch Al Capone.
You've said that the great challenge of the global economy is to lift the developing world out of poverty - to enable it to share in the prosperity of the West. Separatists claim that globalization hurts those countries even more than it hurts workers here. I know you disagree with that. Why?
The evidence lies in what's happened in the developing world over the past 25 years, and what's been happening in an even pronounced way over the past five. It's only a generation ago that, in much of the world, one out of every five babies was dying before the age of 5; that number is now one in ten or less. That's still much too high, but it is vastly better. The elimination of all cancer in the United States would increase life expectancy by about two years; progress has been made in the developing world that has increased life expectancy by nine years in the last generation. There are enormous problems, but progress is being made, and it's being made more rapidly in places where market principles are being adopted. Compare South Korea and North Korea. Compare western Germany and eastern Germany. These are as good a pair of controlled experiments that the science of political economy will ever have, and the results are in, and they are clear, and they are surprising to a large number of people who in 1975 would have regarded the outcome as very much in doubt. John Kennedy, for one, believed as president that the Soviet Union would surpass the United States economically within the 20th century. We have learned great lessons. It's a long way from the end of economics, but there is much that we know, and what we know carries with it staggering potential for human emancipation.
