Ethan B. Kapstein, "A Global Third Way Social Justice and the World Economy," World Policy Journal, Vol. XV, No. 4 (Winter 1998/99)


The postwar economy was a machine so perfect that for over a generation it delivered both peace and prosperity to the members of the Western alliance. The product of a blueprint drawn up by British and American leaders during the Second World War, it combined the virtues of globalization  (or "free multilateralism," as they called it) with those of the national welfare state. In essence, the model represented a grand bargain between capital and labor, ending an antagonism that had, in the leaders' view, been responsible for a half-century of international conflict. 

According to their plans, globalization was meant to serve as the great engine of economic growth, spurring innovation and making capital and labor much more productive than they were under protectionism. But the leaders were also aware that free trade and capital flows must inevitably destroy some domestic industries, releasing churning forces that could produce social disruption and political instability. That made some governing institution a necessary complement if order was to be maintained, a role given to the welfare state. It would cast safety nets (unemployment compensation, education benefits, income transfers, and the like) for those citizens who, through no fault of their own, were tossed aside by economic and technological change. 

For over a generation, this postwar machine, this model of social capitalism, carried the industrial world to a bountiful era characterized by unprecedented levels of economic growth and rising per capita incomes. Even some developing countries managed to hitch their wagons to it for part of the ride, enjoying a generation of export-led growth. By the early 1990s, with the collapse of the Soviet Union, economists and policymakers were crowing that the West's wartime vision had become a global reality, with countries everywhere seeking to liberalize and privatize their economies. 

But today we look back at our arrogance with shame. As the world economy suffers from an endless series of fiscal, monetary, and currency crises, the old design's internal flaws are becoming evident. Fundamentally, we see that the bond between globalization and the welfare state is breaking down, as mobile capital flees social expenditure and the taxation that must come with it. Everywhere, states are failing to meet their obligations to those who are most vulnerable. 

The system's failure could not have come at a worse moment. In the advanced welfare states, fiscal pressures have led to sharp reductions in social programs, and this at a time of rising income inequality in the United States and double-digit unemployment in Western Europe. In the developing world and postcommunist transition countries, the distant promise of a durable welfare state has vanished beyond hope, another victim of their constant budgetary crises and the austerity measures thrust upon them by the International Monetary Fund (IMF) and global financial markets. And in East Asia, a region that once believed in its unique capacity to use export-led growth as a proxy for welfare state policies, the tragic failures of that strategy are now evident. From Korea to Indonesia, millions of newly unemployed have fallen into misery's deep pit, without social insurance of any kind. 

In facing this tragedy, such leaders as British prime minister Tony Blair and President Clinton have called for a "third way" in economic policy as an alternative to free market liberalism on the one hand and active state interventionism on the other. But the third way they propose, as captured by such phrases as "from welfare to workfare," goes no further than welfare state reform in the major industrial nations, which in any event is likely to fall on the backs of the least advantaged. At no time have they addressed the social calamity facing the world's submerging economies, or stated their willingness to go after one of the major players in that drama, mobile capital. 

If any lesson is clear from the recent round of financial crises, it is that in a global economy, the third way simply cannot be forged by national governments acting on their own; that road is a dead end. Instead, like the original postwar order, it must be the product of international cooperation. Illuminating a viable third-way strategy, which reconciles the cool logic of globalization with our moral sense of social justice, is our present purpose. 

The Third Way in History 

Searching for a third way is hardly unprecedented. During the late nineteenth century, as industrial capitalism became increasingly associated with urban poverty, it took the form of finding some alternative to the Darwinian strand of laissez-faire economics, with its crude emphasis on the "survival of the fittest," and socialism, with its rejection of private enterprise. In Britain, Chartists, utopians, and union men were among those making the case that working people had an inherent dignity that went beyond profit-and-loss calculations. They called, among other things, for factory laws, minimum wages, unemployment insurance, pensions, and suffrage extension. Their shared purpose was to "de-commodify" labor, removing a worker's fate from the alleged laws of nature and the free market. 

In the United States, the Protestant-led Social Gospel movement and its associated "new political economy" made similar pleas, and some of its academic members would go on to establish the American Economics Association (AEA) in 1885 so as to advance the cause of "Christian economics." According to historian Sidney Fine, to followers of the social gospel, the philosophy of laissez-faire economics was "selfish," "inhumane," "unchristian," "unethical," "immoral," and "barbaric." It was, in the words of one preacher, "the science of extortion, the gentle art of grinding the faces of the poor." Said leading movement figure Washington Gladden,"Economics without ethics is a mutilated science--the play of Hamlet without Hamlet." 

For the economists who were influenced by the social gospel's calling, most notably AEA founders Richard Ely and John Commons of the University of Wisconsin, it was clear that the federal government had a moral responsibility to intervene in the labor market on behalf of the common man. Only in this way could the industrialist's single-minded search for profits be counterbalanced. Ely asserted that "God works through the State in carrying out his purposes more universally than through any other institution." For his part, Commons stated that "Government is the only supreme authority among men...the only means whereby refractory, obstructive, and selfishly interested elements of society may be brought into line with social progress." 

It would take many decades for the Social Gospel movement to make its influence felt in the American polity. Even during the depression of the 1890s, which brought unemployment levels to 20 percent of the working population, sparking riots and demonstrations throughout the country, the government showed no interest in trying to create jobs or provide social insurance. But as the squalid conditions of working people and their families became a regular topic of newspaper reporters and photographers, who produced images that became seared into the collective consciousness, and as labor unions grew in strength, public policy tentatively began seeking ways to balance economics with ethics. Infusing the tradition of American progressivism, many of the new political economy's basic demands finally entered the White House with the election of Franklin Roosevelt in 1932. 

Galvanizing an Activist State 

Taking over from a Hoover administration that could perceive in the Great Depression a natural economic process of creative destruction, Roosevelt instead sought to galvanize an activist state that would lead the nation out of its morass. In launching the New Deal, he called for a "new order of things designed to benefit the great mass of our farmers, workers, and business men." He said that "Government itself was going to...bring about its avowed objectives rather than stand by and hope that general economic laws alone would attain them." The objective was to "replace the old order of privilege in a Nation which was completely and thoroughly disgusted with the existing dispensation." All told, the New Deal's overriding purpose was to help people "to gain a larger social justice." 

Roosevelt's policies, including public jobs programs, government investment in infrastructure, and social security, were widely attacked by Wall Street bankers and conservative politicians as being a first step on the road to an American socialist state. But the president was confident that he was acting to save the capitalist system from its own failures. The safety nets he cast to those whose lives were being destroyed by the Depression represented an effort to preserve social stability at a time of great turmoil, and he recognized that any economic system that was widely viewed as unjust could not long endure. 

As Roosevelt experimented with his New Deal policies, John Maynard Keynes, whose work remains central to the third-way debate, was developing the theoretical underpinnings of the modern welfare state. In his Depression-era writing, Keynes attacked the classical school of economics. It treated labor like any other commodity, subject to the laws of supply and demand, and it prescribed that unemployment could only be countered by wage cuts. Keynes, in contrast, argued that workers should receive a decent wage so as to maintain aggregate consumption, and he made the case for governments to produce budget deficits if needed to stimulate economic activity and create full employment at reasonable wage levels. "The outstanding faults of the economic society in which we live," he wrote in his 1936 treatise, The General Theory of Employment, Interest and Money, "Are its failure to provide full employment and its arbitrary and inequitable distribution of wealth and incomes." Keynes believed that these faults, if not corrected, would ultimately lead to the collapse of democratic-capitalist regimes, with Weimar Germany providing a tragic example. 

These British and American currents of political-economic thought would come together during the Second World War--and most appropriately, in the first instance, off the Canadian coast of Newfoundland. Meeting in August 1941, four months before the surprise attack on Pearl Harbor, Franklin Roosevelt and Winston Churchill forged the Atlantic Charter, which laid the cornerstones for the new world order they were determined to build following Hitler's defeat. They pledged at the war's end to seek "for all countries and peoples improved labor standards, economic advancement, and social security." They also vowed to end "freedom from fear or want." 

The charter's social and economic emphasis grew out of a shared view of what had caused the tragedies of the past generation: the First World War, the Russian Revolution, and the Second World War. The two leaders believed that economic distress was at the core of political instability, and that depression was a surefire recipe for domestic conflict and international war. They had seen the global economy of the 1930s turn into a beggar-thy-neighbor battleground, as countries--including their own--adopted mercantilist policies aimed at maximizing exports and limiting imports, impossible if practiced by all. Social disruption within nations, economic conflict abroad, and the result was a Hitler and a world war. 

Drawing from this account, it was clear to Roosevelt and Churchill that the path to peace and prosperity must be grounded in domestic economic stability, tightly coupled with international cooperation. In that basic insight lay the outlines of the postwar order. It would require, as Keynes had argued, an interventionist state, a welfare state, to protect workers against the world economy's harshest blows. But in order to prevent states from trying to export their economic problems, international cooperation would also be needed. The task of reconciling the nation-state and the international system would fall to a new set of multilateral organizations, ensuring a cooperative interdependence among trading partners. That was the plan, sketched even before the Second World War was over. But putting it into place would have to await the Allied victory. 

The Postwar Order 

In his penultimate address to Congress in January 1944, Roosevelt declared, "We have come to a clear realization of the fact that true individual freedom cannot exist without economic security and independence.... We have accepted, so to speak, a second Bill of Rights under which a new basis of security and prosperity can be established for all--regardless of station, race or creed." Every American had a right to a job, and the right to "earn enough to provide adequate food and clothing and recreation." And it was the government's responsibility to ensure that these rights were protected under law. 

At the war's end, no political-economic objective became more crucial to the advanced industrial countries than the achievement of full employment, and almost all of these economies had adopted something like full employment legislation by 1945. The pacesetter in this development was Great Britain, now operating under the sway of Keynesian ideas. As early as 1944, the Churchill government's White Paper on Employment stated that "the Government accept as one of their primary aims and responsibilities the maintenance of a high and stable level of employment after the war."ţ With those words, the modern welfare state was launched. 

In the United States, the quest for full employment faced a bumpier road, despite the urgings of President Roosevelt and his successor, Harry Truman. Conservatives in Congress argued that legislation mandating such a role for government would represent a first step toward a planned, socialist economy. Ultimately, a winning political coalition was formed around the somewhat more muted 1946 Employment Act, which called upon the government "to foster and promote...conditions under which there will be afforded useful employment for those able, willing, and seeking to work, and to promote maximum employment, production, and purchasing power." Still, the act and its companion, the G.I. Bill, which provided financial assistance to returning veterans, suggested that even the American state was prepared to become more active in the field of economic management. 

But the welfare state, with its promise of full employment, living wages, and social insurance, only provided one piece of the postwar order. For it could not survive an autarkic existence (as the collapse of the ultimate welfare state, the Soviet Union, would later demonstrate). It was a tremendously costly undertaking, requiring a significant share of a society's output to function. If the welfare state was to work, it had to make efficient use of its capital and labor, in order to generate the wealth needed to keep its societal promises. 

This, in turn, meant that a generous welfare state had to be nested within a global economy characterized by free trade and investment flows. By respecting the principle of comparative advantage, nations would maximize their economic output, bolstering domestic wealth and, through taxation of both capital and labor, making available the revenues needed for social policy. Globalization and the welfare state were thus fitted hand in glove. 

The New Religion 

That economic reality dovetailed nicely with the fact that the postwar leaders also sought to rebuild the international economy in the interest of world peace, since they believed that trading states were unlikely to go to war with one another. 

American officials in particular held what can only be described as a religious belief in the blessings of free multilateralism. Of course, having emerged from the war as the world's strongest and most dynamic economy, it was certain that the United States would benefit mightily from a free trade regime. 

During the summer of 1944, as their troops clawed toward Berlin, the Allies met at Bretton Woods, New Hampshire, to build this postwar order. Their shared objective was to prevent any return to the 1930s world of economic conflict. In so doing, they sought to design a structure that would promote free trade and investment while allowing governments considerable autonomy to advance welfare state policies. They now faced the twin tasks of writing a clear set of rules for international transactions and coupling them to a cooperative, multilateral system that would help states cope with periods of economic distress. Unlike the Depression-era game of Monopoly, in which bankruptcy weeded out the losers, the objective here was to force all players to pony up when someone faced a cash crunch, permitting the global economy to keep running on a peaceful plane. 

The focus at Bretton Woods was on international finance, for it was money that breathed life into trade and investment. Here, the Allies quickly rejected the nineteenth-century path to international financial stability: the gold standard. That standard, which rigidly fixed national currencies against the price of the precious metal, had governed the global economy for almost 100 years before the First World War. It forced states to adopt what today we would call ýresponsibleţ macroeconomic policies, meaning balanced budgets and low inflation. Any wavering from the gold orthodoxy was met by a quick withdrawal of credits from the global capital markets centered in London. But while the gold standard may have prevented irresponsible finance ministers from acting badly, it also blocked governments from doing anything good for their workers during hard times. 

The economics of the gold standard were simple and cruel. The problem was that, when countries ran trade deficits, they had no choice but to export gold to meet their payments requirements. This reduction in gold holdings eventually had to be counteracted by a rise in domestic interest rates, so as to prevent the loss of gold from becoming too great. Higher interest rates then caused a contraction in domestic economic activity and an increase in unemployment. With no safety nets to protect them, the jobless faced starvation, threatening social disruption. As Russian finance minister I. A. Vysnegradskii said of his country's foreign wheat sales during the famine of the 1890s, "We must export though we die." And none of the delegates could forget the more recent human toll that the gold standard had taken on Weimar Germany--a contraction of economic activity so great that it led voters to reject the sitting government in 1932, paving the way for Adolf Hitler. 

The alternative offered at Bretton Woods represented a compromise between the international need for financial stability and the domestic need for economic autonomy. Under the aegis of Keynes and American Treasury official Harry Dexter White, the contracting parties agreed to a "dollar standard." Under this standard, national currencies would have a fixed exchange rate in relation to the greenback, which itself was convertible to gold at $35 per ounce--that provided the stability part. But states would retain the right to maintain controls on international capital movements during a so-called transition period (which in fact lasted for many countries until the 1980s), giving them significant capacity to manage investment flows--that was the autonomy part. 

At the same time, the delegates laid the foundation for international economic cooperation by establishing the International Monetary Fund and the World Bank. The IMF was given two main tasks. First, it would decide upon any exchange rate adjustments that might be needed, preventing countries from devaluing their currencies unilaterally in beggar-thy-neighbor fashion. Second, it was charged with making emergency loans when countries were suffering balance-of-payments crises, so that they would not be tempted to opt out of the global economy by adopting protectionist trade measures. 

For its part, the World Bank was to provide funds for postwar reconstruction, and give aid and technical assistance, largely for infrastructure projects, to developing countries that were seeking to attract foreign direct investment. Overall, the idea was to keep all member states moving down the road toward a liberalized global economy. 

It is difficult for us to recapture the great expectations that the postwar leaders had for the new system they had created. They thought they had found the keys to the kingdom, a way of achieving the three great wartime goals of peace, prosperity, and social justice. Free trade and managed investment flows held the promise of advancing world peace and prosperity, as economists and philosophers going back to Adam Smith, David Ricardo, and Immanuel Kant had argued. And the egalitarian welfare state, with its full employment policies and social safety nets, would create a more just economy for all workers. 

But there were major gaps in the Bretton Woods order. For one thing, the developing countries, many of which were just emerging from colonialism, had little voice in the proceedings. Owing to their diminutive status in the global economy, these countries were naturally suspicious of the ideology and practice of free multilateralism, a policy that, in their view, would only make the rich countries richer. The World Bank, with its focus on foreign direct investment, seemed to be nothing more than a tool of multinational corporations, all of which were based in the United States and, to a lesser degree, Western Europe. This skepticism about the emerging international system hardly stemmed from ignorance of economic theory, but instead was fed by much of the existing academic literature at the time. 

U.N. economists Raul Prebisch and Gunnar Myrdal were perhaps the most prominent of those arguing that developing countries faced an inherently unfavorable trade environment. The problem, in their view, was that the prices of developing country commodity exports were falling in relation to the prices of the manufactured goods imported from the industrial world. As a result, developing countries literally had to produce and export more and more in order to import less and less, a modern-day version of "we must export though we die."  The solution they offered was industrial diversification developed behind protectionist trade barriers, a philosophy that was at sharp variance to a liberal global economy based on the principle of comparative advantage. 

Further, these same countries lacked the social safety nets that were being knitted in the developed countries of the North, leaving their workers without the social insurance needed to help overcome the hard times. Making matters worse, these governments were often politically weak and corrupt, incapable of carrying out development programs but masterful at undermining entrepreneurial behavior. Indeed, it was only in 1997 that the World Bank would devote its annual World Development Report to "the state" and its role in social and economic policymaking. 

In the industrial heartland of Europe, too, there were gaps between the Bretton Woods design and its execution. There, the wartime devastation was so complete that any talk of free trade and investment flows was pretty much meaningless. During the late 1940s there were few goods to trade and little cash for imports. It was a world of shortages, black markets, and political instability, which finally provoked a bilateral American response with the launching of the Marshall Plan in 1947ˇ48. 

But these problems, important as they were, forestalled rather than doomed the Bretton Woods system. After all, Western Europe, with American assistance, would recover from its war damage, creating some of the international economy's greatest trading states. And even among the developing countries, particularly in East Asia, successful transitions to the global market occurred. As a result, a world economy has been built since the late 1940s, realizing many of the postwar leaders' ambitions. 

In fact, between 1950 and 1973, the world enjoyed the greatest growth spurt in its history. Equally important, these economic gains were being distributed (at least within most Western societies) in such a way as to mute any complaints about how the system was creating "winners" and "losers," thus quelling domestic conflict. Simply stated, the vast majority of citizens seemed to be among the winners. Economic policy was so successful during this period that it was hardly discussed, much less debated, outside professional circles. And to the extent that "Third World" countries were failing to join in the global bounty, it could be argued that was solely due to domestic failings rather than to any inherent flaws in the international economic design. 

So what happened? 

Globalization Launched 

The Bretton Woods system revolved around the United States. Washington fueled the world's economic recovery by pumping dollars into the system with one hand while importing foreign goods and services in ever-increasing quantities with the other. That virtuous circle made it possible for countries to enter the international economy by adopting export-led growth strategies, often relying on U.S.-based multinational corporations and banks for technology and investment finance. 

But it was impossible to keep that system running. Ironically, the United States was like a developing country whose primary commodity export was dollars. Over time, the imputed value of the dollar declined as it flooded the international system. America's trading partners began to lose confidence in Washington's ability to abide by its commitment to convert all those dollars into gold on demand, since there was not enough of the precious metal on reserve in Fort Knox. It was the French who put the needle in the balloon by threatening to cash in their dollar holdings. 

On August 15, 1971, the Bretton Woods system collapsed. Without consulting his allies, President Richard Nixon announced that the American dollar was no longer freely convertible. The decision to close the gold window ended the era of fixed exchange rates and ushered in a new period of floating rates, with the financial instability that has ever since been an inherent part of the world economy. The consequences of that systemic shift have been so great that we are still struggling to make sense of it. 

Globalization in its contemporary form was really launched on that fateful day in August. By allowing exchange rates to float, currencies themselves became the object of intense speculation, creating entirely new financial markets. Banks invested heavily in computer technologies that enabled them to exploit arbitrage opportunities--that is, any mismatch between the price and underlying value of currencies--buying and selling foreign exchange in response to a state's actual and projected economic conditions. 

Under this new regime, capital controls became harder to maintain, since economic agents sought to diversify their currency holdings and exploit the opportunities offered by floating rates. French corporations, for example, might now find that it was cheaper to borrow money in London than in Paris. To put this another way, with the end of Bretton Woods, mobile capital finally broke the shackles that had held it down since the war, and now it was free to roam the planet. That gave it tremendous power over economic policymaking, forcing countries to get their monetary and fiscal houses in order if they wished to be on the receiving end of international investment. As with the gold standard, capital markets began to penalize states that failed to adopt balanced budgets or contain inflation by the simple trick of selling off their currencies. 

All these developments placed finance at the epicenter of the world economy, and its interests trumped those of other societal groups, particularly immobile labor. With increasing capital mobility, governments found themselves in a potential "race to the bottom" against other nations in which they had to lower taxes and cut spending to attract investors and maintain economic confidence. The hegemony of international finance received a varnish of academic respectability under the guise of neoliberalism, which touted the benefits of free trade, free capital flows, and floating exchange rates. 

Greener Pastures 
Yet all was not well with this new world order. With mobile finance calling the economic policy tune, the postwar bargain of equitable growth between capital and labor began to founder. States had to reward capital holders, lest they flee to greener pastures. Under the administration of Ronald Reagan, taxes were slashed for the wealthiest Americans, with the promise that their gains would "trickle down" to the working stiff. Instead, income inequality began to increase sharply, as those who held financial assets grew immensely richer in comparison to those who lived on their wages. 

In Western Europe, the effort to maintain a greater degree of income equality, or social cohesion as the French call it, was paid for with double-digit levels of unemployment. There, workers who kept their jobs earned relatively good wages, but companies simply stopped hiring new employees. The result has been a lost generation of youth, sacrificed on the altar of fiscal responsibility. European elites are asserting that the single currency, the euro, will mean a turning of the tide toward greater economic growth and job creation, and an end to financial instability. But as companies restructure and privatize in the face of the single market, it is likely that the job toll will only increase. 

In both the old and new worlds, union membership has dropped precipitously. Both Ronald Reagan and his British contemporary Margaret Thatcher turned union bashing into an art form. Not surprisingly, the sorts of welfare state policies that labor had fought for since the end of the Second World War came under sharp attack. The Bretton Woods order, which coupled free multilateralism with social safety nets, now revealed a monstrous aspect: rather than a beatific visage of peace and prosperity, what workers faced was increasing import competition, higher taxes, lower wages, greater job insecurity, and fewer assistance programs. 

For the developing countries, the new system has proved overwhelming. Lacking a well-developed financial sector and capable regulatory authorities, their banks have crashed in the face of global and domestic currency instability. Ever since the late 1970s they have been buffeted by successive waves of financial crises that, in the absence of social insurance of any kind, have left millions of working people destitute. In the postcommunist transition economies of Eastern Europe and the former Soviet Union, the coming of global capitalism has similarly meant rising poverty and unemployment. The plain fact is that these "emerging economies" never possessed the political institutions that provide the necessary foundation for successful market economies. 

Liberalism--Too Much or Not Enough? 

That is the present conundrum that has led to calls for reform of the international financial system from every corner of economic life. For conservatives, the underlying problem is not that there is too much liberalism but that there is not enough of it; in short, states still play too large a role in the world marketplace. Only with the complete removal of all barriers to the movement of capital, goods, and investment (note that labor is generally not included here) will the postwar dream of a peaceful and prosperous global economy be realized. As painful and disruptive as this liberalization process must be, they say, we have no choice but to press onward. 

For liberals, the solution must, on the contrary, be found in a return to the activist state. Liberals believe that states have lost the will rather than the capacity to manage their interaction with the global economy, and that more restrictions, especially on capital flows, would be to society's benefit. Further, they argue, governments can reorient their spending so as to fully fund or even expand welfare state programs. In short, the state retains considerable room for maneuver. 

Between these two perspectives is the "third way" of Tony Blair and Bill Clinton, who believe that since the globalization train cannot be stopped, governments should focus on reforming the welfare state, making it friendlier to holders of mobile capital. That means emphasizing such programs as "workfare," "upskilling," and "retraining," which will allegedly create a more productive labor force. 

But this option is incomplete, for so long as capital can flee the welfare state and its tax policies, social safety nets will necessarily be pared back. In almost every country the tax burden on workers is growing, while that on capital is shrinking. What this means is that if we wish to create a third way, redressing the balance between mobile capital and immobile labor, it must be done on the basis of international cooperation, rather than by states acting on their own. If any lesson is clear from the successive waves of recent financial crises, it should be this one. 

The Third Way 

Reflecting the intellectual hegemony of economic reasoning, contemporary debates over public policy usually revolve around the steps that governments must take in order to increase the efficient use of scarce national resources, including capital and labor. From this it follows that markets must be liberalized, since that is the only way to achieve an efficient allocation. But the problem of increasing efficiency, as Harvard philosopher John Rawls taught us in A Theory of Justice (1971), represents only one societal concern among others. Equality and justice are of even greater consequence, and they must be taken into account by policymakers, since an economic system that is widely viewed as unjust cannot, should not, endure. 

The starting point for this discussion of the third way draws on that insight and begins with the premise that the purpose of economic policy is to provide an environment in which every individual is able to realize his or her talents to the fullest extent possible, compatible with similar liberties for all other individuals. This proposition represents not just softhearted moral philosophy, but hardheaded economics as well. 

The logic is simply this: to the extent that all individuals have the opportunity to expand their horizons and increase their productivity--for example, through better access to education and health care--societies will generate greater wealth and enjoy domestic peace in return. And when individuals enjoy some security with respect to their old age and in the event of hard times, they are more likely to provide political support for the economic system, since it is in their long-run interest to do so. That, in a nutshell, is the underlying philosophy of the democratic welfare state. 

Now as we think about third-way strategies, let us imagine the existence of a would-be reformer who wishes to promote a more equitable economy. This reformer will naturally wish to launch policies and programs on behalf of the least-advantaged citizens. The expansion of educational opportunities and retraining facilities, and the provision of income transfers, health care, and social safety nets, would be typical of such an approach. 

Taxes will be needed to pay for these social goods. But in a world of mobile capital, potential investors will likely quit this reformer's regime. With government revenues falling, the reformer will face increasing budgetary pressures, and ultimately the IMF may be called in to provide emergency assistance. In return for a loan, it will demand cuts in public spending, increasing taxation of labor (which will often take the regressive form of, say, higher sales taxes), and a speeding of the process of economic liberalization. As a result, programs for the most vulnerable will likely get pared back. In a word, economic policy becomes perverse. 

Our Collective Plight 

This single, hypothetical case is suggestive of our collective plight. In the current financial environment, every country is feeling similar pressures in varying degrees. The welfare states of the industrial world are shrinking, while in the developing world they never had the chance to emerge. Leaders are flailing at solutions in the interest of domestic peace and prosperity, yet their record is not promising. Economic instability, income inequality, unemployment, and poverty are becoming increasingly associated with globalization. Even in the United States, with its enviable record of economic growth and job creation, the number of working poor, who usually lack health or pension benefits of any kind, is increasing. 

To be sure, many economic problems are to be found within societies themselves. Corruption, overregulation, and discrimination are among the maladies that can only impoverish a country. At the same time, welfare policies that reward slackers must eventually undermine broad public support for social safety nets. The obvious point here is that globalization cannot be blamed for all of a nation's ills; to the contrary, it often penalizes bad policymaking. 
But this should not blind us to the fundamental conflict that so troubles the entire international system, namely that between mobile capital and the welfare state. Those who seek to end the conflict must act quickly, for the state itself is being captured. Increasingly, governments are becoming instruments for capital holders, rather than institutions that are broadly representative of domestic politics. Reining in mobile capital and putting it to work on behalf of a just economic policy must be at the heart of any third-way strategy, and this can only be done on a multilateral basis. National governments, acting unilaterally, will inevitably fall short. 

In contemplating what must be done, it is tempting to turn back the clock and call for a return to the original Bretton Woods system. Some prominent economists and politicians would go back even further, to a renewed gold standard. This nostalgia for international stability is understandable, but in that past we can find no future. No country today dominates the world economy, as did Great Britain in the nineteenth century or the United States after the Second World War, moments when the entire wheel of globalization revolved around their hegemonic leadership. The orders they created reflected the particular circumstances of those times, and the one we design now must do the same. 

A progressive third-way strategy must focus on two, interrelated problems: the renegade and destabilizing nature of mobile capital and the erosion of social safety nets. This suggests the need for two, interrelated solutions. First, mobile capital must pay its fair share for the goods provided by governments. Second, a substantial share of those revenues must be devoted to social policy, which should be at the core rather than the periphery of our economic concerns. Taken together, these two measures will mean a strengthening of the two Bretton Woods institutions, the International Monetary Fund and the World Bank. 

If mobile capital can escape taxation at the national level, it should be fenced in by multilateral action. This means that political leaders must contemplate the coordination of tax policy, an idea that is already being floated by some international bureaucrats. IMF official Vito Tanzi is perhaps the most prominent advocate of this idea, and he asserts that greater cooperation represents the only way for states to avoid a race to the bottom in terms of capital taxation. The purpose of such efforts to coordinate tax policy, which should be based in the IMF, would be to reach agreement on what constitutes an acceptable, minimal level of taxation, of course allowing states that are so able to extract even more at the national level. By way of analogy, the federal government of the United States has its own corporate tax rate, but that does not prevent the individual states from establishing local revenue codes. An international agreement on taxation would bring a halt to the damaging competition among states that has enabled mobile capital to avoid paying its share of social dues. 

It may be objected that countries should have the right to impose zero tax rates on mobile capital if they wish, and that tax policy lies squarely within the domestic purview. The problem here is that tax policies have spillover effects on other countries and on the global economy as a whole. In essence, these states are cheating on the system, just like countries with lax pollution codes. To the extent that social safety nets contribute to global political and economic stability, every economic agent, no matter where located, should contribute to them. 

Beyond establishing some minimum tax rate, multilateral tax cooperation would have other purposes as well. It would certainly provide a forum for studying the feasibility of taxing speculative, cross-border financial transactions when they occur, as proposed by the Nobel prize-winning economist James Tobin. The idea underlying this suggestion is that a small tax on such transactions would have the practical effect of reducing short-term capital flows, since trading profits would be cut by tax payments. Chile, where investors must pay a heavy penalty tax if they withdraw their funds from the country after less than one year, provides a possible model. Overall, the international system has an interest in creating a tax regime that motivates capital to make long-term investments in the real economy, rather than one that rewards speculators for destabilizing currency markets. 

Why not attack the problem of capital mobility directly and impose capital controls? This might make sense for some countries at particular moments in their development, but as a general rule it would do considerable harm to the world economy. It would freeze a good share of trade and investment flows, lowering growth rates and creating new sources of conflict. It would also offer up new opportunities for corruption, as officials make markets in offshore vehicles that enable capital holders to export their savings; Russia provides a good example of all these ills. Again we should recall that our objective is to harness mobile capital rather than destroy it, and the best way to do that is through taxation. 

It would be fitting for the European Union to take the leading role in calling for a conference to consider this proposal for greater tax cooperation. After all, as the single market proceeds, the EU itself will inevitably face the problem of establishing some acceptable minimum tax level on mobile capital within its own domain. It should invite other countries to enter these discussions, forming the basis for a broad multi-lateral agreement. 

On one level it may seem strange that no major world figure has yet called for an international tax conference, since it seems to be such an obvious and necessary way of increasing government revenues. But on another level we cannot be surprised, for it obviously goes against the interests of the capital holders who are currently so prominent in economic policy circles. Instead, they have naturally focused on the need for domestic reforms, which inevitably places the brunt of the adjustment burden on those with the least political voice, namely the poor. 

Racing to the Top 

An international tax agreement, however, represents but one cornerstone of a multilateral third-way strategy. Since the purpose of tax cooperation is to increase the revenues available for social safety nets, a second needs to be built around social policy. And while it is neither feasible nor desirable to determine an international minimum wage or levels of unemployment insurance or health care, there is a more effective way of attacking the problem globally. 

That would be for some international organization, say the World Bank, to request each member state to define what constitutes an acceptable social minimum within its borders. The bank would then perform an annual social policy review, in the same way that the IMF surveys macroeconomic performance, focusing on gaps between stated policies and social reality. This would have the useful effect of spurring a "race to the top" among countries, since the reputation effects associated with having a poor social policy review can hardly be conducive to garnering fresh investment. Again, the American experience may provide some guidance here, in that states that have used revenues to improve schools, public safety, and the environment have tended to be more successful than those that have narrowly focused on cutting taxes. 

These social policy reviews could also help identify priorities for foreign assistance; and indeed both the World Bank and the IMF should be tasked by their members to insure that safety nets are bolstered rather than slashed by official lending programs. Placing social welfare rather than macro-economic stability at the center of every reform package would provide a useful corrective to their current way of doing business, though this would entail significant reforms within these organizations, not just in the countries they are meant to serve. Again, the recent financial catastrophes in Indonesia and Russia remind us that the costs are borne by the most vulnerable citizens. 

As we contemplate the third way, then, we see that our challenge is to join mobile capital to a broader social purpose. For a decade or more capital has ruled the roost, and it has arrogantly told us that states alone are responsible for their economic ills, with the cure being found in balanced budgets and low inflation. Current events have overwhelmed that prescription, and today we see that the world economy has again become a cruel affair for millions of working people. 

If we are to pursue a third-way strategy, we must accept that far from being inimical to globalization, the welfare state is its necessary companion. That was the great insight of the postwar leaders, who recognized that without social peace there could be no prosperity. And while the machine they built has now become a museum piece, it remains a source of wonder and inspiration. It demonstrates that we can have a future that combines growth with justice, so long as we possess the political will to create it.


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