Open Society: Reforming Global Capitalism
George Soros is the best-known financial speculator of our time, godfather of hedge funds, those fast-moving and largely unregulated raiders in the corporate jungle that make their killings from fluctuations in the prices of stocks, commodities, currencies. When he writes books readers might reasonably expect tips on how to make money. They will be disappointed. Soros’s ambitions are altogether more exalted. Having become a billionaire, he has set himself up as the philosopher and statesman of global capitalism, tirelessly telling the world that it now needs to remove the ladder by which he himself climbed to fame and fortune. On January 2 he was reported predicting a “hard and bouncy” landing for the US economy.
It is true that recently his predictions have been less successful. In his book The Crisis of Global Capitalism (1998), he foretold the imminent collapse of the world economy. However, it was not global capitalism that collapsed, but Soros’s reputation as a financial wizard and post-Communist guru. He was revealed as fallible, both as a moneymaker and as a thinker. As he now admits, he failed to foresee that the Federal Reserve Bank of New York would organize a bailout of Long Term Capital Management, the US hedge fund that found itself with capital of $600 million against debts of more than $1 trillion. He also failed to give “adequate weight” to the Internet revolution which pulled up the US economy and stock market to new heights, and locked peripheral countries ever more tightly into the global market. His “boom-bust” model, he now concedes, is silent on when the bust will happen. Chastened, he writes: “I made my bet and lost. It was a painful experience to endure both personally and professionally.”
His new book, Open Society: Reforming Global Capitalism, may be read as an effort at retrieval. It is a reworking of his much-criticized earlier work, but is more modest in its theoretical claims and predictions, though no less ambitious in its pol-icy proposals. He has added a new chapter, “Who Lost Russia?,” which has this somber passage: “Russia is not lost; on the contrary, it may revive under Putin. But the West has lost Russia as a friend and ally.” What survives is Soros’s conviction that the global capitalist economy is inherently unstable, and that new institutions of world government will need to be devised to keep the peace and prevent depressions. These are serious arguments. It is no longer so easy to dismiss his ideas as “at best an incoherent rendition of some common themes,” as the MIT economist Rudi Dornbusch did in 1998. Now that Soros is no longer a figure of fable, it is time to take him seriously.
Soros’s has been one of the most extraordinary careers of the postwar era. He was the archetypal outsider, determined to break into a privileged world which refused to take him seriously. He was born in Budapest in 1930, of Hungarian Jewish parents. He and his family avoided the Holocaust and emigrated to England in 1947. He graduated from the London School of Economics in 1952, where he was greatly influenced by Karl Popper, and had an unhappy time in the City of London. “Who is this fella Soros?” one can just imagine that coterie of Old Etonian bankers saying to one another. Revenge must have been sweet when he “broke the Bank of England” in 1992, by betting successfully on a devaluation of sterling, a transaction that netted him $1 billion.
In 1956 he moved to New York, where, in 1969, he set up the Quantum Fund, a pioneer hedge fund. Over thirty-one years, the Quantum Fund provided its shareholders a better than 30 percent annual return: $100,000 invested in the fund in 1969 would be worth $420 million today. Soros’s uniqueness, however, does not lie in his success in moneymaking. He is a much rarer bird: a successful man of action who is also an intellectual. I don’t suppose he worked out in advance a system for beating the market. Like all successful tycoons he acted on instinct, hunch, judgment, bias, inside information. But unlike most successful men of action he had the capacity for reflecting systematically on the reasons for his success, and it is not implausible to believe that as he prospered, he did increasingly come to see business life as a laboratory for testing his theories of how markets worked.
Using the conglomerate boom of the 1960s as his model, Soros worked out an eight-stage archetypal “boom-bust” sequence, in which herd behavior, latching on to an existing market trend, carries prices to dizzying heights before “reality” brings about a catastrophic crash. In his book The Alchemy of Finance (1987), he developed the idea of “reflexivity,” which was neatly summed up in these pages as follows:
People habitually misperceive the world around them and either are unable or refuse to acknowledge this fact. In the financial markets—which are, of course, a natural laboratory for examining misperceptions—investors’ often superficially arrived-at beliefs about market tendencies are reinforced when the market price goes their way when they buy or sell. They gain confidence in their mistaken notions and push prices even further in the same direction. This feedback, or what Soros calls reflexivity, is to him a natural law. Thus, prices typically run up too high or stay too low for far too long, because people become fixed in their partial convictions.1
In Opening the Soviet System (1990), he applied his boom-bust theory of financial cycles to historical cycles like the rise and fall of communism.
Although Soros must have enjoyed making all that money and being able to show his superiority to hereditary wealth, there is no reason to doubt his own claim that he increasingly came to see making money as the means to promoting his ideal of an “open society.” In 1979 he set up the Open Society Fund, whose mission was “to help open up closed societies, to help make open societies more viable, and to foster a critical mode of thinking.” His foundations have provided money to foster democracy and the rule of law in former Communist countries. His belief that market fundamentalism has replaced communism as the greatest threat to the open society has recently led him to concentrate his efforts on reforming capitalism. Despite much disillusionment with his philanthropic activities, Soros intends to keep spending his fortune, currently estimated at between $3 billion and $5 billion, on his causes until the money runs out.
By revealing what is on his mind, Soros has placed himself in triple jeopardy. His profits depended on him “staying ahead of the curve” (i.e., the crowd). Now, he admits, “the glory days are over: Too many people have read my books, and I lost my edge.” The Quantum Fund has been turned into a “more conservative vehicle.” His economic theorizing exposed him to academic attack. His policies for world improvement were dismissed as naive or utopian by critics who saw themselves as hardheaded realists.
Of the three, the academic attack on his economics probably rankled most. Its viciousness cannot be attributed entirely to professional jealousy. Soros has an irritating habit of announcing, as great discoveries of his own, ideas that are, in fact, familiar; and of attacking ideas he does not fully understand. In fact, his economics is quite orthodox: only it is the orthodoxy of thirty years ago—old-fashioned ideas dressed up as novelties. He is a Keynesian in his belief that the market sys-tem is inherently unstable; and a pre-Keynesian in his belief that it swings back and forth like a pendulum, always attracted to, but always overshooting, its equilibrium, or point of rest.
Readers would have got a better idea of where Soros is coming from had he acknowledged this intellectual inheritance (as he amply does his debt to Karl Popper), and confined his attack to that class of economic models produced by the new classical school, which does assume that markets always “clear”—i.e., that supply and demand always balance—and that unemployment is always voluntary. Soros’s attack on economics is further weakened by his confusing the idea of “rational expectations” with the idea of “market clearing.” Normally the first does imply the second, but it need not.2 The most charitable explanation of these lapses is that Soros was too busy making money to keep up with the literature.
If the reader can stifle his irritation at Soros’s ignorance of the discipline he is attacking, he will read Open Society as an intelligent critique of the state of global capitalism written from the vantage point of a successful fund manager. He will also concede that some of Soros’s thrusts strike home. Soros is right to argue that the “new classical” belief that markets always clear encourages “market fundamentalism,” or what used to be called laissez faire. He is right to query the assumption by some economists that fluctuations in prices, output, and employment can be safely ignored by government policymakers because they have already been “discounted” by participants in the market. Soros should be given credit for spotting, earlier than most economists did, the danger that premature financial de-regulation would lead to serious financial instability. Recent models of “multiple equilibria” in financial markets are simply catching up with what Soros was saying in the 1980s.
Soros argues for a more modest economics which accepts the fallibility of knowledge, recognizes market volatility as a major problem, and gives government a role in dampening economic fluctuations. The fact that many economists, some in positions of power, agree with him should not detract from the value of the message coming from this particular source. “After the recent financial crisis,” Soros writes, “the aim has been to impose greater market discipline. But if markets are inherently unstable, imposing market discipline means imposing instability—and how much instability can societies tolerate?” This is not a trivial question.
The first few chapters of Open Society develop Soros’s theory of knowledge as the basis of his attack on “economics” and his explanation of why financial markets are so volatile. Soros’s two organizing concepts are “reflexivity” and “fallibility.” In human affairs, unlike in the natural world, subject and object are not independent. A scientist can study the natural world, and learn its laws, without impinging on it. The apple falls to the ground without knowing what I think it will, or should, do. Scientific inquiry proceeds by the controlled laboratory testing of hypotheses, to build up a body of true statements (laws, generalizations) about nature. At least, this is still a serviceable view of scientific procedure.
Social science cannot do as well, because, as Soros rightly says, “what we think has a way of affecting what we think about.” It is as though the apple’s trajectory is influenced by ideas—its own, and those of other apples—about what it should do. If statements about facts influence the behavior of the facts to which they refer, the truth of such statements cannot be established by testing them against the facts. In economic life, fluctuating beliefs about the future (“expectations”) heavily influence the way people behave today.
Rational expectations theory assumes that over time unexpected events will cancel each other out and that, on average, expectations will be fulfilled. This is because people make optimal use of the information available to them and learn from their mistakes. The apparent conclusion that government intervention to "correct" market outcomes is usually futile has been challenged by the "New Keynesians," who argue that information failures and the costs of decision-making can cause markets to fail even when market agents form their expectations "rationally."↩
Rational expectations theory assumes that over time unexpected events will cancel each other out and that, on average, expectations will be fulfilled. This is because people make optimal use of the information available to them and learn from their mistakes. The apparent conclusion that government intervention to “correct” market outcomes is usually futile has been challenged by the “New Keynesians,” who argue that information failures and the costs of decision-making can cause markets to fail even when market agents form their expectations “rationally.”↩