The triumph of the global over the local

'It is capitalism, not communism, that generates what the communist Leon Trotsky once called the "permanent revolution"

'It is capitalism, not communism, that generates what the communist Leon Trotsky once called the "permanent revolution". It is the only economic system of which that is true, writes Martin Wolf.

Joseph Schumpeter called it "creative destruction". Now, after the fall of its adversary, has come another revolutionary period. Capitalism is mutating once again.

Much of the institutional scenery of two decades ago - distinct national business elites, stable managerial control over companies and long-term relationships with financial institutions - is disappearing into economic history. We have, instead, the triumph of the global over the local, of the speculator over the manager and of the financier over the producer. We are witnessing the transformation of mid-20th century managerial capitalism into global financial capitalism.

The financial sector, which was placed in chains after the Depression of the 1930s, is now unbound. New capitalism is ever more global and the globalisation of financial capitalism is seen in the players as well as in the nature of the holdings.

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What then are the consequences of this vast expansion in financial activity, much of it across international borders?

Among the results are that households can hold a wider array of assets and also borrow more easily, so smoothing out their consumption over lifetimes.

Similarly, it is ever easier for companies to be taken over by, or merge with, other companies. The total value of global mergers and acquisitions in 2006 was $3,861 billion (€2,830 billion), the highest figure on record.

This new financial capitalism represents the triumph of the trader in assets over the long-term producer. Hedge funds are perfect examples of the speculative trader and arbitrageur.

Another consequence has been the emergence of two dominant international financial centres: London and New York. It is no accident that these are located in English-speaking countries with a long history of financial capitalism. It is no accident either that Hong Kong, not Tokyo, is generally viewed as the leading international financial centre in Asia, even though Japan is the world's biggest creditor country. Hong Kong's legacy is British. The legal tradition and attitudes of English-speaking countries appear to be big assets in the development of financial centres.

How then should one evaluate this latest transformation of capitalism? Is it a "good thing"?

Powerful arguments can be made in its favour: active financial investors swiftly identify and attack pockets of inefficiency; in doing so, they improve the efficiency of capital everywhere; they impose the disciplines of the market on incumbent management; they finance new activities and put inefficient old activities into the hands of those who can exploit them better; they create a better global ability to cope with risk; they put their capital where it will work best anywhere in the world; and, in the process, they give quite ordinary people the ability to manage their finances more successfully.

Yet it is equally obvious that the emergence of the new financial capitalism creates vast new regulatory, social and political challenges.

Optimists would argue that the new financial system combines efficiency with stability to an unprecedented degree. Pessimists would argue that monetary conditions have been so benign for so long that huge risks are being built up, unidentified and uncontrolled, within the system. They would also argue that the new global financial capitalism remains untested.

Regulating a system that is this complex and global is a novel task for what are still predominantly national regulators. The regulatory challenges are big enough. But they are far from the only ones. Lionel Jospin's hostility to what he called a "market society" is widely shared. Powerful political coalitions are forming to curb the impact of the new players and new markets: trade unions, incumbent managers, national politicians and hundreds of millions of ordinary people feel threatened by a profit-seeking machine viewed as remote and inhuman, if not inhumane.

Last but not least are the challenges to politics itself. Across the globe there has been a sizeable shift in income from labour to capital. Newly "incentivised" managers, free from inhibitions, feel entitled to earn vast multiples of their employees' wages. Financial speculators earn billions of dollars, not over a lifetime but in a single year. Such outcomes raise political questions in most societies. In the US they seem to be tolerable. Elsewhere, however, they are less so.

Our brave new capitalist world has many similarities to that of the early 1900s. But, in many ways, it has gone far beyond it. It brings exciting opportunities, but it is also largely untested. It is creating new elites. This modern mutation of capitalism has loyal friends and fierce foes. But both can agree that its emergence is among the most significant events or our time.

This original version of this article first appeared in the Financial Times