Liberalism of a kind is being restored to the world's economy after a series of experiments with a variety of formulae, says Martin Wolf

The 20th century began in 1914, with the first world war, and ended between 1989 and 1991, with the collapse of the Soviet empire. This is not just true of politics. The century has witnessed the testing of virtually every imaginable economic idea.

By its end, however, the world had returned, in a modernised and modified form, to the economic liberalism with which it began.

At the beginning of the century, the liberal verities of the 19th century had not yet perished. The gold standard remained the anchor of monetary policy, guaranteeing long-run price stability.

Budgets were supposed to balance - and, in higher income countries, generally did. The UK, at least, remained wedded to free trade. Capital flows were free - and very large. By the standards of the late-20th century, government also remained small.

In 1913 total spending, by all levels of government, was just 8 per cent of GDP in the US, 9 per cent in France, 13 per cent in the UK and 18 per cent in Germany.

Yet the 19th century world was also in retreat. The most important early sign was in trade. The two rising economic powers, the US and Germany, were protectionist, the US hugely so, with an average tariff of more than 40 per cent on manufactured goods in 1913.

Laissez faire, already under attack, was to be destroyed in two world wars and the great depression. The gold standard was abandoned during the first world war, reinstated in the 1920s and then collapsed forever in the 1930s.

Even the UK abandoned free trade. World trade fell sharply, both in absolute terms and as a share of economic activity. Government spending grew as a share of GDP, even in peacetime; and governments intervened increasingly in their economies.

Behind these changes was an acceptance of the idea that governments were responsible for - and should be judged by their success in delivering - prosperity and economic security.

Disagreements were largely about how far governments felt they needed to depart from the norms of the market economy in order to meet these new responsibilities.

The most significant group was the advanced economies of North America and western Europe. Here emerged the Keynesian consensus - after John Maynard Keynes, author of the century's most influential book on economic policy, the General Theory of Employment, Interest and Money (1936).

Its essential message was a combination of the market economy with active management of aggregate demand, through fiscal and monetary policy, to ensure full employment.

This domestic macro-economic management was to be complemented by liberal trade, but not free capital flows. To allow countries to combine trade liberalisation with full employment, there was acceptance of the occasional need to devalue the currency.

The International Monetary Fund was established to oversee the new exchange rate system and provide liquidity to countries that were in temporary need of additional foreign exchange reserves.

The Keynesian consensus ruled, with growing legitimacy, for three decades. By the late-1960s, it had become orthodoxy. The period from 1948 to 1973 was also the most successful in the history of the world economy: world real GDP rose at an average rate of close to 5 per cent a year.

Yet, this golden age ended with the inflation of the 1970s and the breakdown of the IMF-regulated regime of fixed, but adjustable, exchange rates.

What war and depression did for 19th century laissez faire, inflation and then rising unemployment, notably in western Europe, did for the Keynesian consensus.

And, just as 19th century attitudes were eroded by the new ideas of greater state involvement, so Keynesianism was undermined by an intellectual counter-revolution - Milton Friedman's monetarism.

Professor Friedman argued both that it was impossible to secure a permanent reduction in unemployment by accepting higher inflation and that there was a close link between monetary growth and demand.

Of these propositions, experience has confirmed the first, but not the second. The new European Central Bank is the only significant central bank to remain wedded to some form of monetary targeting. Today's consensus is that the target should be price stability. The chief policy instrument is monetary policy, as Professor Friedman recommended, though not via monetary targets. Meanwhile, fiscal policy should be aimed, in normal circumstances, at long-run sustainability.

To secure a combination of stable money with growth and high employment, economies also need to be made more competitive and inter nationally open. This rediscovery of the market was led by the US and the UK over the past two decades, with a focus on privatisation, lowering of marginal tax rates, liberalisation of financial systems, opening of the capital account of the balance of payments, and deregulation, notably of financial and labour markets.

eanwhile, for much of the post-second world war era, the communist bloc and developing countries, many of them newly independent, stood aside from the consensus of the industrial countries.

They became wedded to state control, embracing planning, comprehensive regulation, state ownership and national self-sufficiency. The attraction of these ideas had been stimulated by the experience of planning in the two world wars, by the apparent success of Stalinism and by the collapse of world trade and commodity prices in the 1930s.

By the early 1970s, these attempts were failing. The contrast between the dynamism of the more outward-looking market economies of east Asia and the slow growth of inward-looking India was striking.

So too were the difficulties of the Soviet Union. In the 1970s the disarray of the advanced market-oriented countries gave the highly interventionist economies a breathing space. But the recovery of the market economies in the 1980s ended central planning. Deng Xiaoping had started to move China towards the market in the late-1970s. In 1991, the Soviet Union disappeared, while India embraced liberalisation.

At the end of a turbulent century, full of dreadful mistakes and disastrous experiments, a new synthesis has emerged, one that has restored some of the liberalism with which it began.

Yet, while the policy world of the late-20th century has similarities with that of its beginning, it is also quite different. This is a world of big governments, heavy regulation and managed national moneys, with floating exchange rates among them.

The question is whether what will emerge in the next century is a rational evolution of the successful system of today or, once again, its destruction.

It is possible to foresee both possibilities: the former could include a move towards a single global money, or even the disappearance of money as we know it, as the information economy advances; the latter could involve a destruction of the liberal global economy by successful coalitions of often rabidly anti-market, non-governmental organisations.

Which it is to be depends on whether the policy-makers who are to come remember the painfully learned lessons of this century - or forget them, instead.

RELATED ARTICLES
GLOBAL BUSINESSES: Multinationals come into their own
INDUSTRY: A cure is found for the mundaneness of making things
CURRENCY: Internet heralds coincidence of wants
FINANCIAL SERVICES: Cottages consolidate