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Globalization and Economic Stability

July 24, 2008


In two previous posts, I examined articles that discussed two different aspects of globalization: capital flows [Financial Globalization] and the agricultural sector [Globalization, Food, and Resilience]. The post about financial globalization was about studies that question whether the free flow of capital (one of the three legs that prop up the globalization stool) is really good for developing countries. Those raising the questions note that “when investment opportunities are scarce, capital inflows simply displace domestic savings and encourage consumption.” They also note that countries that tie their currencies to another currency (like the dollar) inevitably track the economic gains or woes of the economy to which their money is pegged. The rapid devaluation of the dollar has had a significant negative effect on many such economies. Their point was that dumb policies (like a lack of regulation in critical economic sectors) as well as poor savings and spending habits can generate ripple effects throughout the global economy — especially when the economy that causes the perturbation is as large as the United States.


In the post about the agricultural sector, Anthony Faiola of the Washington Post examined why globalization hadn’t made agricultural products more widely available around the globe and kept down the prices of food. One of the reasons, of course, is that there is no free flow of agricultural products as a result of food subsidies and hoarding. The point of these posts was to show that globalization is not the culprit that causes bad things to happen. Bad things happen when people do dumb things. Globalization takes the rap when those same people go looking for a scapegoat. Washington Post columnist Robert J. Samuelson examines the current global economy and wonders why globalization hasn’t helped stabilize it [“A Baffling Global Economy,” 16 July 2008]. He writes:


We’ve been having the wrong discussion about globalization. For years, we’ve argued over whether this or that industry and its workers might suffer from imports and whether the social costs were worth the economic gains from foreign products, technologies and investments. By and large, the answer has been yes. But the harder questions, I think, lie elsewhere. Is an increasingly interconnected world economy basically stable? Or does it generate periodic crises that harm everyone and spawn international conflict?


Those are excellent questions. Just as sound is transmitted faster through a solid substance than through the air, bad economic effects spread faster through the international economy the denser the economic connections. On the other hand, benefits spread faster as well. As a result, stability becomes more important with each new economy that joins the global economy. Samuelson continues:


These questions go to the core of a great puzzle: the yawning gap between the U.S. economy’s actual performance (poor, but not horrific) and mass psychology (almost horrific). June’s unemployment rate of 5.5 percent, though up from 4.4 percent in early 2007, barely exceeds the average of 5.4 percent since 1990. Contrast that with consumer confidence, as measured by the ReutersUniversity of Michigan survey. It’s at the lowest point since 1952 with two exceptions (April and May 1980). Granted, the present U.S. economic slowdown — maybe already a recession — stems mostly from familiar domestic causes, dominated by the burst housing ‘bubble.’ The Bush administration’s rescue of Fannie Mae and Freddie Mac, the struggling government-sponsored housing enterprises, is the latest reminder. Still, global factors, notably high oil and food prices, have aggravated the slump. The line between what’s local and what’s global seems increasingly blurred, and there is a general anxiety that we are in the grip of mysterious worldwide forces.”


I suspect the rest of the world would argue that the global economy is in the grip of bad choices made in America — not so mysterious at all. Samuelson doesn’t really address that point. Instead, he goes on to examine whether fingers can or should be pointed at the usual suspect — globalization.


The good that globalization has done is hard to dispute. Trade-driven economic growth and technology transfer have alleviated much human misery. If present economic trends continue (a big “if”), the worldwide middle class will expand by 2 billion by 2030, estimates a Goldman Sachs study. (Goldman’s definition of middle class: people with incomes from $6,000 to $30,000.) In the United States, imports and foreign competition have raised incomes by 10 percent since World War II, some studies suggest. Job losses, though real, are often exaggerated. But a disorderly global economy could reverse these advances. By disorderly I mean an economy plagued by financial crises, interruptions of crucial supplies (oil, obviously), trade wars or violent business cycles. This is globalization’s Achilles’ heel. Connections among countries have deepened and become more contradictory. Take oil producers. On one hand, high oil prices hurt advanced countries. But on the other, oil countries have an interest in keeping advanced countries prosperous, because that’s where much surplus oil wealth is invested.”


Samuelson goes on to note that the current situation involves the greatest redistribution of wealth in the world’s history.


Vast global flows of money threaten unintended side effects. Foreigners own more than $1 trillion of debt issued or guaranteed by Fannie Mae and Freddie Mac, reports economist Harm Bandholz of UniCredit. In the past six years, he notes, foreigners have purchased $5.7 trillion of U.S. stocks and bonds. Bandholz says the inflow of money cut U.S. interest rates by 0.75 percentage points. So: Surplus savings from Asia and the Middle East, funneled into U.S. financial markets, may have abetted the ‘subprime’ mortgage crisis by encouraging sloppy American credit practices. Too much money chased too few good investment opportunities.”


That is basically the argument put forth in the post about financial globalization noted above. The solution, of course, is common sense investing. There are many such investments around the world, especially in emerging market countries — and they could use the funds. Unfortunately, they don’t have the cachet of an investment in the U.S. The problem, as Samuelson points out, is that when people lose money investing in the U.S. the negative consequences can be severe.


A loss of confidence in U.S. financial markets could be calamitous; that was one reason for the rescue of Fannie and Freddie. But just possibly, we’re at a crucial — and desirable — turning point. For several decades, the U.S. economy has been the world’s economic locomotive. Americans borrowed and shopped; the U.S. trade deficit ballooned to $759 billion in 2006, stimulating exports from other countries. The trouble is that this pattern of growth could not continue indefinitely, because it required that Americans raise their debt burdens indefinitely. Now, China and other emerging markets may be moving beyond export-led growth. Unfortunately, that shift could abort, if high inflation (8 percent in China and India) derails domestic expansion.”


America needs to retool its economy. There will be some short-term pain, but if it emerges from the transformation with a higher savings rate, lower per capita debt rate, and jobs being created in new economic sectors, the pain will soon pass. Samuelson, however, writes that those who must instigate this transformation seem to be lost at sea.


Today’s global economy baffles experts — corporate executives, bankers, economists — as much as it puzzles ordinary people. Countries are growing economically more interdependent and politically more nationalistic. This is a combustible combination. The old global economy had few power centers (the United States, Europe, Japan), was defined mainly by trade and was committed to the dollar as the central currency. Its major countries shared democratic values and alliances. Today’s global economy has many power centers (including China, Saudi Arabia and Russia), is also defined by finance and is exploring currency alternatives to the dollar. Major trading nations now lack common political values and alliances.”


One had to be deaf, blind, and dumb not to have understood that America’s consumer economy would eventually run out of steam if it continued to be fueled by credit. Fortunately, the new centers of power hold so many petro-dollars and so much U.S. debt that they have a vested interest in helping ensure that the U.S. economy doesn’t collapse. Clearly, the U.S. can use the help. That’s where globalization plays a role.


It is no more possible to undo globalization than it was possible, in the 19th century, to undo the Industrial Revolution. But our understanding of international markets, shaped by impersonal economic forces and explicit political decisions, is poor. Countries try to maximize their advantages rather than make the system work for everyone. Considering how much could go wrong, the record is so far remarkably favorable. Alas, that’s no guarantee for the future.”


Samuelson hit the nail on the head when he implied that the answer to the current financial downturn is making the system work for everyone. Unfortunately, U.S. politicians on both sides of the congressional aisle are appealing to base nationalism in their attempts to get elected. This “America first” mindset will ultimately result in an “America last” outcome. America’s fate rests in cooperating and collaborating with the rest of the world. The sooner this is understood, the sooner solutions for many of the challenges raised by Samuelson can be addressed.

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