Globalisation and Second Best Solutions
As I’ve made clear on more than one occasion, I strongly disagree with Mervyn King’s views on fiscal policy and his belief that falling real wage are inevitable. I also think he was allowed himself to wander too far into the political debate in the UK – damaging the Bank’s credibility as independent institution.
But on some issues I agree with him, most notably on the need for a substantial reform of the banking system.
As they report “it’s really quite heady stuff for a central bank head. There’s a not-so-subtle yearning for Bretton Woods, plus a tacit admission that regulation can only go so far in combating banking crises, which, at their heart, are caused by gluts and greed.”
The key chart is below, showing the strong correlation between international capital mobility and the appearance of banking crisis.
King notes that regulation can only go so far in preventing crises and compares the post war Bretton Woods system to the current international regime:
[The current system has] also coexisted, on average, with: slower, more volatile, global growth; more frequent downturns; higher inﬂation and inﬂation volatility; larger current account imbalances; and more frequent banking crises, currency crises and external defaults. However, to some extent these period-average metrics obscure signiﬁcant improvements over the current period, with the ‘great moderation’ period post-1990 associated with much better outcomes than those achieved in the 1970s and 1980s. Nevertheless, with the important exception of inﬂ ation, the outcomes achieved during the Bretton Woods period were better than those attained since 1990. While this does not imply causation of course, it does suggest that better outcomes may be possible.
King ends by calling for a ‘grand bargain’ amongst the major economic powers:
What is needed now is a “grand bargain” among the major players in the world economy. A bargain that recognises the beneﬁts of compromise on the real path of economic adjustment in order to avoid the damaging consequences of a move towards protectionism. Exchange rates will have to be part of such a bargain, but they logically follow a higher level agreement on rebalancing and sustaining a high level of world demand.
I fully agree, and have argued previously that a grand bargain (along the lines of Keynes’ proposed International Clearing Union) is what is required to resolve some of the underlying problems in the world macroeconomy.
But what if such a bargain can’t be struck?
We live in a world where, in theory, global economic and political governance is in the hands of the G-20. In practice, however, there is no global leadership and severe disarray and disagreement among G-20 members about monetary and fiscal policy, exchange rates and global imbalances, climate change, trade, financial stability, the international monetary system, and energy, food and global security. Indeed, the major powers now see these issues as zero-sum games rather than positive-sum games. So ours is, in essence, a G-Zero world.
China versus the USA: in which the US wants China to allow the RMB to rise against the dollar, weakening China’s competitiveness by raising the price of Chinese exports.
There is the USA versus the Emerging Markets: in which the USA’s quantitative easing policy is seen to be exporting inflation, again forcing the currencies of Brazil, South Korea and other export giants to rise against the dollar.
With the Brazilian real up 40% against the dollar in two years Brazil responded to QE2 with
a. A tax on foreign purchases of bonds, designed to suppress the flow of capital in Brazil
b. $40bn of intervention into the spot market for its own currency
c. This month, a ban on short selling of the dollar against the real in Brazil
There is the Euro versus the dollar. Analysts at Goldman Sachs estimated that the entire negative impact of European austerity programmes in 2010 could be offset by a fall in the Euro’s exchange rate to parity with the dollar: to the extent that this does not happen, Europe bears the cost of its own crisis.
Then there is north Europe verus south Europe. The Eurozone is locked into one exchange rate but peripheral Europe has, over a nine year period lost competitiveness against the core industrialised and export-led countries above all Germany. Southern Europe cannot devalue, so it is being forced to impose an internal devaluation by the Eurozone authorities – which means massive austerity, wage cuts and the erosion of welfare state provision.
Then there is Japan versus America. When America did QE, so did Japan – in part justifying the move on the grounds that QE was an act of exchange rate competition.
Finally there is Britain versus the rest of the world. Sterling underwent a 25% devaluation during the Lehman crisis, stabilising at a net 20% fall against the currencies of its main trading partners. In this way Britain has offset the cost of the crisis, avoiding double-digit unemployment but amplifying the impact of the commodity price inflation that has now taken off. (My emphasis)
I am simply not convinced that a belief in “free trade, global integration and open markets” is the best starting point when considering globalisation. And I’m far from convinced that centre-left policy makers retreating into a more protectionist mode is a major risk. The bigger risk, as I see it, is centre-left policy makers (who like the authors of the IPPR press release remain convinced of the benefits of free trade) reacting to the world as they wish it to be rather than as it is.
Now let me caveat this – my ideal solution to the question of global imbalances would be some form of International Clearing Union (as proposed by Keynes as Bretton Woods), in the spirit of this I thought the Geithner Plan presented at the recent G20 summit was a worthy aim. I agree with Gordon Brown that a Global New Deal focussed on correcting imbalances and creating jobs and, in a first best world, some form of progressive multilateralism is the centre-left’s base response to globalisation.
But we don’t live in a first best world. We live in a world of rising currency and trade tensions. We live in world in which Germany seems unprepared to engage in multilateral action within the Eurozone itself, let alone globally.
Leaving aside the current currency and trade tensions, we live in a world in which the future of globalisation will be shaped more by China than by liberal democracies.
The only thing I’d add to that now is the below quote form Harold James (an eminent international economic and financial historian) taken from his book on the End of Globalization:
Nobody would suggest that the restrictive trade regimes of the 1930s adopted in country after country represented an optimal path. But there is a powerful argument that they represented a viable, and indeed perhaps the only viable, second-best option. When other countries were imposing monetary deflation and restricting their trade, an attempt to preserve incomes by means of protective legislation represented a logical strategy against externally imposed misery.