It’s rare, in economics as in life, to get a second chance. Though economists are constantly learning lessons from past mistakes, seldom are there obvious opportunities to apply them. The current downturn, however, may provide such an opportunity. Globalization, the dominant economic trend of the past quarter century, has slowed significantly since the recession began several years ago. As economies around the world recover, the march of globalization will inevitably resume — but it need not return in the same often destructive form it had before 2008. This time, perhaps, we can get a few things right.
First, let’s be clear: expansions in trade can stimulate growth. A surge in trade contributed to the post–World War II boom experienced in much of the West, which is what persuaded so many economists and journalists in the 1990s that trade protections should be eliminated, this time even faster. But directly after the war, global economic governance was healthy. Beginning at the Bretton Woods conference of 1944, the international community created rules and institutions — notably the General Agreement on Tariffs and Trade and the International Monetary Fund — to regulate global trade and finance. Tariffs were cut, but the creators of the new system were careful to give individual nations latitude to implement many of their own policies. Domestically, governments were for the most part free to do as they pleased — they could adopt generous public-welfare programs or subsidize nascent industries. They could also control the flow of capital across their borders. Currencies were fixed against the U.S. dollar to help reduce uncertainty among traders and investors.
Globalization as we know it today looks rather different. It took firm hold in the mid-1990s, when the World Trade Organization replaced GATT. Under the WTO, tariffs and quotas were widely reduced, as free trade ideology swept up economists and policymakers alike. By this time, currencies were no longer fixed to the dollar, instead left to float in the marketplace, leaving them more vulnerable to manipulation. The loopholes that had been common under GATT’s patchwork regulations gave way to strictly enforced, one-size-fits-all rules. Around the same time the WTO was “liberalizing” (as the expression goes) the trade of goods, governments in the developing world were lifting long-standing restrictions on the flow of money into and out of their nations. Though sometimes the work of true believers in the free-trade orthodoxy within the national governments, the repeal of these capital controls was just as often the result of pressure from the IMF and the Organisation for Economic Co-operation and Development (with the enthusiastic support of the Clinton Administration and its globalization guru, Lawrence Summers).
While academic and business economists made the case for globalization, the press brought us word of its inevitable rewards. In his 1999 book, The Lexus and the Olive Tree, Thomas Friedman sang the praises of free trade and deregulation as the ideal path toward global growth and social progress for poor and rich alike. The title of Friedman’s 2005 bestseller, The World Is Flat, became the governing (and fittingly nonsensical) metaphor of this new order. More sophisticated observers, among them the influential Financial Times columnist Martin Wolf, were also persistent enthusiasts. The fairy-tale optimism of these commentators was based on the crudest interpretation of Adam Smith’s invisible hand. The dismantling of tariffs, the deregulation of finance, and the reduction of government interference would work free-market magic. Trade would soar for emerging nations and rich nations alike, with each one making what it manufactured best. Capital would flow wherever it was needed, information would spread with equal ease, and wages would rise everywhere.
But flat-world globalization didn’t work out that way. Trade among nations became highly imbalanced. China and Germany ran huge surpluses, while the United States and much of Europe ran corresponding deficits, undermining local manufacturing and overall financial stability. Such inequalities, in which a few countries suck the jobs and the potential for economic growth from others, cannot be sustained. Nations running a deficit ultimately buy fewer exports from those running a surplus, resulting in a vicious circle.
And the WTO extended its reach well beyond trade. Where the loose confederation established by Bretton Woods had allowed member nations to structure their own markets, the WTO became, as the economist Dani Rodrik puts it in his book The Globalization Paradox, “an instrument for attacking the full range of transaction costs that impeded international commerce, including differences in national regulations and standards.” Subsidizing a domestic industry could now be viewed as a violation of trade rules. Environmental regulations could be challenged, as when an E.U. ban on hormone-treated-meat imports from the United States was deemed illegal by the WTO, supposedly on scientific grounds.
The extensive globalization brought about by the WTO has in many cases pitted nations against one another rather than encouraging them to cooperate. For example, a proposed WTO mandate reducing agricultural subsidies within wealthy countries, designed to help developing nations sell more of their food, would benefit Brazil and other exporters but harm food importers such as Egypt, whose prices rose. Finance and telecommunications also went global under the WTO’s regime. Wealthy nations lost not only manufacturing jobs but also middle-income jobs in finance, insurance, and sales.
Meanwhile, economic growth in Latin America, which rapidly liberalized in the 1990s, was well below the level it had reached in the 1960s and 1970s, when tariffs and domestic subsidies were high. Sub-Saharan Africa experienced negative growth over the course of the 1990s. China’s economy flourished after it joined the WTO, but it offset lowered tariffs and other trade barriers with currency manipulation, keeping the value of its renminbi artificially low to stimulate exports.
The weakness of flat-world economics is clearest in the misguided globalization of capital. By the 1990s, the concerns voiced by John Maynard Keynes at Bretton Woods over the risks of free-flowing capital had been forgotten. The Clinton Administration, eager to open markets for American financial firms, demanded an end to capital controls in nations such as South Korea. Economists now seemed to believe without reservation in the rationality of financial markets, their ability under almost any circumstances to distribute capital efficiently and avoid speculative bubbles. They pointed to the growth of many Asian economies in this period as proof, but this growth occurred less because of open markets than because of government investment in particular industries, educational reforms, and capital protections. An ideological shift, pure and simple, reinforced by the powerful interests of banks and investors in the world’s major money centers, was at the heart of financial globalization. And the result was severe financial crisis. Southeast Asian nations, Thailand chief among them, collapsed into painful recession, precisely because the “hot” money made possible by financial deregulations fled when times got tough.
Although it took a bit longer in our case, the United States was likewise eventually punished for its free use of global money, mostly from China, when the mortgage boom turned to bust in 2008. The rush of capital also pushed up the value of the dollar as the Chinese bought American securities, raising the cost of American exports to the rest of the world. This is the chief cause of our country’s persistent unemployment problem.
The one sure economic achievement of this period, according to partisans of globalization, was the worldwide drop in poverty. It’s certainly true that global poverty — at least as measured by the number of people living on less than $1.25 a day, rather a modest benchmark — has lessened dramatically in the past two decades. But it’s not clear what role WTO and IMF policies played in this reduction, especially since so much of it occurred in the mixed economy of China, which did not follow the orthodox free-market path.
By the time of the 2008 financial crisis, even free-trade advocates, including Alan Blinder, Paul Krugman, and Summers himself, had doubts about globalization.
According to figures released by the United Nations, growth in trade activity, which soared immediately after the recession, has since slowed dramatically, creating room for a reset of policies. In the area of finance, the world is actually deglobalizing: the total volume of stocks, bonds, and bank loans as a percentage of the world’s economy has plunged to the level it held in the early 1990s. There has been a dramatic decrease in “hot” money — the short-term bank loans that led to catastrophe in South Korea, Russia, and Thailand in the 1990s and southern Europe in the 2000s.
This pause in trade and tightening in capital offers us an opportunity, now that we’ve seen the ravages of flat-earth globalization, to get things right.
First, the WTO should stop tearing apart useful domestic policies. If one nation’s leaders choose to invest in a particular set of local industries, they should have some leeway to act, and if another’s choose to bankroll a substantial social safety net, they, too, should have that option. If the United States wishes to protect certain sectors of manufacturing, perhaps it should have that right, within limits.
Second, policymakers in emerging economies should take advantage of the recent drop-off in capital flows to put in place controls, perhaps administered by the IMF or a new ad hoc international organization. Ideally, these controls would be set by individual nations according to their needs and stages of development.
Third, international trade in its current form — huge deficits for some, huge surpluses for others — must be rebalanced. Countries such as Germany, which enjoyed booming trade with other members of the euro zone in the early 2000s but lent excessively to Greece, Italy, Portugal, and Spain, can no longer expect to run the surpluses they once did.
At Bretton Woods, Keynes proposed a mechanism to sanction nations with persistent trade surpluses by charging them interest and forcing them to increase the value of their currencies. (The United States, which had big surpluses then, would not approve Keynes’s plan.) In a new book, The Leaderless Economy, veteran economists Peter Temin and David Vines argue that a similar global agreement is now required among nations.
If such a plan were in place today, it might mandate more fiscal stimulus within Germany, increasing domestic demand for goods. It might also put regulations in place to continue spurring domestic demand in China, to make the country less dependent on exports and the low value of its currency. (The good news is that China, with average wages on the rise, is already moving in this direction.) The authors propose that a meeting of the G20 might be the forum in which to forge an agreement. This group includes wealthy Western nations as well as countries such as Brazil, China, Russia, and Saudi Arabia. Is getting all their leaders to agree a tall order? Yes, of course — but it’s worth the fight.
Fourth, those who preach free trade should also preach a stronger safety net. Economists almost without exception are free-trade advocates, but they rarely acknowledge that free trade means some individuals and businesses will inevitably lose jobs and the ability to compete. To compensate the losers, advocates should propose a safety net of unemployment insurance, welfare programs, job retraining, and health care. (Scandinavian nations maintain popular support for trade partly by way of welfare states that protect those citizens and businesses damaged by imports.)
In periods of slow growth, the risk of a trade war breaking out is high. China and Europe are battling over wines. France is demanding that arts be excluded from trade agreements. Regional agreements are being made among the nations of South America and by the United States in Asia, giving benefits to members at the expense of outsiders — in the latter case, China. Clearly the answer is not to abolish the WTO and return to every-nation-for-itself trading. But we must invigorate the public discussion of what a healthy trade policy looks like. The headlong rush to free trade is a mistake we shouldn’t repeat.