Globalization—driven by technological forces that cannot be restrained or reversed—appears to be here to stay, raising questions about how, against this background, policy should be handled. Panelists at the Eighteenth Annual International Monetary and Trade Conference, sponsored by the Global Interdependence Center in Philadelphia on November 15, discussed the ramifications of globalization, focusing on the financial crises that have characterized the last dozen years of the twentieth century and the nascent recovery, as well as economic conditions and prospects in different regions of the world.
The goal of the conference series is to translate the ideas of decision makers, the media, the academic and business communities, and the interested public into practical suggestions for public policy.
Globalization: blessing or curse?
Globalization is both a blessing and a curse, said E. Gerald Corrigan, although the net effect is a distinct plus for the world economy despite the accompanying growing pains, which he said would be around for a long time. In the past 12 years, he noted, the world has experienced 12 bouts of financial instability, which have given rise to uneasiness that all is not well. Markets, he observed, are good at sorting things out until questions having to do with credit arise, such as “will people be paid?” These episodes of instability, Corrigan noted, made it clear why there have been calls for reform, which has been labeled “the new architecture.” In his opinion, however, the focus should be on making existing arrangements work better—improving macroeconomic policies as well as risk- and debt-management policies, increasing disclosure, and instituting floating exchange rate regimes (not a panacea, in his view, but better than the alternatives). Progress in these areas is possible, he said, even over the short run, although he recognized that institution building was a tough, long-term problem in emerging markets. He wondered if these countries could sustain the political will to implement such reforms when they were still in the early stages of the fragile process of building democratic political institutions.
Economists say that each crisis is “a new breed of crisis,” according to Carmen Reinhart, but she contended that all crises have similar characteristics. “Every ‘respectable’ crisis,” she explained, “is preceded by a boom.” On the eve of a crisis, a country has a budget surplus, low inflation, and a liberalized trade and capital account, but it also has weak, badly managed banks that are piling up short-term debt in foreign currencies.
Then, the boom is punctured. These conditions describe events in Chile in 1981 and Asia in 1997. The difference between earlier crises and more recent ones, she said, is how quickly the effects of the latter spread to other regions.
How can these crises be prevented? Not, Reinhart emphasized, by turning back the clock and instituting capital controls. The problem emerging markets have is not too much capital flowing in, but too little. According to the new financial architecture—which is not so different from the old, in Reinhart’s view— countries should float rather than peg their currencies. But this would not work, she argued, because countries borrow in foreign currency while their income is in domestic currency, which leads to currency mismatches. In her view, the only way to alleviate crises is to have fewer currencies, such as the dollar and the euro.
Is the economic recovery durable?
Focusing on recovery, Lawrence Klein asked whether the impressive improvements in most of the world represented not just a restoration of order in financial markets but a deeper turnaround in “real” economic conditions. He listed a number of problems that could disrupt the world pattern of recovery, including a possible stock market correction in the United States and overreaction by the monetary authorities, a major failure of computer systems worldwide attributable to the impending date change, a cumulative deflationary spiral, and, in Asia, setbacks in individual countries.
Addressing the concerns about the U.S. economy, Klein noted that the strength of the economy had been consistently underestimated, with monetary officials calling for financial restraint whenever growth seemed too high and unemployment too low. He cited evidence from econometric studies that information and other new technology were contributing to stronger productivity growth, with a long-term growth potential of 3 percent or more. He acknowledged that U.S. stock prices had been driven excessively high, but suggested that it was up to the monetary authorities to bear this information in mind: “not to set specific target values, but to be aware of side effects on market valuations as a result of their normal policy decisions.”
For a long time, the United States has been the sole engine of growth in the world economy, but new ones are appearing, Klein said, which is a good thing. First, Western Europe has been expanding, which he believed was helping fuel recovery in the rest of the world, and the large Asian economies are also beginning to play a role in energizing the global economy. According to Klein, Japan has been surprisingly strong in the past few months, with GDP growth expanding by a small amount, and monthly data on industrial production and unemployment showing that better times lie ahead.
Elsewhere in Asia, Klein pointed to the experience of Hong Kong SAR as being indicative of the Asian recovery. An extreme example of the free market system at work, the economy went into recession soon after returning to Chinese sovereignty in July 1997 but was expanding by the second quarter of 1999. The projections are for continuing improvement, without a near-term lapse. In other regions, Russia turned in a better economic performance in 1999 than had been expected the previous year. Brazil, too, was poised to go into a decline at the time of the Russian default in August 1998, but emerged in better shape than expected. According to Klein, the projections for 2000 and 2001 in Brazil are quite optimistic for the “first steps of a healthy recovery.”
One current feature of the world economy, Klein noted, is the weakness of basic commodity prices, which has hurt the primary producers (mainly developing countries) and benefited industrial countries. Oil prices have begun to rise this year—not high enough to knock the broad recovery off its path but enough, perhaps, to cause some world income redistribution. Along with weak commodity prices, growth in world trade has been poor, but the outlook is for a moderate recovery, to about 6 percent. Summarizing his evidence, Klein said that moderate but solid growth in the industrial countries and in major parts of the developing and transition world was “fully consistent with the thesis that the world economic crisis is coming to an end.”
U.S. performance underestimated?
Lawrence Kudlow echoed Klein in emphasizing that economists had been underestimating U.S. economic performance for almost twenty years. This, he said, is because both the models and the economic theory on which they are based are wrong: (1) they ascribe limits to growth, which fosters a pessimistic approach to analyses of economic performance; (2) they are based on assumptions of diminishing rather than increasing returns; and (3) they exhibit a lack of confidence in free markets and their ability to regulate business. In Kudlow’s opinion, inflation could continue to drop, or at least would not rise, because increasing use of the Internet will improve the flow of information, encouraging cost cutting and price cutting around the world. Thus, the U.S. economy could grow at the current rate forever—continuing to be a global locomotive—as long as government obstacles to entrepreneurship are removed and barring, for example, a war or an oil price shock.
Martin Barnes agreed that the United States is experiencing a long-wave upturn, with no sign that the technological boom is slowing. The big question, he said, is whether the trend in productivity will continue to improve. On a less heady note, he cautioned that inflation could rise even as the global economy recovers. Thus, he said, “we cannot ignore short-term cyclical pressures,” such as rising U.S. import prices. He argued that inflationary pressures would continue to mount as long as demand growth outstripped the supply potential of the economy. To control inflation, Barnes added, tighter financial conditions would be necessary, which could be achieved through a strengthening of the dollar, a weakening of the stock market, or an increase in interest rates. In the end, he said, the economy must slow and get back into better balance. In Europe and Japan, where unemployment rates are higher, “there is no need to fear an early upturn in inflation,” according to Barnes. However, he described interest rates in these regions as being below equilibrium levels and predicted that they would rise significantly in the next couple of years.
Japan, Latin America, Europe
Discussing Asia, Scott Pardee focused on the growing Japanese economy, suggesting that the country should follow easy fiscal and monetary policies for some time. Japan must address serious structural issues, including the aging of its population, declining birth rates, and a dearth of professional women in the work force, he said. Worry about jobs has led to a collapse of confidence; when confidence improves, people will begin to spend and invest again, stimulating the economy. Until changes are made, which Pardee indicated would take decades, the Japanese economy will “limp along trying to compete in the global economy.” The positive news is that Japan cannot fail to restart its economy—the political climate for reform is favorable.
In his discussion of lessons learned about foreign capital in Latin America, Arturo Porzecanski agreed with Corrigan that globalization—like the telephone—is both a blessing and a curse. Latin America, he said, is the region that depends most heavily on foreign capital. But it has not always been this way. A wave of nationalism in the 1960s discouraged foreign direct investment, which, in the 1990s, has begun to flow back because of an ideological shift in favor of opening up the economy. Without this foreign direct investment, the region would have contracted even more severely than it did in the wake of the Asian crisis. Not all capital, Porzecanski observed, was created equal, but “you cannot say ‘yes’ to foreign direct investment and ‘no’ to other flows.” Long-term foreign direct investment is the most stable and brings with it managerial know-how and technology transfers, among other good things. To limit their dependency on short-term flows, countries might consider instituting capital controls in the banking system, he argued.
Why is Latin America so dependent on foreign capital? The reason, according to Porzecanski, is that the saving rate is very low and consumption rates are high, so that the region must import savings. He said foreign capital would continue to play a dominant role in Latin America, but the region could reduce its dependence over time. Most Latin American countries have conquered hyperinflation, and interest rates have been liberalized. As a result, people have more incentive to save—and to save at home. As the state withdraws from economic activity, there are more investment opportunities, including private pension funds. Also, Latin America now has a large young baby boom population. As the members of this cohort move through time, they will become able-bodied workers and begin to save in anticipation of retirement. Global financial integration is irreversible, Porzecanski concluded, and Latin America must learn to live with capital flows.
Robert Solomon, discussing the creation of the common currency area in Europe, felt it was not possible to conclude that the euro area would energize Europe or the world economy. How well European Economic and Monetary Union will work has often been discussed in terms of whether it is an optimal currency area—that is, one in which its regions are affected similarly by shocks and among which labor and capital move freely. In the euro area as a whole, unemployment exceeds 10 percent and is even higher for people under the age of 25, although several euro-area countries have lower unemployment rates. Currently, labor is not highly mobile and has not moved to the countries with lower unemployment, partly because of differences in language and culture. Moreover, the countries in the euro area are likely to experience different rates of economic growth because of the relative importance of manufacturing and services. It has been argued that the move to a single currency will make this region an optimal currency area, but Solomon expressed uncertainty about the possibility of increased labor mobility. In addition, he said, the different countries need to retain flexibility of fiscal policy in the event that their economies grow at different rates, which would also influence developments in the region. Nonetheless, he recognized that the single currency would eliminate uncertainty about exchange rates, thereby promoting trade within the area and raising growth rates.
Global Markets, Blessing or Curse?
E. Gerald Corrigan
Chairman, International Advisors, Goldman Sachs & Co.
Managing Editor, The Bank Credit Analyst
Benjamin Franklin Professor of Economics Emeritus, University of Pennsylvania (and Nobel Laureate)
Chief Economist and Managing Director, Schroder & Co., Inc.
Scott E. Pardee
Senior Director of Finance Research Center, Sloan School, Massachusetts Institute of Technology
Managing Director and Americas Chief Economist, ING Barings
Associate Professor, University of Maryland School of Public Affairs
Guest Scholar, The Brookings Institution