Globalisation has undermined economic autonomy by more than most people realise

“We are all in this together.” Thus spoke George Osborne, Britain’s Chancellor of the Exchequer in 2010, to justify the austerity policies of the Conservative and Liberal Democrat coalition. He meant that the burden of austerity should be shared right across society. Whether or not his government delivered on that promise, it is true in another sense. The world increasingly works as a single economy, and individual nations are losing their power to manage their own  microclimates.

This is the message of a very interesting article in last week’s Economist. The immediate point of the article is to criticise Germany for its persistent and large current account surplus. This is making it harder for its neighbours, especially in the Eurozone. It is sucking demand out of the European economy; meanwhile, through its strong advocacy of budget discipline, Germany is making it very hard for other European countries to make up the shortfall, especially in countries like Greece, who arguably need it the most.  This is an old story, which has been pursued many times by commentators such as the FT’s Martin Wolf; some recent IMF research just underlines the matter.

But the article goes on to make a wider point. There seems to be a wider contagion problem in global demand. In weak economies, demand falls, and one way or another this reduces current account deficits and increases surpluses. Weak demand directly reduces imports; a weak currency or pressure on wages makes exports more competitive. Greece has turned a spectacular deficit in 2009 into a significant surplus. But this reduces demand in healthier economies, spreading the weakness. There arises a cycle of doom, unless surplus economies, like Germany, start borrowing to stoke up demand.  But there is little political imperative to do so: there are political benefits to surplus, which tend to strengthen the hands of ruling elites and allow greater stability. Financially secure deficit countries, like the US and Britain, might also do a bit to stoke up demand – but ultimately their deficits limit their capacity to do so. Sustained fiscal stimulus, as practised by Japan for example, really requires a current account surplus.

But this is only the start of global interconnectedness. Both inflation and interest rates seem to be determined more by world markets than domestic policy – in the developed world at least. Hence a remarkable convergence between nations as far a apart as Japan, Britain and the USA. The penny does not seem to have dropped amongst many economic commentators, though.

What accounts for this degree of interconnectedness? It was not so evident in the 1970s, when there was much more divergence between the major economies: compare that decade for Britain, Germany, Japan and the US. The most important single driver was the collapse of the Bretton Woods system of global capital controls, and the liberation of currencies to float where markets took them. There is a paradox here: these freedoms should in principle make governments more independent. Alas there are no free lunches in economics.

Free capital movement frees up countries to run large current account surpluses and deficits. In a system of limited capital flows a surplus country had a problem of what to do with its foreign currency earnings. Meanwhile deficit countries can find it quite hard to find the money to pay for imports. The decades before the 1970s were dominated by balance of trade crises. Older Britons will remember the devaluation crisis in 1967 (which I still remember though I was but 9 years old – such was its impact). In 1956 the US abruptly ended Britain’s adventure in Suez as it threatened to cut support for the UK currency.

Now governments find it much easier to ride imbalances of trade, though eventually deficit countries run out of road (Argentina comes to mind); surplus countries find things much easier, except every so often their foreign financial holdings can take a hit.

But the freedom to run up surpluses and deficits has also given rise to a dependency on global capital markets to fund businesses, governments and private individuals (typically to fund house purchases). The financial crash of 2008-2009 was only the nastiest episode of many, where events in one country shook economies far away. The British government of the time could not believe that a tumble in US sub-prime real estate prices could totally derail their own economy. Labour politicians still put on an air of injured innocence – though Britain’s dependence on global capital flows was positively reckless.

There has been an important second development, apart from the freedom of global capital, though: the rise of global supply chains, and of China in particular. It is hard to underestimate the impact of global trade and global competition on the world economy. This has led to the biggest reduction in world poverty in human history – but the impact on traditional industrial areas of the developed world has not been so benign. One of the most important consequences has been to change the dynamics of price movements in both the labour and goods markets. A rise in the price of goods does not automatically lead to a rise in wages, as it used to. In the 1990s and 2000s economists attributed the remarkable stability of inflation in the developed world to sound monetary policy. But the globalisation of supply chains was a large factor – which may have allowed monetary policy to be looser than it should have been, contributing to the eventual crash.

All this leads to a key question in the current world economy. Does the generally disappointing level of demand in the developed world arise from the lack of coordination of economic policy, rather than deeper factors like demographics and changes to technology? The recent G20 meeting seemed to suggest as much, but no concerted action was agreed upon. I have always suggested that deeper factors where more significant – but  Economist article poses troubling questions.

And then there is a question of economic strategy. A global economic government is clearly out of the question. We only have to look at the struggles of the Eurozone to see that. So is there a way of regaining control of our microclimates, without throwing away the gains from world trade? This applies, incidentally, not just to countries, but regions within countries. Clearly the answer is not the free movement of currencies, as some Anglo-Saxon commentators like to think.  But we do need to think about how to manage the movement of capital better, both internationally and within our countries.


23 thoughts on “Globalisation has undermined economic autonomy by more than most people realise”

  1. “Sustained fiscal stimulus, as practised by Japan for example, really requires a current account surplus.”

    “individual nations are losing their power to manage their own microclimates.”

    It’s difficult to know where to start with all this. Individual nations, providing they just issue their own currency and don’t borrow in a foreign currency, have all the power they need to manage their own economies. Note: neither Greece nor the other EZ countries have their own currency and Argentina borrowed too much in a foreign currency. If nations accepted the erroneous arguments presented in this article they really would be throwing in a winning hand.

    The idea that only surplus countries can apply a fiscal stimulus doesn’t have any theoretical justification.

    Let’s conduct a simple thought experiment. Let’s suppose the global economy consists of just two island nations: A and B. Each have their own currencies. Island A is happy for its currency to float with respect to currency B according to the process of supply and demand. A generally allows trade to flow without any government interference . Country B, on the other hand, wishes to restrict imports from A and boost its own exports to A. To do that it has to hold down its own currency’s value. Which is simple enough. It just sells its own currency at a lower than what would be the free market rate.

    So Country A ends up in trading deficit deficit and country B ends up in trading surplus. Country B ends up with more of currency A than it wants to spend to buying imports from A. So it buys treasury bonds in A and creates an excess of its own currency B to satisfy the needs of its own exporters.

    Country A deficit spends the proceeds of the sale of the bonds into its own economy to keep it functioning at close to full capacity. Country B has to suppress demand in its own economy so it runs a budget surplus.

    Does this mean that B is better placed than A to regulate its own economy by fiscal measures? No of course not. Both A and B can do whatever they like subject to the constraints of not creating too much inflation. Does A need to borrow from B to maintain its deficit? Or does B need to lend to A to maintain its surplus?

    We might well ask what is the point of B running a surplus in its trade with A? And really there isn’t any point at all. All it is doing is building up a stock of IOUs which it isn’t spending.

    So perhaps one day the citizens of B will wake up to themselves and decide its their turn to run a trade deficit. If they are smart they’ll just move over a period of a few years from running a surplus of , say, 5% of GDP to and deficit of 5%. That’s not going to cause A any problems at all.

    But if B gets silly about it and decide they want to spend their accumulated surplus too quickly, A can put the squeeze on B by imposing an export tax. What can B do? Nothing at all except start talking to A about how it can start to spend its accumulated fortune without causing too much strain on the economy of A.

    If any country has the whip hand it is the former deficit country A. But the conventional wisdom suggests just the opposite.

    So, really the Americans aren’t as dumb as some might like to make out. If the Chinese and Germans want to accumulate American IOUs (aka US $) without limit they really need to ask themselves why they should want to do this.

    1. Peter. In one your earlier comments you criticised conventional economists for hanging on to their precious models in the face of contrary evidence. Dare I suggest you are guilty of exactly that?

      Your comment “The idea that only surplus countries can apply a fiscal stimulus doesn’t have any theoretical justification.” is saying that to me. In theory perhaps, but my blog piece, and even more the Economist article that inspired it, is based on recent empirical evidence from the IMF and academics. It’s the practice that matters, not the theory.

      In fact it is not so hard to find the flaw in your reasoning. It lies in the sentence “Individual nations, providing they just issue their own currency and don’t borrow in a foreign currency, have all the power they need to manage their own economies.” In a world without capital controls, and even with them, that is not a practical proposition. Argentina was forced to borrow dollars because nobody in their right minds would lend them money in their own currency. If Greece had been outside the Euro it would have found the same thing: its government would have had to finance themselves in Euros or USD to maintain their fiscal policies – and would have defaulted long before 2009, as interest rates would have been much higher. Severe austerity would have followed. This is a position that most deficit countries find themselves in, since by definition the economy as a whole needs support from outside. The US is a special case; the UK has also been getting away with it, but there have been times in its history (most recently in 1975 when it called in the IMF) when it hasn’t. That’s what spooked the Treasury in 2010, even if it looks panicky in hindsight.

      The same problem emerges with your theoretical example – even without my saying that a two-nation model does not represent much of the competitive tension in the world economy – B could usually refuse to do business with A and go to C, D and E instead. B could still insist that its exports were paid for in its own currency, which they would happily lend to agents in A. They might find that a better alternative than buying dodgy A government stock – especially if they know that their own currency is undervalued.

      1. “Argentina was forced to borrow dollars because nobody in their right minds would lend them money in their own currency. ”

        Ok Let’s think about what you are saying here. Argentina’s currency is the Argentine Peso. Just like the Swiss currency is the Swiss franc. The US currency is the US$ etc etc

        All these currencies are the monopoly issue of the governments of these countries. The Swiss have monopoly rights to the Swiss franc. The Swiss don’t need anyone to lend them Swiss francs. They can create as many of of them as they please. And they’ve done just that, over the years, to hold down their currency to try to maintain a peg to the euro and other currencies.

        When we try to sell stuff to Switzerland they’ll want to pay in Swiss francs. Of course if are British we just look up the exchange rate, and do the conversion and we are usually happy enough.

        It’s really no different for Argentina. If they want to buy some A320’s , or whatever, from Airbus in Europe, there is no reason for them to offer to pay in anything other than Pesos. They don’t have to raise a loan in euros anymore than do the Swiss.

        The Europeans have to decide whether to accept the Pesos. If they do they can either spend them on goods and services from Argentina or they can buy bonds from the Argentine government to maintain the value of the Peso, in exactly the same way as they maintain the value of the pound and the dollar.

        The duty of the all governments is to keep their economies functioning at close to full capacity and prevent high levels of inflation. They shouldn’t overdo their ability to create their own currency. That would cause inflation. But neither should they underdo it. That leads to recession and high levels of business failure and unemployment.

        1. It’s really no different for Argentina. If they want to buy some A320’s , or whatever, from Airbus in Europe, there is no reason for them to offer to pay in anything other than Pesos
          Peter, you have absolutely got to be kidding! Airbus will demand to be paid in USD or Euro (or Swiss francs perhaps) because it will not want to accept the currency risk from Pesos, especially if there is a deferred element. There comes a point when people lose confidence in a currency and will not accept it, or the exchange market is too thin to have confidence in its conversion. And telling exporters that’s it’s all OK because Argentina can print all the Pesos it needs won’t inspire confidence, believe you me! If you doubt me, do your own research into the way foreign trade works.

          1. Absolutely not kidding at all. Airbus will take pounds even though the UK runs a deficit. So why won’t they take pesos?

            Of course they will take pesos. And they’ll just convert them on the forex markets to euros. It then becomes a political decision on the part of the PTB in Europe whether to support the peso by buying bonds in pesos in the same way as they buy bonds in pounds.

            The Germans spend less than half of all the pounds receive in buying Goods and Services from the UK , for example. They just buy up bonds with the rest to support their surplus in trade with the UK.

            Some economists are more sanguine than others about this state of affairs. There are arguments either way. Either we fix up the trade imbalance by forcing down the pound’s value or we learn to stop bothering about deficits. Both trade and budget.

          2. Britain, and there may be others, is an exception. We can speculate why. A combination of liquid currency markets and strength and depth of financial resources. Unless things change, one day that will come to an end – but I have no idea how close or far that day of reckoning will be – when HMG has to borrow USD or Euro or RMB. Even so, in my accounting days I often found examples of British businesses paying in foreign currency – in fact that was the default for B2B – just as they would often bill exports in GBP. It depends a bit on whether it is a buyer’s or seller’s market, and how geared up the seller is.
            And no major business would accept to be paid in Pesos, unless it had a substantial Argentine business, let me assure you. It’s pointless risk. Remember that most business is done on credit (especially aircraft). You are exposed from the point the deal is done until you are actually paid – which is usually months, and can be years (e.g. leasing deals). And then you need to be confident that the currency markets are efficient enough to deliver you a good deal. With Pesos none of that adds up.

      2. B could usually refuse to do business with A and go to C, D and E instead.”

        We could consider that A is the USA, or perhaps the UK, and B is the Rest-of-the World.

        So who is the ROW going to do business with instead? Mars?

        The problem for all surplus seeking countries is that they have to accept that to a maintain their surpluses they have to lend them back to their customers. I don’t quite see why they should want to do that, or why they should want to maintain a surplus, year after year. But, apparently they do.

        I’ve yet to meet any German person who doesn’t view their continuing surplus as a good thing.

        1. ROW can be played off against each other. It’s a diverse and competitive place! No need to sell into a dodgy country with an overspending government – there is usually somebody else offering something more secure.

          I have often wondered about why so many countries favour surpluses. I don’t think that their governments think that maximisation of consumption is particularly important, so long as their people have enough – and the people seem quite happy to go along with that. The benefit of a surplus is that it makes life easier and more secure for the government. It’s a lesson many Far Eastern economies learnt the hard way in the 1990s. They associate deficits with financial crisis, the IMF and austerity. And they’ve been proved right – they came through the 2008/09crisis relatively unscathed.

          1. “They associate deficits with financial crisis”

            Deficits and surpluses have to balance. So, are you saying that half of the world has to be in a state of financial crisis? Is this the logic of 21st century capitalism?

  2. I’d generally agree with the thrust of the article you linked to in the Economist. It’s not helpful for Germany to run one budget surplus after another given its dominant position in the Eurozone. It wouldn’t be such a problem if Germany and the other EU countries had their own freely floating currencies for reasons explained in my previous comment.

    There is one line in the Economist which suggests some muddled thinking though.

    “Other countries, notably America, ran correspondingly large current-account deficits, financed in part by flows of investment from surplus countries that flooded into the country’s overheating housing market. “

    The USA’s (or the UK’s or Australia’s) overheated housing market, wasn’t the result of “flows of investment from the surplus countries”

    If the USA has a current account deficit, then someone in the USA has to fund that deficit by borrowing. It can be by the Government. It can be by the Private Sector. Or, a mixture of both. So for any given current account deficit, the trade off is between more Government borrowing and less private sector borrowing. Or less Government borrowing and more private sector borrowing.

    So, if the Economist is saying that too much money went into the US housing market, and they are probably right, which caused an asset bubble, then it must have been because the US government ran too small a deficit. To have avoided the crash they should have approached 2008 with a tighter monetary policy and looser fiscal policy to compensate.

    It was the same for the UK too. In other words, entirely the opposite of the conventional ‘wisdom’ that the Blair and Brown governments should have run a tighter fiscal policy.

    1. I think you underestimate the power of capital markets. Incidentally the Economist’s statement is clearly correct – your proposition is this was not inevitable because the US government could have scooped up the hot money instead by running a bigger deficit. True in theory, perhaps, but how practical?

      First problem is selling that proposition to the German and other bankers who piled into US real estate. At the time US real estate looked a much more attractive proposition that US government stock (how wrong they were, of course…). A further problem is that fiscal deficits are very political, and quite hard to move up, or especially down, at will. This was hot money that could disappear to finance the next big thing in global finance. Far Eastern governments found that out the hard way in the late 1990s: one reason why they don’t like current account deficits. The US government could have found itself stranded. Actually I think George W was doing his best to stoke up the deficit with tax cuts, unfunded wars and blank cheques to Medicare. To head off the housing bubble would have been hard indeed.

      And as for the UK, as you know, I profoundly disagree. A looser fiscal policy at that point in the business cycle would have made the current account deficit much worse by sucking in more imports (the British economy was already beyond capacity), until one day the whole went bang. What the government should have done is run a fiscal surplus: that would have helped the current account deficit down and moved the economy towards a more sustainable path.

      1. Matthew, The problem nearly everyone has, include yourself and myself (until the penny dropped), when thinking about deficits is that it is hard to avoid making the link between our own personal finances and government finances.

        But it isn’t too difficult, when you think about it, to see that for every deficit there has to be a corresponding surplus which matches to the penny. And , vice versa.

        So when you argue that the Government should have been in surplus (presumably in the USA too?) in the run up to the 2008 crash you are equally well arguing that everyone else should have been in deficit. Which would have certainly brought forward the date of the crash. For us, as individuals, we can build up a surplus in the good times to protect us against adversity in the bad times, But, all we are doing is saving someone else’s IOUs. That makes sense because they aren’t our IOUs. But, it never makes sense for the issuer of the IOUs to save up their own IOUs. This is just as true of government as it is for anyone else.

        Now this is me, as a Physicist, thinking in the way I’ve been taught to think! If the world economies are working the way the world’s economists are thinking they should work, then perhaps it is they who need to change their way of thinking and become a little more scientific?

        1. Not at all Peter. I’m using the same accounting identities as you, but a different way round! I’m saying that, by one means or another the government deficit and the current account deficit are a mutual reflection of each other. That’s basic economics, and nothing to do with the household finance analogy (which no trained economist, or even semi-trained economist like me uses – it practically the fist thing you are taught not to do). So, by bringing the budget back into surplus, you would bring the current account deficit down. The current account balance, the budget balance and the private sector balance must zero out. Move the budget balance to deficit and you must either move current account to deficit or private sector balance to surplus – I.e. either crowd out the private sector (which I think is what you are suggesting), or fund from outside. Because the pound was high, it suggests that the problem was with the public sector deficit and not the private sector. This is what my Economics tutor at UCL thought at the time (2007).

          1. Your economics tutor could have been wrong! A high public sector deficit doesn’t necessarily create a high currency. Otherwise the cure for the UK’s previous sterling crises would have been simply for Govt to spend more.

            A high currency and a high trade deficit simply means that we are making it too attractive for overseas lenders to park their surplus money in the UK.

            We could fix that by simply creating the currency that Government needed rather than borrowing it back on the markets. In other words, more QE to force interest rates and the currency down to where it needs to be to have a more balanced level of trade.

          2. My tutor suggested that it was the most plausible of the various alternative explanations we examined – and she was a very smart person! I don’t think interest rates were that high, or any other reason that capital flows alone might have been the problem. The evidence that the deficit was out of line with the cycle, on the other hand… It suited the government that the pound was high, so I can understand why they didn’t want to undermine it. They were concerned about inflation too. QE would have entailed a whole set of new risks.

            It is possible, Peter, that you could be wrong…

      2. Yes I am always open to the possibility that I’m wrong! If something happens that I’d previously thought couldn’t happen then I have a good rethink about it it all.

        There are some small signs that Economists are moving in the right direction. The IMF has started, in just a small way, to side with those who had made the case that Government debts and defiicts were a necessary part of the financial system and had previously denounced as heretics. OK they may have not used that word but you know what I mean!

        If the IMF had been smarter than they have been, and at an earlier stage than they have been, they would have categorically refused to become embroiled in the euro fiasco. There’s no need for any IMF involvement.

        If there’s a problem that Spain or Ireland is running short of euros, why is there any need for the IMF? The IMF can’t create euros. The ECB, on the other hand, can create as many as it likes just like the US Fed can create as many dollars as it likes.

        If California runs out of dollars the US government doesn’t need the IMF to fix the problem. It has all the fiscal space it needs. Just like the PTB in the EZ have all the fiscal space they need.

  3. “So, by bringing the budget back into surplus, you would bring the current account deficit down. The current account balance, the budget balance and the private sector balance must zero out.”

    Yes this is correct. And this is what has happened in Greece. You’ve acknowledged that the Greek Govt is now in surplus after previously running a high deficit.

    But we can’t accept that this is a success given the State of the Greek economy. The UK govt could do the same. All they would end up doing was making everyone poorer so they couldn’t afford imports and couldn’t afford to save anything.

    From the UK govt’s perspective in the last decade or so the choice has been about how best to maintain economic activity at close to full capacity. They managed that reasonably well up until 2008 but by encouraging too much private sector borrowing. We can now say that, admittedly with benefit of hindsight.

    So, how else could they have achieved the same objective? They could have had more public sector borrowing. Or, they could have reduced the need for anyone to borrow by forcing down the exchange rate. There’s only those choices unless we go for the Greek solution.

    The Greeks had no other option. They weren’t allowed more public sector borrowing and they weren’t able to devalue their currency.

    1. You have a case with Greece. They were/are operating at under capacity so you could argue austerity is self-hard. Uk in 2008 was overheated and required counter-cyclical fiscal correction. Quite different.

      1. The UK had about 5% unemployment and 4% inflation in 2008. You’d be saying the UK economy was becoming overheated if you were arguing that the first figure was too low and the second figure was too high.

        If so, the the correct course of action would be a fiscal squeeze and/or an increase in interest rates. There may have been some mutterings about the 4% inflation but was anyone really saying unemployment was too low?

        1. People were suggesting imports were too high and that 5% was equilibrium unemployment, below which inflation would take off. Inflation at 4% would ordinarily be seen as too high, but I think that was a temporary blip. Inflation without being brought down by cheap imports of manufactures had been about 4% for some time – but arguably more to do with inflation expectations than anything else.

  4. It’s strike me that the basic levers of control aren’t sufficiently well understood. This rather than any political differences is why we are in disagreement.

    For example:
    Reducing the Budget defict:
    Conventional Thinking : Cut Spending and/or Raise Taxes
    Correct Thinking: Reduce the Trade Deficit, Reduce Levels of Saving

    Reducing the Trade Deficit:
    Conventional Thinking: Reduce Budget Deficit as Above
    Correct Thinking: Devalue the Currency. Reduce Interest Rates. More QE.

    Increasing Economic Activity:
    Conventional Thinking: Reduce Interest Rates
    Correct Thinking: Increase Govt Spending and/or Reduce Taxes.

    Reducing Economic Activity (to prevent inflation):
    Conventional Thinking: Increase Interest Rates
    Correct Thinking: Cut Govt Spending and/or Raise Taxes

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