The Unforeseen Perils of Financial Globalization

For decades economist’s faith in financial globalization has maintained a level of confidence, sanctity and optimism among its contributors and proponents, many of whom believed that increasing financial activity and mobility across country lines including the actions of global banking, investment, trade, currency exchanges, as well as continued rising interconnectedness within the world economy benefited the entirety of all economies, even those in poorer and developing countries. Proponents of this narrative claimed that global markets worked best when they were handled by themselves, internally, encouraging the idea that self-regulation and weak governing financial institutions benefited the entire world economy due to large influxes of more sophisticated investors buying big into the global market and subsequently bearing the brunt of potential losses in a recession or a stock market collapse. They claimed that developing nations would also benefit because of their poorer status as economies, and that potential investment into their countries would stimulate their cash-lacking markets and promote much-needed economic growth, simultaneously providing further equality to the peripheries of the world economy in the process. The hubris of these claims were foreseen already to hold devastating possibilities for certain economic participators in financial globalizing, as the author of the book The Globalization Paradox: Democracy and The Future of the World Economy Dani Rodrik writes, that the ideas originally bolstering the surge in international financial activity would ultimately lead to heightened inequality and exploitation of poorer economies and their workforces[1]. But furthermore, he states that pro-globalization advocates —himself admittedly included— in maintaining their now-realized overconfidence in global economic freedom and the lax economic regulations enjoyed prior to the late 2000s, ultimately allowed the world economy to become a ticking time-bomb. In this book, Dani Rodrik attempts to persuade readers that the extent and effectiveness of the global market is limited only to the scope of its corresponding financial regulators. That markets aren’t self-regulating, that they need the support of outside non-market governing bodies and that the support of effective and conscientious government intervention is what leads to a stable world economy. He also believes that the narrative of global economic growth being perceived as the catalyst for the domestic growth of economies is a substantial error in our logic and that national economies should first and foremost do what’s best for themselves before attempting to contribute, as well as take advantage of financial globalization. In this appraisal I will be analyzing Rodrik’s arguments and comparing them to that of other contemporary authors on global economics to further uncover the nature of financial globalization and whether it’s something we should set free or keep on a tight leash.

The First Signs of Exploitation

Rodrik prefaces his arguments on financial globalization by providing a historical account of one of its earliest instances. He references the beginning of the Hudson’s Bay company, a French exploration group that discovered new land in Canada and was thereafter given complete territorial control over the area. This made the company “a government in all but name”[2] The company originally set out to find beavers for the making of beaver skins which during this time period was a popular commodity, but when they returned, King Charles II was so pleased with the haul they had brought that he granted them complete monopoly rights over the area including full commerce over the “seas, straits, bays, rivers, lakes, creeks, and sounds in whatever latitude they shall be”[3]. This was one of the first times that a private company was given full reign over a land of that amount, covering almost 40% of all Canada as well as all of the land that the natives had held for generations, without even first obtaining their consent. This meant they could wage wars, pass laws, and execute justice by their own decision. Rodrik uses this example to show how financial globalization in its youth was used to extort land that was under the domain of other autonomous groups, as the Hudson Bay Company did with the land traditionally home to the Native Americans. Because of the mercantilist economic philosophy prevalent at the time, and the unknowest of the Native Americans to the schemes of the European trading methods, they were able to monopolize the pelt trade and made exorbitant amounts of profit off the beaver pelts, only needing to exchange brandy and firearms to the Native Americans. This is one argument towards Rodrik’s initial claims that globalization is leading to inequality and exploitation of poorer nations that was prominent going back to the year 1671.

The True Cost of Globalized Production

Rodrik goes on to talk about domestic inequality, only this time in its relation to globalized production, in his reference to modern economist Paul Krugan, who revised his views on the effects of globalization on inequality in a paper he wrote just months after receiving the Nobel Peace prize in 2008. Originally, the income gap was thought to be perpetuated by a change in the needs of the economy and the shifting labor economy moving towards a more knowledge and skill-based economy. Krugman was among the economists who believed this was the most prominent reason why the income gap was widening. However, he felt that the increase in imports that America had reported since the 1990s was something many economists overlooked, specifically citing those from China. While American imports increased, China’s wages had decreased and workers now were producing goods for much less payment than in the decades prior. This in turn made the US wages of competing producers decrease in order to compete with the cheap production coming in from China, widening the income gap between America’s laborers and the business owners participating in globalized production. Krugman recognized that this global competition in production has had substantial impacts upon the prosperity of low-income workers, who have had to take the brunt of the competitive wage reduction as well as heightened unemployment due to imports from other countries where production can be done more cheaply. Rodrik uses the example of a shoe machine operator and cites experts' estimates that “trade produced an 11 percent reduction in shoe machine operator’s earnings over this period” and that “similar effects hold for many other occupations in the textile and clothing industries.”[4]

Above in figure 4A, we see the share of GDP that total imports from other countries hold in America’s economy, compared with the share that imports solely from less-developed countries hold. Over the years the relationship has evened, with imports from less-developed countries making up about half of all imports. Using this information to perceive figure 4b we can see that manufacturing output has grown along with the increase in imports from less developed countries, and simultaneously US manufacturing employment has decreased dramatically showing the negative effect cheap imports from less-developed countries has had on our country’s economic health and employment rate.

Obama’s Economic Advisor Larry Summers has also had his concerns, even after being an outspoken free-market advocate until recently changing opinions on the regulation of globalized trade. In recent opinion pieces he wrote, “The opposition to globalization… reflects a growing recognition by workers that what is good for the global economy and its business champions, is not necessarily good for them.”[5] He argues that elites no longer hold any allegiance to the country they are headquartered in and essentially use the global economy as their own personal market to grow their own profits and further their own prosperity rather than acting in the interest of the nation and stakeholders personally invested in the success of their company.

This development suggests that the deregulation of financial globalization not only adds to the low wages of foreign and domestic producers of goods but also adds to the lacking of societal and economic reciprocity between America’s financial elites and the rest of society. This progression in neoliberal ideology furthers business owners' leverage and willingness to lobby politicians for tax breaks and loopholes in tax code as well as encourages them to stowaway their wealth in offshore bank accounts in foreign tax havens such as the Cayman Islands. This is all likely due to the perception in economic growth due to GDP growth numbers but in reality, developments like this actually quite often add to the growth in national debts and to domestic wealth disparities ultimately harming the economies of nations.

Globalized Liberalization or Regulation?

A predictable but unpredicted disaster, Rodrik notes, was the impending subprime mortgage crisis that awaited the world in 2008, causing the great recession and sending the world into massive economic shock and ruin that was primarily dug out of by government bailouts and takeovers of governing financial institutions. But before this crisis, even Rodrik believed that the basic banking-policies and institutional regulations that were holding the global economy accountable would be enough to avert globalized disaster. He believes otherwise now. The crisis of 2008 sent a shockwave through the entire world economy and inspired a plethora of new economic literature attempting to explain what exactly went wrong and how the worst could have been avoided.

Rodrik begins his analysis by explaining the development of the effect of the Bretton Woods compromise and its progression from success in the post-WWII era to failure during the economic setbacks that afflicted the world during the 1970s such as the oil shortage that hit advanced economies and incited the unemployment and inflation causing stagflation, and ultimately leading to the neoliberal “trickle-down” policies of the 1980s.

In 1944, world leaders convened at the Bretton Woods resort in New Hampshire to establish a new economic system that would bring the world back from the toil of WWII. The system that was agreed upon allowed nations to adjust the old system to serve the new needs of the recovering world economy. They created the International Monetary Fund and World Bank, as well as fundamental policy changes like drawing back restrictions on trade flow, and allowing governments to construct their own versions of the welfare state as a part of the propositions installed into the new monetary regime.[6] The compromise that was originally struck, gave the global economy, in the words of Rodrik, “enough international discipline and progress to ensure vibrant world commerce, but plenty of space for governments to respond to social and economic needs at home.”[7]

While these policies did work for decades, they eventually proved to conflict with the way the global economy was developing. Financial and capital movement was becoming more common in the globalizing modern world economy, and the institutional policies governing capital flows that had, in decades past, enforced high transactional costs ensuring that domestic economic health was placed over the globalist’s desires for liberalized capital mobility were beginning to lose traction. The world economy’s stability had come into question because of a few simple reasons, the first and foremost being the international medium of transaction and exchange. What would the money of the international economy be and how will the fair exchanges of value be insured in global transactions? The medium of gold had long been seen as non-viable since the shortage in the 1870s, causing a worldwide price deflation that ultimately played a fatal role in facilitating the Great Depression of the 1930s. The agreement that was determined to be the fix was establishing the US dollar as the international standard and “global currency serving as the reserve asset of choice for international banks around the world”.[8] It was priced at 35 dollars to an ounce of gold until President Nixon eventually removed the gold standard in 1971 due to pressure from other countries to convert their dollar holdings to gold, forcing the government to choose between the options of either cutting expenditures and/or raising taxes to generate the revenue to be able to do this, or eliminate the fixed-exchange rate the Bretton Woods regime was built on entirely.

How The Bubble Burst

Rodrik believes the problems that ultimately accompanied the deregulation and liberalization of capital flow were instilled in the global economy soon after and can be summed up by Keynesian economist James Tobin. “National economies and national governments are not capable of adjusting to massive movements of funds across the foreign exchanges, without real hardship and without significant sacrifice of the objectives of national economic policy with respect to employment, output, and inflation”.[9] Essentially, the hyper-globalization and liberalization of capital mobility in the global economy makes it so that national governments cannot possibly keep up and maintain domestic policy that properly fits their economy. This instability of currency values across foreign exchanges and the ineffectiveness of the domestic policies that would normally subvert the negative outcomes that free capital mobility may perpetuate caused massive economic strife and many recessions, especially post-1980s and with economies dependent on international markets. The worst of these came in 2008 when the subprime loan crisis caused the worst financial crisis in United States history, and had a major effect on the rest of the world economy. Risky subprime mortgage loans based on overconfident beliefs in ever-rising rising prices in the housing market and regulatory failings by credit raters and economic policy makers allowed a bubble to form around the housing market that was primed for collision with failure. The result was banking failures around the world such as in Ireland which inevitably which spread to the rest of Europe as well as widespread credit tightening making lending and stock exchanges decline rapidly, and having a major effect on developing economies due to the decline in the international trade and foreign investment that many of them depended on for sustained economic growth. Ultimately, the Federal Reserve had to bailout the failing financial institutions with a stimulus of multiple trillions of dollars to keep the economy from completely imploding.

Rodrik argues that while regulation and more responsibility from individuals may have postponed this disaster, liberalization and hyper-globalization through international regulatory institutions can no longer act with all-or-nothing perfection, and that it will have to heed the wishes of individual domestic economy’s desires to either have more capital control or more relaxed regulatory ambitions for their economy’s capital mobility.[10] He asserts that the balance to find here will be difficult to say the least and that lots of practice and experimentation will be needed in order to truly create institutions that will ensure stability.

Contemporary Authors

2002 Nobel Peace Prize winner Joseph Stiglitz follows along with Rodrik’s claims that regulation and governance can be a significant remedy for the impending crises that hyperglobalization and weak ineffective financial policies may put us in. Stiglitz asserts in his book People, Power, and Profits: Progressive Capitalism for an Age of Discontent that the notion that government is the problem, not the solution is wrong. He asserts that financial instability and the many problems circulating the political sphere today were and are still being perpetuated by the private markets. Things like inequality, the climate disaster and other pressing concerns are created by the private sector and will need the support of government intervention. In his 2002 book Globalization and Its Discontents, Stiglitz reprimands the IMF and the neoliberal policies that he believes led to failures across the world economy such as Russia’s inability to become a market economy, as well the severe lack of economic development in sub-saharan Africa, citing high interest rates, and the liberalization of capital markets as the culprits of these poor developments. Like Rodrik, he also believes that globalization needs to be under the autonomy of national governments who will put the domestic needs of their economies ahead of the needs of the global economy and will ensure transparency and accountability in policy-decisions.[11]

On the other hand, Jagdish Bhagwati in his book In Defense of Globalization takes a much more positive stance on capital movement and invokes optimism in the current development of globalization, asserting the beneficial effects that it’s had on the underdeveloped nations and economies it has touched. Bhagwati states that in the underdeveloped countries that have been reached by globalization, women’s rights and equality have risen, child labor has declined as well as illiteracy, and that overall economic prosperity is shooting upwards. He asserts that claims of self-interest being the main driver of globalization and liberalization of capital movement are false and that altruism and empathy are players in the economic investments of developing nations, stating that globalization shows a more human face than many economists let on.[12]

I believe both of these authors have merit. I think it comes down to a matter of whether one perceives capital gains from investment in foreign economies and especially underdeveloped economies as simply the spoils of assisting economic growth in nations behind the world curve, or as exploitation of workforces willing and able to do labor for cheap wages. Stiglitz’ synopsis of translucency in the multilateral institutions governing the world economy is eyebrow raising, as transparency, especially in determining policy governing capital mobility that has the power to cause major effects on various domestic economies and its people, is at stake. But while I believe regulation and tighter capital controls is the way forward, I think for nations making the leap to becoming developed economies, foreign investment can certainly be a beneficial blessing if enacted in rightful ways.

Conclusion

Rodrik’s analysis of the perils of hyper-globalization and the challenges that instituting balanced and conscientious regulation on the global economy is humbling. The state of the global economy is largely a whimsical game of determination by private entities and the institutions made to govern these whims are still largely in their elementary development. In order to avert disasters like the Great Recession of 2008 and the plethora of smaller financial disasters across domestic economies post-1980s, a new more tried-and-true method of financial regulation on the global economy will have to be instituted. Capital controls will need to be enacted carefully in order to ensure domestic economic policy the chance to keep up and be flexible but liberalization cannot entirely fully be thrown away or development in the peripheries of the economy might stagnate. Input from nations looking to ensure the security of their domestic economies along with democratic decision-making in the making of regulations in international economic policy will likely be the route towards garnering prosperity in the global economy. -Mack LaBar

Bibliography

Rodrik, Dani. The Globalization Paradox: Democracy and the Future of the World Economy. Langara College, 2017.

Bhagwati, Jagdish. In Defense of Globalization: with a New Afterword. Oxford University Press, 2007.

Stiglitz, Joseph E. Globalization and Its Discontents. Penguin Books, 2017.

Stiglitz, Joseph E. People, Power, and Profits: Progressive Capitalism for an Age of Discontent. W.W. Norton & Company, 2020.

[1] Rodrik, The Globalization Paradox: Democracy and the Future of the World Economy, Introduction [2] Rodrik, The Globalization Paradox: Democracy and the Future of the World Economy, 6 [3] Rodrik, The Globalization Paradox: Democracy and the Future of the World Economy, 6 [4] Rodrik, The Globalization Paradox, Democracy and the Future of the World Economy, 85 [5] Rodrik, The Globalization Paradox, Democracy and the Future of the World Economy, 86 [6] Rodrik, The Globalization Paradox, Democracy and the Future of the World Economy, 69 [7] Rodrik, The Globalization Paradox, Democracy and the Future of the World Economy, 69 [8] Rodrik, The Globalization Paradox, Democracy and the Future of the World Economy, 99 [9] Rodrik, The Globalization Paradox: Democracy and the Future of the World Economy, 107 [10] Rodrik, The Globalization Paradox: Democracy and the Future of the World Economy, 129 [11] Joseph Stiglitz, Globalization and its Discontents [12] Jagdish N. Bhagwati, In Defense of Globalization