LOSING CONTROL (6 page)

The most powerful nation on Earth, the UK, ran a balance of payments current-account surplus in the late nineteenth century, using its excess savings to invest in potentially lucrative opportunities in less advantaged parts of the world.
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Since 1977, the US has, for the
most part, run an ever-widening balance of payments current-account deficit (punctuated by occasional recession-induced surpluses).
By the beginning of the twenty-first century, the US had become enormously dependent on the deep pockets of emerging creditor nations.

Before the First World War, public sectors were small.
Over the last hundred years, the role of the state in economic affairs has expanded enormously.
Government spending in the Organization for Economic Co-operation and Development (OECD) area, for example, varies from around 30 per cent in South Korea and 35 per cent in the US through to around 50 per cent in the UK, France and Germany and approaching 60 per cent in Sweden.
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The market’s influence on the allocation of resources is only a shadow of its nineteenth-century self, notwithstanding the efforts of Margaret Thatcher and Ronald Reagan.

The global rules that used to be set by the imperial powers are now agreed upon in shifting multilateral groupings, from the G20 through to NATO, from the North American Free Trade Association through to the European Union and from the United Nations through to, as we shall see, the Shanghai Co-operation Organization.
Organizations exist to promote global commerce – alongside the regional arrangements in Europe and North America, the World Trade Organization plays a vital role.
And there has been some, very limited, progress on climate change, even though the 2009 Copenhagen summit ended in acrimony.

There is, however, no such forum within which the perils and pitfalls of global capital markets can be acted upon, even though the massive growth of capital markets is surely
the
defining feature of modern-day globalization.
Until recently, the closest we had was the International Monetary Fund (IMF).
In the world of capital markets, though, the IMF has little information, no teeth and, across the emerging world, little trust.
Nor can it offer the gunboat diplomacy
that, in the nineteenth century, proved a useful way of enforcing – or imposing – property rights.
As a result, we have a system of capital markets that has proved to be beyond regulation and supervision.
Moreover, it is a system in which powerful nation states, not private investors, are beginning to play the dominant role.
The United States provides the world’s reserve currency even though the Federal Reserve, the US central bank, has only to worry about monetary conditions in the US.
Governments, central banks and sovereign wealth funds in the emerging world increasingly play a pivotal role as agents to transfer their nations’ savings to the developed world.
And those nations which, in the nineteenth century, would have had the dominant say in global economic affairs are no more than has-beens.
For them, the economic and political swagger of yesteryear has gone.
The globalization roadmap is being redrawn.

The United States and Western Europe are being forced to come to terms with this new world order.
They are, slowly but surely, having to accept that the rules of the global game are changing.
The most obvious sign of this change, to date, is the arrival of the G20 as a potentially influential global organization,
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in effect replacing the G8.

The US and other Western nations now have to accept their growing dependence on developments in parts of the world which, a few decades earlier, they would have treated as largely irrelevant.
China, kicked about by the imperial powers in the nineteenth century, partially occupied by the Japanese in the 1930s, and economically handicapped through the policies of Mao Zedong in the 1950s and 1960s, suddenly finds itself in a pivotal position in the world economy.
If, in the first decade of the twenty-first century, the US was the world’s biggest borrower, China had become the world’s biggest lender.
China was not alone.
Other creditor nations included Saudi Arabia and Russia.

The G20 is, so far, only a club for economies, not nation states.
It is not designed to represent military powers or particular political systems (those issues are far too awkward).
It is a modus vivendi, designed to deal with economic matters while conveniently ignoring other, perhaps more important, political affairs.
Its existence is built on a pretence, namely that politics and economics can somehow be separated.
That, I believe, is a false distinction.
The distinction was made because the credit crunch that began in 2007 cried out for a global solution; for a while, then, there was a commonality of interest.

History suggests, however, that commonalities of interest do not last very long.
Until and unless the G20 is able to confront the difficulties outlined in this book, it is likely to head the same way as the League of Nations and the Bretton Woods exchange-rate system – in other words, into the dustbin of history.
The G20 doesn’t really have the teeth to offer the international rule of law which was, in effect, forced upon the world by the imperial powers in the nineteenth century.

What might a new international order begin to look like?
Already, there are clues dotted around the world.
I suspect governments will increasingly use their influence to conduct foreign policy through their influence on international markets, encouraging the creation of bilateral relationships that appear to be driven by commercial interests but which, in reality, are an important part of modern-day realpolitik.
Think, for example, of Gazprom’s dominance of the European energy market or Halliburton’s involvement over the years in Iraq.
The connections between these firms and their political masters are enormously strong.
More broadly, as countries push forward their own agendas, we are seeing the renaissance of ‘state capitalism’.

As already noted, state capitalism has been a fact of economic life for centuries.
The East India Company, with its mercenaries and its cross-border drug dealing, was perhaps its greatest exponent.
Nations have always happily traded land with each other in quasi-commercial strategic deals.
Buying and selling is considerably less
painful than shooting and bombing.
To pretend that the private sector alone should be responsible for trading is pure fantasy.

A fine example is the Louisiana Purchase of 1803, when the US paid France $15 million for what now amounts to about 23 per cent of US territory, including all of present-day Arkansas, Iowa, Kansas, Missouri, Nebraska and Oklahoma, together with assorted bits and pieces of other US states, most obviously Louisiana west of the Mississippi, including New Orleans (interestingly, the US could solve its current debt problems by selling California to the Chinese although it somehow seems an unlikely gambit).

Thomas Jefferson, the US president at that time, was particularly worried about American access to New Orleans, by then a major port, and feared that trade could be undermined by French and Spanish hostility.
Napoleon Bonaparte, meanwhile, had seen French power ebb away in Haiti and in the Caribbean more broadly.
Without the economic benefits stemming from access to the lucrative sugar plantations, Napoleon was happy to strike a deal.
Huge swathes of North American territory fell into US hands, prompting Napoleon to comment, ‘This accession of territory affirms for ever the power of the United States, and I have given England a maritime rival who sooner or later will humble her pride.’
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He was right.
His conclusion prompts the obvious question.
Confronted with increasing economic and political connections across the emerging world, will the US, like the UK before it, find that, at some point, its pride will be humbled?
After all, the US was the nineteenth century’s emerging market.
At the beginning of the twenty-first century, it sits upon the summit of economic and political power, waiting, like the UK a hundred years ago, for someone to knock it off.
There is no shortage of pretenders to the throne.

These, of course, are major long-term issues.
I will return to them in Parts Three and Four.
In Part Two, I turn to some more immediate
difficulties.
The rise of the emerging nations appears to be connected with greater economic instability – equity bubbles, financial crises, housing booms, credit crunches and global imbalances (to name but a few).
Is there a link?
Can Western policymakers really deliver on their promises or are they, instead, losing control of our economic destiny?

Black holes cannot be observed directly.
Their effect can be seen only through their gravitational pull.
Celestial objects that used to behave in a predictable manner begin to act differently as they approach a black hole.
They may start to move faster than normal.
They may heat up and emit radiation as they’re sucked in to the void.
The presence of a black hole can be detected only through these indirect routes.

The emerging nations are a bit like a black hole.
There is little available data, the data that is published is often deemed unreliable and historical comparisons are typically meaningless.
For example, communist Czechoslovakia, hidden behind the Iron Curtain, was a very different economy from the capitalist Czech Republic, which now nestles in the bosom of the European Union.

Proving that emerging nations are economically influential is, therefore, tricky, at least for statisticians.
The available information is not generally up to the task in hand.
An alternative approach is to
think about the influence of the emerging nations indirectly.
What effects are emerging economies having on the Western world?
And have policymakers in the Western world properly come to terms with these effects?

These are key questions.
For Western policymakers, economic success is in part a question about expectations management.
If, for example, a policymaker claims that rising US exports to China are a ‘good thing’, US workers can reasonably expect to experience rising incomes as trade with China opens up.
Similarly, if a policymaker claims the delivery of persistently low inflation is the best single way of producing lasting economic health, investors should not have to worry about impending economic and financial crises.

Yet the promises of policymakers have not been met.
World trade has increased dramatically as emerging nations have made their presence felt, but the trade flows we’re seeing today are not purely the result of comparative advantage, the mainstay of the free-trade argument, and have certainly not delivered rising incomes for all concerned.
Meanwhile, after years in which inflation has been broadly under control, the early years of the twenty-first century witnessed the most extraordinary economic and financial boom and bust.
If price stability was such a good thing, why did the world go on to experience an economic crisis second only to the disasters of the 1930s?

It seems to me that the gravitational pull of the emerging nations has upset the barometers we typically use to calibrate economic success.
In Part Two, I examine this gravitational pull in three different areas – trade, capital markets and price stability.
Has increased trade brought benefits for all?
Have the economic specializations associated with higher trade volumes – for the US and the UK, primarily in financial services – genuinely contributed to lasting economic stability?
Why, despite the rapid growth of emerging nations, have returns for investors been so poor?
And, most controversially,
has the achievement of low inflation in the Western world become a source of economic instability?

One of the more obvious theoretical benefits of globalization is its impact on trade.
Why should the West worry if, for example, rising demand in China, India and elsewhere boosts export opportunities for Western companies and, in the process, creates Western jobs?
Certainly, standard trade theories suggest that increased specialization brings benefits to all involved.
The reality, however, is more complex.
The world trade system is undergoing a series of seismic shocks, creating both winners and losers in the process.
To understand why, we need to go back to the economic world as it was before the destruction of the Berlin Wall, a world where many would-be workers and consumers simply did not have access to Western markets and capital.

Had you been living in affluent West Germany in the early 1980s you might have treated yourself to an Audi Quattro, one of the most desirable automobiles ever made.
It certainly wasn’t the most expensive car available at the time, but it was the first to feature both four-wheel drive and a turbo-charged engine.
Its huge success in rallying provided an extra mystique.
For its day, the Quattro offered an exhilarating performance, with a 0–60mph time of only around seven seconds.
Over 10,000 of these cars were sold in Western Europe in the early 1980s, with a few hundred more sold in North America.
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If you had been living in East Germany in the early 1980s, you might have known about the Audi, but you wouldn’t have been able to get your hands on one unless a kindly West German had given you a very generous gift.
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East Germany’s economy was under the shackles of Soviet-style communism.
The regime survived only by protecting itself from the competitive pressures coming from the
West.
The dreams of central planners had turned into nightmares of bureaucracy and corruption, leaving East German consumers with products that wouldn’t survive in a world dominated by free market choice.
While the West Germans could whiz around in their Audis, the East Germans had to make do with Trabants.
Although the cars are treated with nostalgic affection today, Trabant production lasted only a couple of years after the fall of the Berlin Wall in 1989.
Given the choice, East Germans preferred to scrap their heavily polluting and remarkably slow Trabants (0–60mph in 21 seconds) and replace them with second-hand cars from Western Europe.
The Trabant was dumped onto the scrapheap of Soviet communism.
Those employed making Trabants and other relics of the Soviet era ended up without jobs, and were supported instead by handouts from the wealthy citizens of former West Germany.
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Not all Soviet-era car companies went the same way.
Škoda was a Czech car company originally founded in 1895 as a manufacturer of bicycles.
After the Second World War, the company was nationalized.
It went on to produce a number of innovative designs in the 1960s and 1970s but could make only limited headway in Western markets, where advances in motor technology and marketing were far greater.
Indeed, by the 1980s, the Škoda brand had become something of a joke.
In the UK, Škoda gags became very popular.
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(Q: ‘How do you double the value of a Škoda?’
A: ‘Fill its tank with gas’.)

With the fall of the Berlin Wall it became clear that Škoda, like the manufacturers of the Trabant, would not be able to survive as an independent company.
In 1991, it became part of the Volkswagen Group, alongside Audi and Seat.
Since then, its fortunes have been transformed and the jokes have been long forgotten.
In 2008, Škoda managed 674,530 sales, the largest number in its long and sometimes turbulent history.
Its biggest markets, interestingly, are other emerging economies.
Sales to Russia, China and India have proved to be particularly important.
Škoda still benefits from low Eastern European
wages, which allow cars to be produced relatively cheaply, but it now also benefits from the technologies, management know-how and cheap international finance available to the Volkswagen Group.

Škoda’s experience neatly encapsulates the difficulties in making sense of international trade and investment since the fall of the Berlin Wall.
Škoda exports from its Mladá Boleslav assembly plant in the Czech Republic to customers all over the world.
It offers competition to other car manufacturers which, in earlier decades, did not have to cope with the cheaper labour available on the eastern side of the Berlin Wall.
It provides employment for Czech workers and tax revenues for the Czech government.
It also provides employment in its dealerships across the world.

Škoda’s profits now go to the shareholders of Volkswagen AG who, in turn, are based in Frankfurt, London, New York and countless other locations.
While Škoda’s geographical location says something about trading relationships – Czech car exports may be higher as a result – the idea that the Czech Republic and its people are somehow the sole beneficiaries of Škoda’s revitalization is untrue.
There are winners spread all over the world.
There are also losers.
Trabant production didn’t survive but nor did Britain’s Rover Group.
America’s Big Three didn’t do too well either.
With the competitive pressures unleashed by globalization, unprofitable, poorly managed companies have no place to hide.

Political arrangements can get in the way of economic opportunity and preserve economic rents for the lucky few.
They create barriers to free trade, migration and capital flows.
Since the 1980s, those barriers have slowly come down.
The developed world is now trading with countries that, only a few years ago, were treated as strange lands.
In analysing these new patterns of trade, economists
routinely resort to the principles of comparative advantage famously described by David Ricardo in On the Principles of Political Economy and Taxation, published in 1817.
Today’s trade patterns, however, are much more a story about outsourcing, off-shoring, upscaling and downsizing.
The developed world has increasingly been exporting its factories to the emerging economies.
I’m not sure we’ve understood the full implications.

Ricardo was, rightly, keen to extol the advantages of trade.
He had a brilliant argument to do so.
Both England and Portugal could produce wine and cloth, but Portugal was better at producing both goods.
Portugal therefore had an absolute advantage in the production of both wine and cloth.
Trade between the two countries therefore did not seem to be promising; certainly, there appeared to be little benefit for Portugal.

Ricardo was not put off.
If the cost of producing cloth in Portugal was relatively high, in terms of the reduced production of bottles of Portuguese wine, and wasn’t so high in England, it would make sense for Portugal to devote more of its resources to the production of wine, which could then be traded for cloth produced in England.
The net result would be higher output and higher consumption in both Portugal and England.

Ricardo’s argument is in effect an international extension of the economic principles established by Adam Smith and others fifty years earlier.
Each of us should specialize in the things we are relatively good at.
A dentist might be better as a dental nurse than the dental nurse she employs, but if she spent all her time being a dental nurse, she wouldn’t be able to practise dentistry to the best of her ability and her patients would be left with toothache.
Similarly, if Portuguese wine is particularly good and English cloth just about passes muster, it benefits everyone if the Portuguese spend their time tending their vines.
I’ve drunk English wine and, with perhaps one or two exceptions, I’d rather leave viticulture to the Portuguese.

If all trade were the result of Ricardo’s comparative advantage, then we’d all be potentially better off.
Yet comparative advantage is not the only reason for trade.
Ricardo’s arguments work only under specific assumptions which do not always hold true.
Of these, perhaps the most important are, first, that capital and labour are immobile across nations and, second, that capital and labour are very mobile within nations.

Neither of these assumptions typically holds.
If, for example, the opening up of trade between England and Portugal leaves lots of wine producers in England threatened with unemployment, comparative advantage works best only when those workers can easily get new jobs making cloth.
Let’s imagine that wages in cloth making are much lower than wages in wine manufacturing.
If so, those who are forced to leave the wine-making industry might end up taking a pay cut.
Alternatively, they might fail to gain employment because of a lack of suitable qualifications or willingness to work at the new, lower wage.
England and Portugal might both be better off in aggregate as a result of the opening up of trade, but some individuals in England may still be worse off.
There is, therefore, a possible unwelcome redistributional consequence of trade.

As for the immobility of labour and capital between nations, that is only true under certain strict conditions.
Ricardo’s arguments work only if national borders cannot shift.
Yet borders are constantly being redrawn.
Take California and Oregon.
We consider California and Oregon to be part of a single, very large economy.
California, however, wasn’t always part of the US, only ending up in US hands following the signing of the Treaty of Guadalupe Hidalgo in 1848 after two years of fighting in the Mexican–American war.
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Do these changing circumstances imply that the principles of comparative advantage worked only while California was ‘south of the border’ and not when it subsequently fell into US hands?
Possibly, but given
the number of Mexicans living in California and the number of US companies operating in Mexico, the more likely answer is that Ricardo’s assumptions of labour and capital immobility across borders were never going to stand up to close scrutiny.
The movement of American capital south of the border and the movement of Mexican labour north of the border may have benefited the owners of capital (because they now make more profit) and Mexican workers, but not necessarily US workers.