I come to bury globalization not to praise it

Inclusive Economy10 Nov 2009Peter van Bergeijk

Is the process of globalization over the top? The period since the Second World War has been characterised by an exceptional strong rate of growth of world trade. The last sixty years of almost continued growth constitute an exceptional chapter in the history of world trade indeed. Equally exceptional are both the speed and the depth of the downturn in trade that started one year ago and became manifest at the beginning of this year.

In 2007 and 2008 the world trade volume had been growing at a “normal” rate between 5 and 10 per cent, but in October 2008 world trade suddenly came to a virtual halt and then started to decline. This decline rapidly turned into a collapse: early 2009 trade figures were about twenty per cent lower in real terms than they had been just one year earlier. A decrease of this magnitude had not occurred in the post Second World War era.

We have to go back to the Great Depression and its aftermath to see a comparable destruction of trade. But it was not only trade that was in peril. The Foreign Direct Investment (FDI) collapse was even more pronounced. For the first quarter of 2009 UNCTAD estimated a decrease by 54 per cent on the basis of a sample of 57 countries for which quarterly data on FDI inflows are available.

Cross border mergers and acquisitions showed the strongest declines as they were 62% and 77% lower in the last quarter of 2008 and the first quarter of 2009, respectively. UNCTAD’s (2009) World Investment Prospects Survey reports that 57% of the multinationals expects a decrease in Foreign Direct Investment and about half of them expect that this decrease will be more than 30%. So the world de-globalizes rather than globalizes.

A preliminary cross-country investigation of competing theories regarding the drivers of the trade collapse in individual countries provides a few clues. Countries that have strongly opened up to international trade and investment will reduce their imports comparatively to a lesser extent. It is especially relevant that the extent of (de)centralized decision making is significant.

To put it simply, democracies trade too much for their own good – their decentralized reaction to trade uncertainty is suboptimal. This would seem to suggest that trade needs to be reduced to some extent and this do-it-yourself policy advice brings me to the role of the economist in designing economic policies to meet the issue of de-globalization.

In times of severe crisis purely national interests gain the upper hand and often policy advisors propose protectionist measures. Especially (the threat of) high unemployment is a powerful incentive to reduce imports by means of tariffs and non-tariff barriers such as quota and regulations. Even economists that under normal conditions are pro free trade advisors may find themselves in a position where they have to compromise between ‘the theoretically optimal’ and the ‘practically possible’.

The archetype is Keynes in the 1930s. Keynes considered import barriers as appropriate second best instruments to fight the depression and was also convinced that trade barriers were needed as an element in the international institutional framework that was to be created after the Second World War. Keynes’ intellectual position in the wake of critical economic developments is by no means a unique phenomenon. It is characteristic for periods of de-globalization and depression that import substitution is seen as a viable alternative in policy quarters.

Presently, even institutions that are assumed to underpin the open world economic system fall into this trap of second-best de-internationalization. An example is the IMF’s 2009 Article IV Consultation of China. Actually, the Executive Board “supported the steps that China is taking to bolster private consumption as part of a comprehensive, well-sequenced strategy aimed at rebalancing China’s growth model, and saw further room for policies to reduce China’s dependence on exports and high levels of investment” (emphasis added).

Another recent example is Rodrik (2009) who discusses the impact of the crisis on developing countries. Rodrik argues that fast growth of the emerging markets (Japan, the Asian Tigers, Eastern Europe, the BRIIC countries etc.) in the past fifty years was possible due to the fact that these countries captured growing shares of the world market for non primary products – a development strategy no longer feasible for large and middle income economies after the present crisis since the US in all likelihood will no longer be able to run large trade deficits. Accordingly, he proposes industrial policies by tax exemptions, direct credit, payroll subsidies, investment subsidies etc.

There is only one important obstacle, namely the WTO. I disagree. The argument is of course not that the neoclassical free trade recipe is sacred. My point is basically that a shock in trade uncertainty appears to have been one of the factors behind the trade collapse. So far policy makers have avoided the error of the 1930s to rely on trade barriers and other beggar thy neighbour policies. Such errors would have increased trade uncertainty even further.

It is true that there are some early signs that world trade may stabilize, but the situation is still extremely fragile. So what can we actually do? First-best government action should be aimed at reducing uncertainty per se through strict adherence to conflict settlement procedures or other instruments of economic diplomacy that aim at increasing trust in free trade.

Indeed, such policies tackle the source of the problem from which the uncertainty externality arose in the first place. It may be especially relevant for small countries as the WTO seeks to protect their interests in open and multilateral trade against the (market) power of the large economies. If international politics were to resort to economic warfare and economic surveillance more often, this would impose substantial costs on the world economic system.

It is important to note that Bretton Woods institutions were designed to achieve more than stabilization. Bretton Woods also has geopolitical benefits. The architecture for world governance is perhaps imperfect but it offers a multilateral approach to peaceful conflict settlement.

This article is a short version of the inaugural address of 29th of October 2009 at the Dies Natalis of the ISS in The Hague. See here the full lecture.