15. New challenges of the globalised world

Question 1

Globalisations in history

Answer 1

1. 1st wave (16th-17th cent): trade
2. 2nd wave (1870-1914): foreign direct investment (FDI)
3. 3rd wave (1989-): portfolio inv

First 2 waves’ purposes: global markets for goods and services

3rd wave: for money and credit

Question 2

BOP equation

Answer 2

= current account + capital account

= balance of trade + net income + FDI + portfolio inv

Balance of trade - 1st wave

Net income and FDI - 2nd wave

portfolio inv - 3rd wave

Question 3

Factors of financial liberalization

Answer 3

• Technical progress
• Neoliberal ideology
• Deliberate intervention by nation states and international organizations

Question 4

Technical progress

Answer 4

• financial regime differs radically from its precursors in that it was not built by politicians, economists, central bankers or finance ministers, nor did high- level international conferences produce a master plan. It was built by technology
• assembling a global financial marketplace that would replace the Bretton Woods agreements and, over time, alter political structures.
• => no form of political sovereignty that can over shadow capital movements.
• quoted W. B. Wriston, ‘Technology and Sovereignty’

Question 5

Neoliberal ideology

Answer 5

• Wall Street Treasury proceeded on the self-serving assumption that the ideal world is indeed one of free capital flows, with the IMF and its bailouts despite the evidence of the inherent risks
• idea revolves around encouraging the trade of goods and services but restrict the trade of money and credit.
• quoted Jagdish N. Bhagwati, ‘The Capital Myth: The Difference between Trade in Widgets and Dollars’

Question 6

Deliberate intervention

Answer 6

• deregulation: abolition of restrictions on capital movements
• this leads to more effective crisis prevention and management: “lender of last resort” (LOLR)
  
  • 1987-2006: “The Federal Reserve, consistent with its responsibilities as the Nation’s central bank, affirmed today its readiness to serve as a source of liquidity to support the economic and financial system.”

Question 7

Definition of seigniorage

Answer 7

• difference between the value of money and the cost to produce it (profit)
• Such income reflects the return on interest-bearing assets that are financed by the issuance of currency, which pays no interest, or at most a below-market rate, to the holder.’

Question 8

Globalisations of crises

Answer 8

• “Oil shocks”
• Petrodollars invested in LDCs
• Series of debt defaults:
  
  • ’80s LDC (least developed countries) debt crises
  • 1995 Mexico
  • 1997 Southeast Asia
  • 1998 Russia
  • 2001 Argentina
• Capital inflows and crises in the emerging markets at the center:
  
  • new economy
  • subprime mortgages
  • sovereign debts
• => localised credit risk to global liquidity risk

Question 9

The African Crisis: Facts and Figures

Answer 9

• 1975-1999: GNP per capita of Sub-Saharan Africa dropped from 17.6% to 10.5%
• Infant mortality increased: 107 per 1000 births
• adult-literacy fell
• 34% of region are classified as undernourished
• Life expectancy of 49
• 9% of 15-49 have HIV/AIDS

Question 10

Overview of Berg Report

Answer 10

• The report was written in response to a 1979 request from the African Governors of the World Bank for a paper analyzing the development problems facing African countries
• It also responds to a set of policies determined by African Chiefs of State in 1980, called the Lagos Plan of Action.
• While the Lagos Plan endorsed inward-looking policies of African self-reliance, the Berg report advocated for outward-looking policies of increased international trade.

Question 11

Political causes from Berg Report of World Bank

Answer 11

• based on 2 assumptions:
  
  1. gov failed to understand negative effects of bad polices
  2. positive effects of good policies once implemented will not benefit them or the elites - undermined their power
• highly internalist and state-minimalist
• African gov policies undermined dev by destroying agricultural producers’ incentive to increase outputs and exports
• heavily protected manufacturing industries and excessive state intervention
• substantial currency devaluation
• substitution of private for public enterprise—not just in industry but also in the provision of social services
• used the powerful instruments of economic control that they had inherited from colonial regimes to benefit urban elites and themselves
  
  • surplus absorption (Arrighi) - consumption of urban elites and sub-elites in bureaucratic employment, the relatively high mass consumption of ‘labour aristocracies’ and the transfer abroad of profits, interests, dividends and fees of various kinds => restrain growth of agricultural productivity and domestic markets => perpetuated dependence of African economies on growth of world demand for primary products

Question 12

Lagos’ Plan of Action

Answer 12

• heads of state of the OAU (Organisation of African Unities) traced the crisis to a series of external shocks.
• growing protectionism of wealthy countries
• soaring interest rates
• growing debt service commitments
• => resolution of the crisis relies on:
  
  1. capacity of African states to mobilize national resources and foster greater mutual economic integration and cooperation rather than world-market mechanisms
  2. empowerment that African states derived from continent’s formal decolonization
• further reinforced by APPER (Africa’s Priority Programme for Economic Recovery, 1986–1990

Question 13

APPER v. Lagos Plan

Answer 13

• APPER openly acknowledged the responsibilities of African governments for the crisis, and the limitations of any actions undertaken by African states on their own => variety of policy reforms consistent with the Berg Report
• => asked the international community to take action to:
• ease the crushing burden of Africa’s external debt
• stabilize and increase the prices paid for their exports.
• => UNPAAERD (United Nations Programme of Action for African Economic Recovery and Development, 1986–1990)

Question 14

Backfire of structural-adjustments programmes

Answer 14

1. Started with growing number of African states subjected themselves to IMF and World Bank
2. NPE (New Political Economy) and World Bank started to revise their neo-utilitarian, state-minimalist prescriptions and to emphasize the role of institutions and ‘good governance’
3. World Development Report, adhered after structural-adjustment prog., put even greater responsibility on African elites and governments for the failure of their economies to recover and for the social disasters accompanying that failure.
4. => African compliance with IMF and World Bank were followed in short order by ever more pessimistic assessments of the capabilities of African governments and elites to resolve the long-standing crisis

Question 15

Pros of surplus absorption

Answer 15

capable of stimulating agricultural productivity as it can attack on the privileges

=> economic dev of Africa can be characterised as “perverse growth” - growth which undermines rather than enhances the potentialities of the economy for long-term growth

Question 16

Uneven development of African crisis

Answer 16

• four in North Africa and the remaining sixteen in Sub-Saharan Africa had exceptionally good performances which compare very favour- ably with those of the ‘miracle’ economies of East Asia => have no ‘character flaw’ that makes them incapable of sustained development
• a larger group of experiences (8) that began in the 1960s and ended in the 1970s, and a smaller group (4) that began in the 1980s
• smaller group consists of countries that had disastrous developmental experiences in earlier years => scope for growth

Question 17

Post-1975 phenomenon figures

Answer 17

• decline in the number of success stories that started in successive sub-periods: from eight in 1960–64, to three in 1965–69, to one in 1970–74, to none in 1975–79.
• a post-1975 phenomenon as up to 1975, the African performance was not much worse than that of the world average and better than that of South Asia
• integral to a major change in the inter-regional unevenness of Third World economic performance

Question 18

Capitalism as cause of crisis

Answer 18

• driver for cons of surplus absorption
  
  • integration of economies in the global circuits of capital contributed to “high mass- consumption levels of assorted ‘labour aristocracies’ “
  • easy import substitution would involve a tightening of the constraints that world capitalism imposed on national development in Africa.
• crisis of profitability: world- wide intensification of competitive pressures on business enterprises ensued from the great expansion of world trade and production of the 1950s and 1960s:
• crisis of legitmacy derived from crisis of profitability - Keynesian policies and ideologies (sustain worldwide expansion of trade and production in 50s-60s

Question 19

Crisis of profitability

Answer 19

• combined with inflation of oil rents
• => routinely deposited in Western banks and ‘extra-territorial’ financial markets => over-abundant/excess liquidity => recycled as loan capital on highly favourable terms to Third and Second World countries
• growing’ and the distribution of income and wealth ‘severely skewed
• competitive pressures had become particularly intense in manufacturing industries => demand for imports are industrial rather than agricultural - African strength; imported instead from North America since they possessed more capital to invest in industrial sector
• Third World countries were bearing the social costs of increasing industrialization and urbanization without the economic benefits they had expected to reap

Question 20

Crisis of legitimacy

Answer 20

• Keynesian policies counterproductive due to increased competition that exhausted resources
• increasing social and economic costs of US reliance on coercion to contain the Communist challenge in the Third World
• US gov opted for economic policies:
  
  • drastic contraction in money supply
  • higher interest rate
  • lower taxes for the wealthy
  • unrestricted freedom of action for capitalist enterprise
• => compete aggressively for capital worldwide, to finance a growing trade and current account deficit in its own balance of payments (due to spending on coercion of Communist regime)
• => world’s main debtor nation and the largest recipient of foreign capital (1980s)
• => provoking a sharp increase in real interest rates worldwide—and a major reversal in the direction of global capital flows.
• => deflate capital flows to African countries

Question 21

Crisis of development project

Answer 21

• attainment of high rates of growth of GNP left:
  
  • infant mortality ‘high’
  • life expectancy ‘low’
  • illiteracy ‘widespread’
  • unemployment ‘endemic

Question 22

Shift of political power as cause of crisis

Answer 22

• the shift:
• US debacle in Vietnam
• Portuguese defeat in Africa
• Israeli difficulties in the 1973 War
• the entry of the PRC into the Security Council of the United Nations
• caused by first and second oil shocks
  
  • 1st: followed the Kippur War of 1973 as a form of retaliation of the Arab oil producers against the Western countries, which had given their support to Israel
  • 2nd: Iranian Rev + Soviet invasion of Afghanistan + war with Iraq => further hike in oil prices (disrupted oil production) + crisis of confidence in the US dollar
• combined with crisis of US hegemony (economic powerhouse that controlled capital flows) meant worsening terms of trade for most non-oil-producing Third World countries.

Question 23

Emergence of Washington Consensus

Answer 23

• accompanied the change in US policies in the military and financial spheres
• a set of 10 economic policy prescriptions considered to constitute the “standard” reform package promoted for crisis-wracked developing countries by Washington, D.C.-based institutions such as the International Monetary Fund (IMF), World Bank and United States Department of the Treasury.
• 3rd world countries were recommended to open up their national economies to:
• intensifying world-market competition
• rival each other and First World countries in creating within their jurisdictions the greatest possible freedom of movement and action for capitalist enterprise
• => contributed to consolidating the bifurcation in the fortunes of Third World regions.

Question 24

Dependence on foreign capital as cause of crisis

Answer 24

dependence became unsustainable due to the redirection of capital flows to the US => regions became vulnerable

Question 25

Colonial causes of crisis

Answer 25

Analysed in terms of labor, entrepreneurship and state/national economy formation

Labor:

• in pre-colonial times—the import of guns and the export of slaves— worsened whatever structural shortage of labour relative to natural resources might have existed in the region as it resulted in low pop dens. and small markets (scarce factor not land but labor)
• colonial times: supply expanded but so did demand + exploitation of resources
• surplus of internal labour mkt supply but fall in external mkt and short of demand => contrasted with East Asia where abundance of labor supply in centres of expansion

Entrepreneurship:

• structural shortage of labour relative to natural resources created an unpropitious setting for the emergence and reproduction of entrepreneurial strata in trade and industry
• slave trade intensified entrepreneurial shortages
• redirected already scarce entrepreneurial resources towards ‘the protection-producing industry’ which were taken over by colonial administrations and armies
• entrepreneurial functions in trade and production came to be exercised predominantly by foreigners; Africans were often barred from operating businesses unlike East Asia where endowments were passed on

state-formation and national- economic integration

• inherited from the pre-colonial and colonial eras a political-economic configuration that left little room for the construction of viable national economies or robust national states
• African elites did deracialise civil society but no de-tribalise rural regions which meant failure of development due to limited economic integration across regions

Question 26

Common traits of financial crises

Answer 26

• detected by Reinhart and Rogo
• overindebtedness which compromised of: excessive lending, exaggeration, and blindness to this exaggeration
• => result of not only uncertainity of future but also excessive confidence (irrationality)
• => derived from individual behaviour and structure of financial system - relationship between money and credit

Question 27

Elusiveness of liquidity

Answer 27

• involves an act of faith/confidence
• => if confidence falters, investors will exercise the right implied by the liquidity of their investments, and will actually liquidate them.
• => Thus, paradoxically, the attempt to remove all uncertainty from the financial system creates another form of uncertainty.
• Keynes: investments which are “ fixed” for the community are thus made “liquid” for the individual
• initial rise in stock price (before 1929 - great depression) linked to fundamentals, solidly grounded on the real economy. Howev- er, with the increase of market liquidity, the link became necessarily elu- sive
• => on a liquid market, impossible to tell whether investors are attracted by promising stocks, or whether stock prices are driven up merely by the arrival of new investors.

Question 28

Keynes and first post-war period

Answer 28

• situation: burdensome legacy of debts that could not be paid
• => suggested principles: change the relationship between unit of account and means of payment
• => France: restoring the convertibility of their currency at a reduced parity => did not lighten burden of the country’s foreign debts (payable in gold) but regulated the supply of money according to the needs of domestic circulation and payments
• Britain (Churchill), on the other hand, returned to gold standard at prewar parity

Question 29

Genoa Conference 1922

Answer 29

• Discuss ways to provide an adequate means of payment for international settlements. 2 alternative options were envisaged:
  
  1. creating additional liquidity (through the establishment of a gold exchange standard)
  2. compensating debts and credits (through the creation of an international clearing system)
• Resolution 11 concluded: «The convention will thus be based on a gold exchange standard» (reported in Eichengreen and Flandreau 1997, 264).

Question 30

Ineffectiveness of gold standard

Answer 30

Overview:

• efforts to restore the ‘age of gold’ threatened to ignite another ‘age of iron’: global gold reserves were too thin to sustain the mountain of debts that the war had left behind
• pressure on international money markets, where there was a chronic excess of demand over supply
• => presence of ‘distress borrowers’ kept interest rates high and retarded recovery.

Chronology:

1. Genoa Conference
2. second half 1920s: Liquidity increased, both in the sense of an increase in the quantity of money and in the sense of an increase in the convertibility of assets into money
   3.

Question 31

Gold standard vs. gold exchange standard

Answer 31

Gold standard:

• paper currency can be converted to gold and vice versa only at preset fixed prices
• one unit of currency is convertible to a fixed amount of gold both in your home country or another country
• huge reserves of gold must be maintained if international payments were to be made
• trade imbalances cvreated clashes for the appropriation of international money
• a trade decit produced an outfow of gold, hence a monetary contraction, hence deflation – hence pre-emptive trade restrictions to avoid the curse

Gold exch. standard

• one country’s currency is converted to the equivalent value of another country’s currency provided that the second country’s currency can be converted to gold at a stable rate of exchange
• foreign exchange convertible into gold, and hence usable as international money, was the us dollar.
• no need to keep surplus of gold
• trade imbalances created international money
• trade de cit was not paid out in gold, but in paper; it increased the sup- ply of money in the surplus country, without reducing the amount of money in the de cit country; it was a boon for the former, without being a burden for the latter.
• to lend without borrowing, and to acquire without paying.

Question 32

Financial innovation as a driver for increased liquidity

Answer 32

1. diffusion of margin trading. e.g. the practice of investing on the stock market money borrowed from the banks => required to hold on deposit only a small share (the margin) of the sum invested on the stock market
   
   • encouraged by the widening gap between low interest rates and high returns on stocks - promise to ample gains for both banks and borrowers
2. rise of investment funds - benefit from the diversification and from the professional management of a large and composite portfolio

Question 33

Competitive struggle for liquidity

Answer 33

• Just as the expectation of rising prices had attracted investors whose purchases had eventually caused prices to rise, the expectation of declining prices induced sales that eventually caused prices to drop.
• => liquidity that had previously own abundantly into the market was now sudden- ly drawn back out again.
• Keynes: each individual who succeeds in getting more liquid forces down the price of assets in the process of getting liquid, with the result that the margins of other individuals are impaired and their courage undermined
• Based on assumption: resources and assets that proved to be unproductive (‘rotten’) would allow to free up money to be employed in more promising endeavors
• => in principle, to reinvest that cash in other more remunerative assets; yet, the fact that money may serve as a store of value, offers the holders of cash also the option not to reinvest it and simply to hoard it => in the midst of deflationary pressures and mounting uncertainty, liquidity led to liquidation, and destruction took the place of production.
  
  • as long as money may be hoarded (i.e., saved without being lent) there is no certainty that an increase in the supply of money will produce an increase in the supply of loans, and hence a reduction of the market rate of interest and a growth of investment and of economic activity. => liquidity trap
• => Keynes: degeneration of the competitive market: it is a situation where entrepreneurs compete not to enter the market, but to exit the market.

Question 34

1st v. 2nd post-war period

Answer 34

• 2nd: The burden of the war debts was not laid upon the shoulders of the country who had provoked and lost the war, but on the shoulders of the country who had only reluctantly entered it and who had given a decisive contribution to win it
• BW agreement = replay of Genoa conference - The alternatives that lay on the table were also the ones that had been envisaged at Genoa twenty-two years before: a gold exchange standard and a clearing system
• However, second option was not merely evoked as a vague principle, but was embodied in Keynes’s very elaborate and very concrete proposal for an International Clearing Union.
• => secret of a deficit without tears allowed the United States to finance generously post-war recovery and prewar preparations: the Marshall Plan and the escalation towards the Cold War.

Question 35

Enhanced liquidy does not equal more liquid markets

Answer 35

Enhanced liquidity meant essentially more money but it did not (yet) mean more liquid nancial markets. In fact, Bretton Woods established a regime of strict controls on international capital movements

Question 36

Risks of “the secret of deficit without tears”

Answer 36

• money can be distracted from productive use by the ‘preference for liquidity’ not in the sense of ready cash, but in the sense of prompt convertibility of assets into money on a liquid market.
• the very fact that money may be held as an asset and assets may be converted into money at no cost.
• the process of money creation might get out of hand, global markets could be flooded with liquidity, and money could end up losing its value.

Question 37

Nixon’s suspension of convertibility

Answer 37

• Cause: US gold reserves were running short of providing an adequate backing to the dollars that were increasingly held abroad
• Effect: increase in the price of gold preceded and exceeded the increase in the price of oil in correspondence of both energy crises => value of the dollar in terms of gold had already declined as a consequence of the suspension of convertibility and of the US balance of payments deficit, before OPEC policies caused the value of the dollar to decrease also in terms of oil.

Question 38

Capital market liberalisation - remedy worse than cause

Answer 38

• a way to divert the growing tide of international liquidity, so that it would not produce an increase in com- modity prices or consumer prices, but rather in stock prices and asset prices in general
• In fact, allowed the United States to run balance of payments de cits, inundating the world economy with dol- lars, without producing in ation
• However, it did not prevent, but in- deed encouraged the formation of asset price bubbles in this or that part of the world, following capital in ows and out ows