Understanding the Global Economy

Chapter 2: The Global Economy

• Globalization involves cultural, social, political, and economic dimensions, with economic globalization being just a part.

Learning Objectives

• Define economic globalization
• Identify and discuss the three waves of economic globalization
• Assess the effects of global economic integration on international trade and trade policies

Introduction to Economic Globalization

• It involves the integration of economies through free trade and financial flows
• Its framework began with planning for the post-World War II economic order.
• Established institutions played a crucial role in integrating markets.
• This process has encountered challenges and produces both advantages and disadvantages.

Defining Economic Globalization

• The International Monetary Fund (IMF) views it as a historical process driven by human innovation and technological advancements
• It is characterized by the increasing integration of economies through the movement of goods, services, and capital across borders
• Economic globalization has interwoven dimensions, including:
  • Globalization of trade of goods and services
  • Globalization of financial and capital markets
  • Globalization of technology and communication
  • Globalization of production

Waves of Economic Globalization

• There are three waves:
  • Early Wave
  • Keynesian Liberal Wave
  • Neo-Liberal Wave

Early Wave of Globalization

• Historians Dennis O. Flynn and Arturo Giraldez claim globalization started when major continents began exchanging products continuously with impacts on trading partners.
• The Silk Road, which lasted 2,000 years and extended from ancient times to the 16th century, connected Asia to Europe, the Middle East, and Africa.
• Predominant goods during this period were artisan products, silk, spices, ceramics, textiles, compasses, and gunpowder
• The Age of Exploration (early 15th to 17th century) was a pivotal era that changed the shape of the world and the course of history.
• Europeans explored for trade routes and new lands, establishing global commercial capitalism.
• In 1571, the galleon trade connected Manila (Philippines) and Acapulco (Mexico), marking the first direct connection between the Americas and Asian trading routes.
• In 1867, a more open trade system emerged when the United Kingdom, the United States, and other European nations adopted the gold standard in Paris.
• The countries established a basis for currency prices and a fixed exchange rate system tied to the value of gold.

Keynesian Liberal Wave

• Delegates from different states gathered in the United States for the Bretton Woods Conference during the final phase of World War II.
• World leaders aimed to create a global economic system to ensure long-lasting global peace.
• One way to achieve this was to establish a network of global financial institutions that promote economic interdependence and prosperity.
• The Bretton Woods system was inaugurated in 1944 during the United Nations Monetary and Financial Conference to prevent the recurrence of early 20th-century catastrophes.
• British economist John Maynard Keynes' ideas influenced the Bretton Woods system.
• Keynes believed economic crises occur when money is not spent and not moving, not due to a lack of money.
• The active role of governments in managing spending was the foundation for the system of global Keynesianism.
• Economic setbacks between 1918 and 1938, including the Great Depression, motivated financial and political leaders to establish three international economic organizations.

Establishment of Financial Institutions

• Delegates at Bretton Woods agreed to create 2 financial institutions:
  • International Bank for Reconstruction and Development (IBRD) or World Bank to fund postwar reconstruction projects
  • The World Bank was designed for the Marshall Plan and loaning financial loans to Europe
  • Loans were expanded in the 1950s to developing countries worldwide to finance industrial projects
  • International Monetary Fund (IMF) served as the global lender of last resort to prevent individual countries from spiraling into credit crises
  • If a country experienced slow growth due to money shortage, the IMF would step in
  • It was also created to coordinate and regulate international monetary transactions to promote global economic prosperity and political stability, and discourage unfair trade practices.
• Numerous countries committed to global economic integration following Bretton Woods through the General Agreement on Tariffs and Trade (GATT) in 1947.
• GATT's main goal was reducing tariffs and other barriers to free trade; it was replaced by the World Trade Organization (WTO) in 1995
• The WTO serves as a forum for negotiating various international issues, including tariff and non-tariff barriers, intellectual property rights, trade-related investment measures, and food safety standards.
• The Bretton Woods goals and strategies included macroeconomic stability, import substitution, and governance reform.

Macroeconomic Stability

• To maintain macroeconomic stability, the US dollar was the only international standard currency of choice peg at $35 per ounce of gold.
• The IMF was expected to maintain equilibrium under the gold standard by providing financial assistance if a country faced balance of payments issues.
• The monopolization of US dollars led to overvaluation relative to other currencies, causing some countries to question US gold reserves.
• Foreign countries converted US dollars into gold, depleting US gold reserves, which led President Nixon to abandon the gold-exchange standard on August 15, 1971.

Import Substitution

• Domestic industries were established in the 1950s and 1960s to replace imports and promote domestic industrial development, eventually achieving industrialization.
• People transitioned from primary industry to manufacturing and better jobs, creating demand for goods and services.
• The availability of financial capital was a key factor.
• Countries combining import substitution industrialization and export promotion performed better, such as the Asian Tiger neighbors, who aggressively built local industries and promoted exports.

Governance Reform

• Loans to poor countries from the IMF often come with conditions to adopt market-oriented economic models and open economies to foreign competition.
• Developing countries' infant industries faced disadvantage as they required protection and couldn't match the scale of foreign firms.
• Another reform of IMF is that is fosters good governance to eradicate corruption.
• Prosperity is impossible if public funds from foreign loans end up in pockets, and crony capitalism was rampant in developing nations.
• Development loans from the IMF have been pocketed by authoritarian political power or enriched local businesses, which usually serves Serve Northern corporations

Neo-Liberal Wave

• In the early 1970s, oil prices sharply increased due to the Organization of Arab Petroleum Exporting Countries (OAPEC) embargo in response to the United States supporting Israel during the Yom Kippur War.
• Arab countries used the embargo to stabilize their economies and growth.
• The oil embargo affected Western economies reliant on oil, worsening stock markets that crashed post-1973, ending the Bretton Woods system.
• Stagflation occurred where economic decline and unemployment coincided with sharp price increases, defying Keynesian economics.
• Economists like Friedman challenged Keynes's ideas, leading to neoliberalism.
• Neoliberalism appeared from the 1980s as it was made the strategy of Treasury Department, the World Bank, the International Monetary Fund (IMF), and the World Trade Organization

Washington Consensus

• The Washington Consensus was named after President Ronald Reagan of the US and Prime Minister Margaret Thatcher of England.
• The Washington Consensus required governments to implement structural adjustments for loans.
• This pushed for reduced government spending and privatization of services like water, power, communications, and transport.
• It pressured governments to reduce tariffs and open economies, arguing for quickest progress.
• However neo-liberal policies adopted by other countries coupled with mandates from international financial institutions do not give a guarantee to take effect once it is replicated.
• Heavy debtor countries rarely made significant improvements from mentioned requirements, because mandated cut on public spending would decrease social programs that constitute greater poverty.

Financial Crisis and Neoliberalism Challenge

• Neoliberalism faced significant strain during the global financial crisis of 2007-2008, the greatest economic downturn since the Great Depression.
• The crisis originated in the 1980s when the United States systematically removed banking and investment restrictions.
• The scaling back of regulations continued in the 2000s, creating a potential for crisis.
• Government authorities failed to regulate bad investments in the US housing market while promoting the free market.
• Americans built houses beyond capacities with cheap housing loans.
• To mitigate the risks with these loans, banks were lending homeowners pooled mortgage payments and sold them as mortgage backed securities (MBSs).
• MBS become a combination of multiple mortgages with an assumed steady rate as there was so much surplus money circulated.
• The demand for MBSs increased and investors clamored for investment opportunities. and banks become less discriminating in their haste to issue the loans.
• Loans began extending to families and individuals with dubious credit records, known as sub-prime mortgages.
• Assumptions by financial experts were it was wrongly assumed that if many of the borrowers were individuals and families who would struggle to pay, that a majority would not default, also assuming that Housing prices would continue to increase.
• In 2007, home prices stopped increasing and there was a realization that families could not pay off loans.
• In this realization, banks resold MBSs, to try get rid of their bad investments.
• In September 2008, major investment banks like Lehman Brothers collapsed, depleting investments.
• The crisis spread beyond the United States and loss of money from investors spread back to their countries and created a multiplier effect.
• Countries such as Spain and Greece are heavily indebted and debt relief that had come at a high price.
• Greece were forced by Germany and the IMF to cut back so cail and public spending, affecting various services causing the most acute effect for the poor.
• The reduction in government spending has slowed down growth and ensured high levels of unemployment.
• The United States recovered relatively quickly thanks to a large Keynesian-style stimulus package created by President Barack Obama.

Perspectives on Economic Globalization

• The globalization of world economy increases several important questions:
  • What causes the global economic interconnectedness in the contemporary world?
  • Why is it that despite the decline of the US in the 1970s, the economic institutions it helped establish continued to function?

Hegemonic Stability Theory

• Asserts that it argues that the power of the United States and its willingness to act as a hegemon, allowing a liberal global economy
• The US emerged as a superpower that was willing to shape global economy
• Today's globalization, the level of economic interconnection, and presence of multinational corporations could be traces back to the US in placing a liberal economy

Neo-Liberal Institutionalist Theory

• It explains international institutions which have an independent impact on global economy
• Government arrangements called regimes, as Robert Keohane 1984 argued, explains endurance international cooperation
• Neo-liberal institutionalists maintain that regimes create regularity in actors' behavior and expectations.
• Neo-liberal is why the 3 institutions persisted as the hegemon which in result resulted to experiencing economic and political decline

Economic Globalization Today

• Exports increase national economies, not just local selling of goods and services
• Advanced nations used benefiting most from free trade previously, as they sold industrial and agricultural goods
• The percentages began changing with WTO-led reduction and trade barriers, also known as trade, that have altered dynamics global economy
• Economic globalization has increased spike in growth rates, caused by increased exports in recent decades
• The global per capital GDP rose with over five fold in the 2nd half of the 20th century created large Asian economies
• It states that Economic globalization remains an uneven process and the series of trade talks under the WTO have often ended unfairly
• First, developed countries tend to be protectionists because they refuse to lift policies to safeguard primary products otherwise overwhelmed
• Trade importers characterize economic relations between developed and developing nations

Beneficiaries Globalization

• Transnational corporations now governements
• They are focused in profit programs rather assisting the programs of the governments hosting
• The term "race to bottom" refers to lower governments. standards that attract investors to seek high profit margins
• Laws become weakened that harm ecological balances