Lesson 2: Market Integration PDF

GE 319 – THE CONTEMPORARY WORLD Lesson 2 Market Integration Learning Outcomes  Identify the key-players that facilitate economic globalization;  Explain the role of international financial institutions in the creation of a global economy, and;  Equip students with 21" century lear...

GE 319 – THE CONTEMPORARY WORLD Lesson 2 Market Integration Learning Outcomes  Identify the key-players that facilitate economic globalization;  Explain the role of international financial institutions in the creation of a global economy, and;  Equip students with 21" century learning and develop higher order thinking skills that will lead towards a deeper understanding of Global economic structures as well as articulate a stance on global economic integration and how it impacts the Philippines. Time Frame: 1 Week Overview The social institution that has one of the biggest impacts in society is the economy. You might think of the economy in terms of number – number of unemployed, gross domestic product (GDP), or whatever the stock market is doing today. While we often talk about it in numerical terms, the economy is composed of people. It is the social institution that organizes all production, consumption, and trade of goods in the society. There are many ways in which products can be made, exchanged, and used. Think about capitalism or socialism. These economic systems – and the economic revolutions that created them – shape the way people live their lives. Economic systems vary from one society to another. But in any given economy, production typically splits into three sectors. The primary sector extracts raw materials from natural environments. Workers like farmers or miners fit in the primary sector. The secondary sector gains the raw materials and transforms them into manufactured goods. This means, for example, that someone from the primary sectors extracts oil from the earth then someone from the secondary sector refines the petroleum to gasoline. Whereas, the tertiary sector involves services rather than goods. It offers services by doing things rather than making things. Thus, economic system is more sophisticated or at least, more sophisticated than the way things used to be for much of human history. This lesson will show the contributions of the different financial and economic institutions that facilitated the growth of the global economy. The history of the global market will be discussed by looking at the different economic revolution. The growth and dynamics of multinational corporations that are emerging in today’s world economy will also be examined. 55 | P a g e  GE 319 – THE CONTEMPORARY WORLD Activity (Let’s Get Started!) At this point, markets will be assessed through your own perspective provided that you already had a good grasp of the different concepts in economic and financial globalization. This activity will help you understand the benefits and harms of global economic processes, structures, and technologies.  Analyze the "global" nature of multinational corporations.  Do you think the positive effects of multinational corporations outweigh the negative effects? Why or why not?  What do you think are the ways to lessen, if not eliminate, the negative consequences of multinational corporations? Analysis (Let’s Think About it!) Now think about the questions below:  What does the world think about globalization?  Are multicultural/multi-ethnic societies more positive about globalization than monocultural/monoethnic societies?  Why is Global Integration necessary in a capitalist economy/ Abstraction (Let’s Explore!) The Post-World War II Economic System and The Role of international financial institutions in the creation of a global economy -The Bretton Woods Conference in July 1944, formally known as the United Nations Monetary and Financial Conference, marked the birth of a new international economic framework. Delegates from 44 countries convened in Bretton Woods, New Hampshire, United States and agreed on the creation of two international economic organizations: International Monetary Fund (IMF) and World Bank or the International Bank for Reconstruction and Development. These institutions are known as the Bretton Woods Institutions. It also includes a third entity, the General Agreement on Tariffs and Trade (GATT). Albeit created in 1947 after the Bretton Woods Conference, this much more informal institution than the IMF and WB served as the primary global trade organization. The postwar institutional framework was created to address the problems that occurred during the interwar period, trade protectionism and exchange controls, which led to the Great Depression and the World War II (Cohn, 2011). The Bretton Woods institutions were known keystone international economic organizations (KIEOs) due to their central role in trade, development, and monetary relations (Cohn, 2011; Jacobson and Oksenberg, 1990). The functions of these institutions will be discussed in detail, as well as how their roles have changed in the contemporary period. International Monetary Fund (IMF) - The primary purpose of the IMF is to promote global monetary cooperation and international financial stability. The institution, created in 1945, was designed to monitor the system of pegged or fixed exchange rates. In this system, 56 | P a g e  GE 319 – THE CONTEMPORARY WORLD official exchange rates of currencies were related to gold and U.S. dollar. It was designed to prevent the trade wars that occurred during the interwar period due to competitive devaluations of states of their currencies (Cohn, 2011). When states suffer from balance- of-payments deficits, they reduce the value of their currencies to boost exports with cheaper products and decrease imports. A balance-of-payment deficit occurs when a country spends more than it takes in. The role of IMF is to provide short-term loans to prevent devaluation and retain the state's fixed exchange rate in instances of the temporary balance of payment deficits. The institution was designed for the mandate of ensuring international financial cooperation and reinforces international trade (Benczes, 2014). IMF's role changed when the fixed-exchange-rate system collapsed and was replaced by floating exchange rates in 1971.It still had the role of providing liquidity but has more focus on countries tied to major currencies instead of countries supplying them (Garber, 1993). The IMF is an institution based on quotas which determine the maximum amount of financial resources that a state is obliged to provide to the fund. The quota of states reflects their relative position is the global economy and determines the voting power of states in IMF decisions. The IMF has since been dominated by the West and has been much criticized for marginalizing the South and failing to include emerging economies in its decision-making. The Global Financial Crisis of 2007-2009 has prompted the IMF to undergo a reform process consisting of two elements: (1) IMF resource expansion to enhance capacity for financial crisis management, and (2) increase in quota and voting power of emerging economies within the institution (Lesage et al., 2013). The 2010 reform structure package involved doubling of the IMF quota, shifting of quota shares; and preserved quota and voting shares of poorest member states. The reform shifted more than six percent from over-represented to under-represented member countries, and to developing and dynamic emerging market and reshuffling seats of the Executive Board to both restore the institution' legitimacy and crisis management capacity. Lesage et al. (2013) explain the outcome of the reform negotiations as a trade- off between money and power. It was an agreement particularly between the BRIC grouping among Brazil, Russia, India, and China to contribute to the Fund's resources in exchange to quota and governance reforms about the redistribution of the quota and Executive Board seats from the West to the South. The 2010 reform, however, has not led to the long-expected reform and strengthening of the IMF. While the IMF resources have tripled with the doubling of the quota complemented by the New Arrangements to Borrow (NAB), a supplementary source of funding from countries that are not tied to voting-rights, there are still doubts on the capacity of the Fund to bailout larger countries (Lesage et.al., 2013). 57 | P a g e  GE 319 – THE CONTEMPORARY WORLD Moreover, the quota and governance reform have not been revolutionary, with the status quo of power relations remain intact as the USA remains to vote shares constituting its veto power but not in the case of the BRIC countries as a bloc (Lesage et al., 2013). International Bank for Reconstruction and the Development or World Bank - While IMF was designed to provide short-term loans to aid countries facing balance-of-payments deficits, the role of International Bank for Reconstruction and Development (the World Bank) was created to grant long-term loans for the economic development of less developed countries and the reconstruction of war-torn countries in Europe. The World Bank today is made up of two institutions. One is the International Bank for Reconstruction and Development (IBRD) which provides International Development Association (IDA) which grants credits and loans to lowest income countries. The World Bank is only a component of the World Bank Group which is comprised of three other institutions: International Finance Corporation (IFC), Multilateral Investment Guarantee Agency (MIGA), and the International Centre for Settlement of Investment Disputes. The renewed role of the World Bank in the modern economy is to reduce extreme poverty while addressing the imperfections of global capital markets continues to be secondary importance (Clemens & Kremer, 2016), Donor countries with recipient countries that involve policy changes. Its policy influence is grounded on the legitimacy and credibility enhanced by its commitment to reducing poverty, along with its technocratic staff and its status as a multilateral organization (Clemens & Kremer, 2016). Contrary to the Bank's supposed normative commitment, the Bank's impact on growth outcomes has been contested. Easterly (2005) finds severe macroeconomic distortions suffered by loan recipients and no statistical evidence of per capita growth improving from increased structural adjustment lending. More than that, the programs have been accused of worsening the state of poverty and underdevelopment of recipient countries. Shandra et al. (2011) find empirical evidence that the Bank's structural adjustment resulted in adverse effects on children in Sub-Saharan Africa. Furthermore, there exists robust evidence in the literature that structural adjustment programs not only of the Bank but also other international financial institutions such as IMF, and the African Development Bank (ADB) have detrimental effects on child and maternal health in the developing world (Thomson, Kentikelenis, & Stubbs, 2013). Such policy reforms significantly undermine access to health care and adversely impact on income and food availability which are social determinants of health (Thomson, Kentikelenis, & Stubbs, 2013). General Agreement on Tariffs and Trade (GATT) and the World Trade Organization (WTO) - The purpose of the GATT was to avoid trade wars by raising protectionist barriers as witnessed during the interwar period. The forum was created years after the Bretton Woods due to the refusal of the U.S. to sign the Havana Charter that would create an International Trade Organization (ITO) at par with that of the IMF and GATT. The agricultural sector in the US feared for losses that may be brought by the ITO and pressures in the US Congress resulted to the failure of reaching an agreement, thus resulting to the informal GATT. States who took part in the GATT were "contracting parties" instead of formal members due to the nature of the agreement as a provisional treaty (Cohn, 2011: 23). 58 | P a g e  GE 319 – THE CONTEMPORARY WORLD While it was effective in liberalizing trade, GAT T was unable to address the expansion of trade in services, investment, and intellectual property. It was also incapable of providing a strong and efficient system for dispute settlement. GATT was eventually superseded by a more formal World Trade Organization (WTO) in 1995 that managed to address these issues. The establishment of a global economic order was heavily influenced by the Western developed countries. The South, comprising of less developed economies, were marginalized while the Soviet Union refused to participate, with attempts to create an alternative economic framework and institutions. Less developed economies The South and the Soviet Union, however, gradually became integrated into the liberal economic order at the end of the twentieth century. The Organization for Economic Cooperation and Development (OECD), the Organization of Petroleum Exporting Countries (OPEC), and the European Union (EU) - The most encompassing club of the richest countries in the world is the Organization for Economic Cooperation and Development (OECD) with 35 member states as of 2016, with Latvia as its latest member. It is highly influential, despite the group having little formal power. This emanates from the member countries' resources and economic power. In 1960, the Organization of Petroleum Exporting Countries (OPEC) was originally comprised of Saudi Arabia, Iraq, Kuwait, Iran, and Venezuela. They are still part of the major exporters of oil in the world today. OPEC was formed because member countries wanted to increase the price of oil, which in the past had a relatively low price and had failed in keeping up with inflation. Today, the United Arab Emirates, Algeria, Libya, Qatar, Nigeria, and Indonesia are also included as members. The European Union (EU) is made up of 28 member states. Most members in the Eurozone adopted the euro as basic currency but some Western European nations like the Great Britain, Sweden, and Denmark did not. Critics argue that the euro increased the prices in Eurozones and resulted in depressed economic growth rates, like in Greece, Spain, and Portugal. The policies of the European Central Bank are considered to be a significant contributor in these situations. North American Free Trade Agreement (NAFTA) - (NAFTA) is a trade pact between the United States, Mexico, and Canada created on January 1, 1994 when Mexico joined the two other nations. It was first created in 1989 with only Canada and the United States as trading partners. NAFTA helps in developing and expanding world trade by broadening international cooperation. It also aims to increase cooperation for improving working conditions in North America by reducing barriers to trade as it expands the markets of the three countries. The creation of NAFTA has caused manufacturing jobs from developed nations (Canada or the United States) to transfer to less developed nations (Mexico) in order to reduce the cost of their products. In Mexico, producer prices dropped and some two million farmers were forced to leave their farms. During this time, consumer food prices rose, causing 20 million Mexicans, about 25% of their population, to live in "food poverty." 59 | P a g e  GE 319 – THE CONTEMPORARY WORLD The free trade, however, gave a modest impact on US GDP. It has become $127 billion richer each year due to trade growth. One can argue that NAFTA was to blame for job losses and wage stagnation in the United States because competition from Mexican firms had forced many U.S. firms to relocate to Mexico. This is because developing nations have less government regulations and cheaper labor. This is called outsourcing. As an example, the United States outsourced approximately 791,000 jobs to Mexico in 2010. As for Canada, 76% of Canadian exports go to the United States and a quarter of the jobs in Canada are dependent in some way on the trade with the United States. This means that if NAFTA changes or is eradicated, it would be devastating for Canada's economy. Generally, NAFTA has its positive and negative consequences. It lowered prices by removing tariffs, opened up new opportunities for small- and medium sized businesses to establish a name for itself, quadrupled trade between three countries, and created five million U.S. jobs. Some of the negative effects, however, include excessive pollution, loss of more than 682,000 manufacturing jobs, exploitation of workers in Mexico, and moving Mexican farmers out of business. International Monetary System - The International Monetary System is defined as "a set of general rules, legal norms, instruments, and institutions shaping payment conditions in foreign trade (international scale)" (Mikita, 2015, p. 505). It is brought by the multilateral international agreements of trading participants, facilitated by international financial organizations. The Gold Standard adopted by England in 1816, being the first country to industrialize, was the first international monetary system (Mikita, 2015). It would later be joined by European countries and the United States. It functioned as a fixed exchange rate regime where countries determined the gold content of their national currencies which would define the fixed exchange rates (Benczes, 2014). The primary features of the gold standard were the unlimited convertibility of currencies into gold and high stability facilitated by trade among countries that eliminated exchange rate fluctuations and risks (Mikita, 2015). The system maintained the equilibrium of the trade balance automatically. The deficit in balance-of-payments due to gold reserve outflows would result in the fewer money supply in the domestic market, causing a decline in domestic prices. This is beneficial to exporting cheaper goods but not on imports of higher priced goods, which then contributes to the balance. This can be derailed by financial policies of raising interest rates to promote capital inflow and to maintain the gold reserves at a fixed level, reversing the downward pressures on prices and influencing demands for imports and exports (Mikita, 2015). The Gold Standard was also non- inflationary because the issuance of money is dependent on a state's gold resources. Price fluctuations would occur due to gold outflows or discovery of gold mines. This, however, also served as the primary weaknesses of this fixed exchange rate system are limited cash flow and curbed economic development (Cohn, 2011). World War I marked the dissolution of the classical gold standard and the shift to paper money that is not tied to gold reserves 60 | P a g e  GE 319 – THE CONTEMPORARY WORLD and whose exchange rate was determined by the supply and demand in the foreign exchange market. Military spending of states could not be backed up by gold reserves anymore (Mikita, 2015). An attempt to return to modify the gold started was held in a 1922 conference in Genoa. The new international monetary system was named the "Gold Bullion Standard." In this standard, bank notes were exchangeable for gold bullion of fixed weight, therefore involving only the exchange of large sums of money. The system failed to facilitate the free convertibility of currencies to gold, and it collapsed in 1931 with the outbreak of Great Depression in the 1930s (Mikita, 2015). The first symptoms of the economic crisis were the Great Crash or the Wall Street Crash of 1929, of stock market prices which delivered a wave of bankruptcies, a decrease in trade and production, and unemployment in the United States, also hitting hard cities around the world. The period of the 1930s interwar period would increase intensity beggar-thy- neighbor policies, trade protectionism, competitive devaluation, rigid capital controls among states. The harsh impacts of these policies to the society steered economic policy toward state interventionism, with primary objectives of increasing employment, income and production based on Keynesian principles of state intervention. In the Bretton Woods Conference of 1994, 44 countries agreed in creating a new international system that would prevent the chaos that occurred during the interwar period. The Bretton Woods System was established, an adjustable-peg system that is also known as the dollar-gold standard or gold-exchange standard, with the US dollar as the only convertible currency that is considered to be as good as gold. As the emerging hegemon, US committed itself to purchase and sell gold at US$35 dollar an ounce without restrictions, while other currencies, in turn, were fixed to the dollar (Benczes, 2014). The stability of currency exchange rates was maintained, and the system bounded member states to maintain the narrow limits of their currency exchange rate within the +/- 1% range (Mikita, 2015). As the world leader sustaining the new regime, US managed to maintain its balance-of- payments surplus. With the restoration and reemergence of the economic powers in Europe and (Japan), US gradually faced persistent deficits which were an inevitable consequence of serving as the world's reserve currency (Benczes, 2014). The stability of operations of the Bretton Woods System was conceived to have only lasted from 1959 to 1968 (Garber, 1993). The growth of private and official private liquid dollar claims of foreigners, reduction in official gold holdings especially that of the US, persistent balance- of-payments problems of the US contributed to the collapse of the system (Cohn, 2011; Garber, 1993; Mikita, 2015). Problems of the Bretton Woods system would be exposed in 61 | P a g e  GE 319 – THE CONTEMPORARY WORLD the 1960s when the United States began to suffer from its balance-of-payments deficits. It was difficult to maintain the stable price of gold - maintaining the fixed gold price in the face of constant price increase globally resulted in its reduction of production (Mikita, 2015). International reserve of gold had stagnant growth due to low official price while most of the growth was seen in foreign-owned US dollars – the growth encountered problems due to deficits and states started losing confidence in the strength of the dollar and began purchasing gold reserves from the US. In the 1960s and the 1970s, a series of changes were introduced to maintain the operations of the Bretton Woods system and to resolve its deficiencies. The series of interventions involved solutions such as the formation Gold Pool and the Special Drawing Rights to expand resources and means for payment (Garber, 1993; Mikita, 2015). However, these changes were insufficient in the face of worsening US deficit, currency speculation, and inflation. The problems would eventually result to US abandonment of the gold-exchange standard and the eventual collapse of the Bretton Woods system in 1973, forcing states to fluctuate their exchange rates to be determined by market forces. Succeeding attempts to return to a regulated exchange rate system would be pursued but to no avail. With the shift from a pegged-system to a floating one, IMF allows flexibility among member states to determine their exchange rates or tie them to major currencies such as the dollar or the SDR. The IMF also allows a managed float system where central banks are allowed to intervene to address the fluctuations in the exchange rate by buying and selling currencies. However, countries are not allowed to manipulate their currencies to achieve short-term gains at the expense of other economies. History of Market Integration: From a Unilateral to a Multilateral Trade Order The mercantilist period during the seventeenth and eighteenth centuries in European international trade was marked with colonial expansionism and surplus accumulation of gold stocks in the balance of payments which boosted exports and curtailed imports (Benczes, 2014). This period was situated in a zero-sum game in economic relations, the pursuit of beggar-thy-neighbor policies with led to trade wars. Industrialization in the 19th century advanced trade liberalization under the leadership of United Kingdom, the first country to industrialize and the hegemon, particularly in 1846 during the Repeal of the British Corn Laws (Benczes, 2014). Not all states, however, embraced free trade during the era of industrialization. The United States together with Germany initially pursued import substitution industrialization, imposing tariffs on manufactured goods to protect their infant industries. The outbreak of World War I resulted to the overturning of the free trade regime and the return of protectionism. The US was unwilling to take over as hegemon after the decline of British hegemony and served as the primary drivers of protectionist policies during the Great Depression of 1929-33 (Benczes, 2014). Other states would respond through a cycle of retaliation, severely reducing the extent and amount of trade among countries. The US Reciprocal Trade Agreements Act in 1932 addressed the decline in international trade by transferring authority to decide on trade matters to the US president, freeing the Congress from pressure coming from protectionist interest (Benczes, 2014). The post-World War II trade regime was established in the backdrop of what Ruggie (1983) calls as "embedded liberal compromise," an offshoot of Keynesianism economics where the promotion of an open global economy was accompanied by government safeguards that would protect the domestic economy and social policies. The trade regime was unique because it was informal and constituted by multilateral trade agreements. Negotiations are guided by the following principles: trade liberalization via tariff reductions; nondiscrimination, reciprocity, safeguards, and development (Cohn, 2011). The 62 | P a g e  GE 319 – THE CONTEMPORARY WORLD development principle, however, has not been sufficiently prioritized by major trading powers. GATT was unable to fully impose the limitations of free trade in exceptional cases concerning essential policy objects such as health, and public moral grounds, which ought to trump over the market goals (Ala'i, 2011) Other criticisms pertained to the inadequate the dispute settlement mechanisms of the institution. Moreover, while GATT was successful in substantively reducing tariffs, these were eventually replaced with non-tariff barriers (NTBs) in forms such as environmental regulations and health and safety requirement, constituting new challenges and limitations to global trade (Ala'i, 2011). The creation of the WTO as "a legitimate multilateral institution, with formal legal status as an international organization and formal diplomatic status for its secretariat" was a development from the informal "club" of Western trading nations in GATT (Barton, Goldstein, Josling, & Steinberg, 2008, p. 1). Detailed rules extensively covered not only goods but also intellectual property, investment, services. WTO has also become "one of the most legalized international institutions in the world" with its binding and automatic dispute settlement mechanism. The developing states, however, were disillusioned by the outcomes of the Uruguay round where less developed countries were perceived to have given up more with the inclusion of services trade and intellectual property than what they have reaped from limited agreements for textile and agriculture (Cohn, 2011). The Uruguay round would then proceed to the Doha round, dubbed as the “development round, which was unable to produce successful agreements. The increasing membership of the organization made it more difficult to reach consensus and countries were not willing to make significant concessions to avoid the failure of the negotiations (Cohn, 2011). The opposing positions of parties also led to its demise. Demands of developing countries to fully implement the Uruguay agreement particularly in the agricultural sector, and demands of the US and EU focusing on matters such as labor, environment, and investment concerns became irreconcilable matters (Benczes, 2014). From Keynesianism to Neoliberalism During the Great Depression in the 1930s, the ideas of John Maynard Keynes, a prominent British economist, have been influential in shaping the economic policy of developed countries. In his seminal work entitled The General Theory of Employment, Interests, and Money (1936), Keynes argued that market-generated equilibrium results in unemployment which causes a decrease in demand. This, in turn, is related to the decrease in investment and production. He sees government spending as a solution to revive the economy by bolstering aggregate demand through fiscal and monetary policies. The Keynes' liberal interventionism approach influenced states to invest in big governments and shaped the post-war global economic order that is grounded on the Keynesian compromise in of promoting open markets without undermining the protection of the society and the domestic market. This allowed exceptions to be accepted in the form of capital controls and domestic trade protections (Balaam & Dillman, 2014). The Keynesian paradigm, however, would be challenged during the economic crisis of stagflation (a combination of rising unemployment and inflation) that occurred in the 1970s (Heywood, 2011). This would mark the entry of resurgence of liberalism through neo- liberalism on a global scale due to the technological advancement that allowed the free flow of capital and goods across the globe. Grounded in the ideas of Friedrich Hayek and Milton Friedman, the neoliberal solution was to have an unregulated market with as little state intervention as possible. It involved the having the market take over tasks and services that ought to be provided by the government. 63 | P a g e  GE 319 – THE CONTEMPORARY WORLD The key neoliberal policies were comprised of privatization, deregulation, lesser public spending, and reduced corporate taxes. The economic paradigm would expand through British Prime Minister Margaret Thatcher and U.S. President Ronald Reagan who popularized the policies and ideas dubbed as Thatcherism and Reaganism, which would then be followed by the emerging economies of East and Southeast Asia (Balaam & Dillman, 2014). The United States and Great Britain, together with the industrialized nations, would promote globalization and integration into the global economy with the promise that capitalism would lead to economic prosperity alongside democratization. The IMF and World Bank also aligned their policies to neo-liberalism through the "Washington Consensus," a set of ten economic policy prescriptions for the recovering and crisis-ridden countries implemented by Washington-based institutions: the IMF, WB, and the US Treasury. The term was coined by John Williamson (2004) which constituted the following principles: 1. Fiscal discipline 2. Reordering Public Expenditure Priorities 3. Tax Reform 4. Liberalizing Interest Rates 5. A Competitive Exchange Rate 6. Trade Liberalization 7, Liberalization of Inward Foreign Direct Investment 8. Privatization 9. Deregulation 10. Property Rights These policies were applied through the structural adjustment programmes (SAP) of the IMF and the WB that imposed conditionality clauses attached to loans which have been criticized for its adverse effects on developing nations. With the expansion of globalization came the reaction from the civil society in the form of transnational and national resistance due to the widening gap between the North and the South. The Zapatista Movement in Mexico against the North American Free Trade Agreement and the Battle of Seattle during the WTO Ministerial Conference in the 1990s were the prominent transnational movements that first sought to challenge against global capitalism and neoliberal globalization. Offshoots of these movements would emerge in the twenty-first century, with the Spanish Indignados Movement, the Arab Spring, and the Occupy Movement. Such movements are part of the broader collective resistance known as the "global justice movement" that fights against inequality and the concentration of wealth among the wealthy minority. These movements have yet to produce strong enough pressure to these international institutions. However, the global civil society continues to persistently and relentlessly expose the ills of today's global economic system. 64 | P a g e