What's New

15 years after 2008, developed countries still making mistakes.

Relevance: 

GS Paper – 2, Deglobalization & Protectionism.

Context:

We’re approaching the 15th anniversary of the Global Financial Crisis (GFC) of 2008. A grim milestone. Not because it reminds us of those fateful months of 2008. But because the chain of events the crisis engendered is likely to have profound consequences for our future. Muscular industrial policy is the latest among a slew of policy errors since the global financial crisis.

Globalization?

Emergence:

• What today is referred to as globalization, gained recognition in India with the end of the Cold war and the disintegration of the Soviet Union in 1991.
• An offshoot of two systems — democracy and capitalism, globalisation rooted for free trade and increased inter-country movement of capital and labour.
• In a political sense, it refers to increasing global governance via international institutions or growing alignment of national policies.

Motivating Factors for Globalization:

• Broadly, economic, financial, political, technological and social factors paved the way to globalization.
• Economic factors such as lower trade & investment barriers and expansion of financial sector;
• Political factors include the reforms in the govt policies worldwide to facilitate trade and commerce;
• Social factors include cultural convergence along with significant ease in transportation and communication; and
• Technology factors such as ease in transmitting information worldwide, and more recently, the accelerating shift towards remote work – made national borders seem largely irrelevant.

How is Globalization becoming Fragmented?

• Advent of Fragmented Globalization: While globalization made markets work better, policymakers lost sight of its adverse distributional consequences. Many communities, countries were left behind contributing to a widespread sense of marginalization and alienation.
• Recent Upheavals in Globalization: The most recent example is the invasion of Ukraine which led to imposition of sanctions on Russia (a G20 country) and the weaponisation of the international payments system.
• The United Kingdom’s vote to leave the European Union was one of the most visible political manifestations against globalization. Moreover, the US entering a tariff war with China has also deepened the divide between the two economic powers.
• With climate change/environmental protection policies gaining recognition, there is a global race for cleantech innovations and circular economy approaches.
• The mass rollout of green technologies from solar PV to electric vehicles is bringing shifts to global supply chains and transferring manufacturing hubs to more ‘suitable’ countries.
• Is De-Globalization the Final Consequence: Despite all these ongoing turmoils, the available data suggest that globalization is not ending so much as it is changing. Fragmentation of the global economy is now resulting in the strengthening of regional economic areas, or globalization of like-minded countries, and not to a de-globalization. Global trade will essentially remain an important pillar in global growth.

Era of globalization and Reform:

• It is appreciated that the rising tide of globalization in the 1990s and 2000s lifted many economics of the world and also led to growing disenchantment in the West. The “China shock” had hollowed out blue-collar jobs and spawned increasing inequality.

 Understanding the 2007-08 Financial Crisis: Causes-

• The massive flow of savings from the surplus countries to the deficit countries lowered global interest rates by encouraging reckless investment into risky housing-related assets such as subprime mortgages.
• These macroeconomic imbalances affected the financial interactions. Apart from this, loose monetary policy in the U.S left the banks with a decrease in net interest margins for the banks, decreasing their profits.
• The bloated financial sector, flawed belief in efficient markets, greedy bankers, incompetent rating agencies are considered to be some of the other causes for the financial crisis.
• However, failure of regulation on the banks’ parts was one of the major reasons behind the crisis. Banks were allowed extraordinarily high levels of debt in relation to equity capital.
• Also, investment by banks in the advanced economies in complex assets called “securitized” assets (securities derived from sub-prime loans or the housing loans of relatively higher risk) added to the vulnerability of the financial infrastructure.
• When debt defaults increased with interest rates while income growth remained subdued, the world became more vulnerable to financial crisis.
• Banks’ dependence on short-term, riskier loans was not just an American problem but a problem for large chunks of the global banking system. Banks in Europe and some in Asia were affected as well.
• Further, the failure of banking systems around the world was aggravated by the by fiscal and monetary expansion. The loss of jobs and output has been enormous.

The Problem of Regulatory Capture:

• The ability of financial institutions to influence policies of governments and regulators also known as ‘regulatory capture’ was experienced after the breakdown of the global financial system.
• Financial institutions are a big source of political funding. Various political consequences were observed in the wake of the crisis. Many European countries like Greece, Spain, Portugal were found to be loaded with government debt that they were unable to refinance (the Eurozone crisis).
• The United Kingdom withdrew from the European Union (Brexit). The U.S. observed the rise of nationalism and anti-immigrant policies along with the return of protectionism.

India and the Crisis:

• India did not suffer much on account of the financial crisis. Absence of full capital account convertibility, a strict check on short-term foreign borrowings and its relative disconnect with the foreign banks insulated it from the devastation that was faced by the global financial system at that time.
• Capital account convertibility: Capital controls are used by the state to protect the economy from potential shocks caused by unpredictable capital flows. Capital account convertibility means the freedom to convert a currency for capital transactions and the rupee is not fully convertible on that front yet, though capital flows have been liberalized in recent years.
  Capital Account Convertibility is not just the currency convertibility freedom, but more than that, it involves the freedom to invest in financial assets of other countries.

Not learning from the Global Financial Crisis (GFC), 2008-

• As per the IMF. “Structural” fiscal deficits in advanced economies tightened a whopping five to 10 percentage points of GDP from peak to trough between 2007 and 2017,
• Some of this was ideological in case of US and some of this was complex and inflexible European fiscal rules that unduly emphasized austerity.
• Worried about public debt, fiscal policy was fighting the last war, even as the hysteresis from the GFC crisis was getting deeper and broader

Tight fiscal policy is half solution to counter the crisis like GFC-2008-

• Excessively tight fiscal policy was only half the problem. It induced excessively loose monetary policy that was struggling to combat post-crisis economic malaise.
• The too-tight-fiscal, too-loose-monetary over the last decade was exactly the wrong policy prescription for advanced economies and the world for several reasons-

First, monetary and fiscal policy, working at cross purposes nullified each other and labor markets in advanced economies were too slow to recover

Second, excessive monetary easing distorted and inflated asset prices that accentuated inequality, and induced a substitution away from labor towards cheap capital, accentuating the employment malaise.

Third, quantitative easing became the cure for every ailment, obviating the need for more fundamental reform in advanced economies: Re-tooling and re-skilling workers confronting the China shock, building infrastructure and cutting regulation, building deeper and smarter safety nets to compensate those who had been displaced from globalization.

Fourth, all this sowed the seeds for deglobalisation. Frustrated by the economic malaise and deepening inequality, politicians in advanced economies did the easy thing — assign blame outside. It was the decade of Brexit and the US-China trade war.

Instead, structural fiscal deficits surged in advanced economies. Fiscal transfers kept private sector demand strong, and in the wake of myriad supply shocks, contributed to the highest inflation in five decades. Fiscal policy had gone from being countercyclical to counterproductive. Meanwhile, monetary policy which was initially fighting the last war, is now scrambling to catch up.

De-Globalization:

• It is the process of diminishing interdependence and integration between the nations. It is characterized by the decline in economic trade and investment between countries.
• It highlights the trend of several countries wanting to go back to economic and trade policies that put their national interests first.
• These policies often take the form of tariffs or quantitative barriers that impede the free movement of people, products and services among countries.
• The idea behind de-globalization is to shield local manufacturing by making imports costlier.

Indicators of De-globalization:

There is some evidence of deglobalization in the aftermath of the 2008 financial crisis. The economic data are mixed and indicate a stall, but not a collapse of globalization.

• Trade Protectionism: The recent trade war between the US and China indicates a change in attitude of AEs in protecting their interests at the cost of developing countries. Trade is not growing as quickly as before the Great Financial Crisis of 2008, that may be the consequence of decreased investment in technological innovation.
• Immigration Control: Instances of immigration control by US, UK and other European countries have been dominant in past one decade. Recent decision of Trump administration of building wall across Mexican border highlights emerging trend of protectionism in free movement of people across the borders.
• Brexit Movement: Brexit and ‘Make America Great Again’ are symptoms of underlying processes of de-globalization that have already generated significant trade and investment uncertainty. This has had a concrete impact on trade & investment flows as firms and consumers are adjusting behavior in anticipation of further trade shocks.
• Flow of Capital: Cross-border financial flows have been reduced due to uncertainty in the global policy making and increased protectionism by AEs.

The reason for de-globalization:

• First, allocative efficiency inevitably suffers, hurting medium-term productivity, competitiveness and growth.
• Second, industrial policy that succeeds in recovering the growth will result in economic balkanization and risks undoing the gains of the last 30 years.
• Globalization induced an outward shift in the global supply curve, boosted global growth, helped low-income countries catch up, structurally reduced inflation, and pulled millions out of poverty. De-globalization risks undoing all those gains. We are on the cusp of the “Great Unravelling”.

Impact on Advanced Economies:

According to think tank Capital Economist, roughly a third of global per capita income growth since 1990 has accrued to the emerging markets (EMs) and not to the AEs. Various impacts visible on AEs due to globalization have been described below:

• Labor Market Loss: The major hurdle faced by the AEs is the death of relatively low skilled sectors like textile and the support economies that grew around it. There are varying estimates of the job losses caused by cheaper imports from China and other emerging economies. The re-absorption of this displaced labor has been slow and incomplete which is reflected in the share of wages to GDP that dropped by 5% from 2000 to 2017.
• Technology: Advanced Economies have largely depended on technological change for per capita income growth and productivity enhancement. There is deceleration in technological change, during the last decade, partly due to low investment in innovation and partly due to fading additional gains from the internet computer revolution.
• Growing Inequality: The slow pace of technological change in AEs had resulted in the stagnation of blue collar incomes which seems to be the major cause of rising inequality in the AEs. AEs have blamed globalization for their deteriorating economies and labor market growth.
• Consumer Credit: As a bid to keep spending alive, AEs focused on the consumer credit in the early 2000s. This precipitated into the Great Financial Crisis of 2008.
• Social Cost of Globalization: The intensity of America’s opioid addiction crisis maps directly into regions and demographic groups that have borne of the contraction of economic opportunities that globalization has brought.

Impact on Emerging Markets:

Emerging Markets have been the greatest beneficiaries of globalization in the past few decades. The recent trends of de-globalization will have profound impact on EMs, which are highlighted below:

• Trade: The increase in tariff barriers by the AEs have led to the shrinking of exports in EMs which is silently destroying their job intensive manufacturing sector.
• Migration: AEs are the hot destination of high skilled labour from EMs. The increased protective measure by AEs for free movement of high skilled labour is threatening their productive growth and job opportunities.
• De-globalisation with respect to the mobility of services and people can impact both the export of services, and the trend of Indians migrating abroad for higher education and jobs.
• Protectionist moves change the fundamental premise on the basis of which international organizations such as the WTO regulates global trade.
• When large, industrialized and prosperous nations break ranks to erect new entry barriers for goods and services, this can drastically impact the fortunes of their many trade partners.
• Calculations of global economic growth, inflation and interest rates can then observe drastic changes.
• The US economy, for instance, imports a lot of inexpensive manufactured goods from China. If a tariff war increases costs of imports into the US, its domestic inflation may rocket and US interest rates may increase faster.

Rising geo-political uncertainties are moving toward de globalization:

• Rising geo-political uncertainty is inevitably inducing multinationals to de-risk their supply chains.
• What’s more worrying is pre-Covid deglobalization tendencies by governments have only gotten stronger, with muscular industrial policy in the West (Inflation Reduction Act, Chips Act) aimed, in part, at re-shoring production and boosting domestic blue-collar job creation. The ostensible justification is resilience and “national security.”
• But national security is often the first refuge of the protectionists. History is replete with examples of how this is a very slippery slope. Incentives are only likely to deepen and broaden. Today it’s semi-conductors and electric vehicles. Tomorrow it could easily be pharmaceuticals and agriculture
• As, Unsurprisingly, South Korea, Japan, Taiwan and Europe have all responded with their own version of subsidies and, in this environment, emerging markets will unfortunately become more emboldened to be protectionist.

The challenges ahead:

• Today, the bigger threat is rapid advances in technology and AI. The “China shock” hollowed out blue-collar jobs in the West.
• The expected impact of ChatGPT on out white-collar jobs . As Every industrial revolution has increased the share of capital vis-à-vis labor. The current technological revolution threatens the same.

Conclusion:

• Therefore, there is need for an intelligent and coordinated global response to these challenges. Educate, train and skill workforces is need of hour so that they can complement technology, not be substituted by it and it will enable creative destruction in response to the breathtaking pace of technological change.
• Along with it, there is need for intelligent and robust safety nets to protect those left behind and need to take measures for counter-productive protectionism.

Source: https://indianexpress.com/article/opinion/columns/2008-global-financial-crisis-globalisation-bretton-woods-conference-8881304/