Nightmares about globalisation

03.09.07 Publication:

There are two popular nightmares about globalisation, and sadly neither is quite foolish enough to be easily proven false. Over the next year, both are going to be tested by events in the world economy—especially by the financial turmoil that woke the world out of its usual August slumber.

         The nightmare that emerges most directly out of that turmoil has already featured in some of the market commentary. It consists of a fear that with open capital markets in most countries around the world, financial distress in one will lead to financial distress in all of them.

         Hence stockmarkets in Asia, Europe and America seem to follow each other’s lead. Currencies held to have similar characteristics—such as the yen and the Swiss franc, both paying low interest rates and so weakened in recent years by the “carry trade”—move in the same way. Losses from the collapse in price of debt securities based obscurely on the American low-grade (“sub-prime”) home mortgage market are seen in banks in Germany, Britain, China and elsewhere.

         In 1998, when the East Asian financial crisis spread to Russia and Latin America and even nearly toppled an American investment firm, Long-Term Capital Management, the nightmare became especially scary. George Soros, one of the greatest fund managers of recent decades, and an even greater philanthropist, wrote a book called “The Crisis in Global Capitalism”, published in 1998, which warned that global markets had been allowed to become far too free, and so we were all now doomed to collapse together.

         Observant readers may have noticed that it didn’t happen. The nightmare was believable, given the way markets reacted in the first few months of the crisis. But in fact, although there were some worldwide effects there was no worldwide collapse.

         In that crisis, it turned out that, contrary to Mr Soros’s fears, globalisation had a stabilising effect, not a destabilising one. In particular, the continued economic boom in America, driven by investment in technology and rising productivity, helped support Asian economies. They did suffer, but thanks to global trade there was no global slump.

         The question is: will this happen again? This time, the origin of the turmoil is in America itself, which as the world’s biggest economy and its biggest importer, has a big effect on everyone else. So if there is an American recession, as looks likely, then global growth will also slow.

         That, however, has always been true: when America sneezes, the rest of us catch a cold. The nightmare is that globalisation will now make this worse. The 1998 experience suggests another possibility, however. Demand in other countries, especially for investment and construction, could prevent the slowdown from being too severe. China and India immediately come to mind, but there are plenty of others too: commodity and oil producers, the reviving economies of Europe, even Japan.

         Moreover, even if credit losses are painful for some banks, there will be no shortage of capital around the world. The real danger is of a loss of trust by lenders. But that is unlikely to take hold on a global scale, with so many different borrowers to choose from. Capital will be reallocated, helping to counteract the slump.

         That is an optimistic prediction; we shall have to wait and see whether it comes true. We mustn’t forget the second nightmare, however. For there is a danger that it could combine with the first, to make things worse.

         The other nightmare about globalisation is the idea that it destroys jobs and incomes in the richer countries, especially of the poorest and least skilled, as low-cost competitors in China and India build up their scale and strength. The trouble with this nightmare is that it carries some truth—in the short term. But it is not much good telling someone who has lost their job or seen their wages stagnate that in the long-term all will be well. They need a job in the short term, not the long.

         They also need to elect a new president, in the United States in 2008, and a new Congress. So calls for protectionism, for tough action against “unfair competition” in China or companies that relocate their factories there are an inevitable part of the American electoral soap opera. With many people’s incomes having stagnated in America in recent years despite a strong economy, everyone has been expecting a highly protectionist campaign next year.

         Now, however, the financial turmoil that has arisen from America’s own mortgage market threatens to give us both nightmares at the same time. Politicians will be arguing that Chinese workers steal American jobs, while also lamenting the way Chinese capital is free to move in and out of financial markets—and politicians in other countries may have the same idea.

         In principle, these nightmares are contradictory: if everyone suffers because of connected capital markets, then the pressure on American jobs will be eased by that process, not worsened. It will also be better to solicit Chinese investment, not rebuff it. Logic and rationality are not, however, the finest features of election campaigns, nor of political discourse in general.

         It will be hard to prevent trade being blamed for job losses. But to avoid a really damaging backlash against globalisation, we will need to promote the benefits of open capital markets with great vigour—as long as, during the coming year, globalisation does turn out to be stabilising, rather than the reverse.