Economic Globalization

Sociology 2, Class 7

Copyright © 2013 by Evan Schofer

Do not copy or distribute without permission

Announcements

• Announcements• Midterm is approaching… 2 weeks• I’ll provide details and a review sheet soon

• Agenda– Today: More on economic globalization

• Capital flows and currency crises• Trade and trade agreements

Review: Economic Globalization• Economic globalization:

• Simple definition: When economic activity that was formally local or national scale becomes organized on a global scale

– Spanning countries, rather than contained within them

• Examples: Globalization of…• Trade – good & services• Production – making things• Corporations – “multi-national corporations”• Labor – immigration• “Direct” Investment – building factories• Capital – Moving money to buy “intangible” assets

Review: What is most globalized?• Some things are more globalized than others…

How Global?

Extremely Capital flows

Very Trade

Moderately Corporations, FDI, Production

Not so much Labor (workers)

Global Capital Flows: Recent Data

• FYI: Recent data on global capital flows

• 2011 Global GDP: $70 Trillion

• 2010 Global Trade $18 Trillion

• 2008 Global capital flows: $604 Trillion• Hard to get good data…

Video: Commanding Heights

• Episode 3, chapters 3-6• Time: 3:30 (or 6:15 or 10:00 if time is short) to 28:00• Basic issues regarding trade, capital flows• Global link:

http://www.pbs.org/wgbh/commandingheights/lo/story/ch_menu_03.html

• Local link: Video\PBS.Commanding.Heights.Ep3.The.New.Rules.of.the.Game.DivX6.avi

Economic Globalization: Origins• Question: What are some basic things that

are absolutely required in order to have a global economy?– 1. Inexpensive transportation & communication– 2. International financial (money) system– 3. Countries that are willing to participate

• Absence of legal or regulatory “barriers”

– For a related discussion, see Greico and Ikenberry “Economic Globalization and Political Backlash.” pp. 220-223.

• Emphasizes role of technology, as well as political changes that permitted globalization.

Transportation• Historically, people only traded lightweight,

valuable items… spices, silk, ivory, etc…• Things that could be easily carried long distances

• Global economic activity requires cost-effective transportation systems

• Otherwise most business activity remains localized• Most changes are pretty obvious: increase in cars,

trucks, planes, trains, ships… • But, one change matters more than others:

containerized shipping

Transportation• Containerized shipping = a huge revolution

in global transportation• Started in the 1970’s

• Shipping containers: a standard 40ft long box

• Easy to load and unload onto ships, trains, trucks• Drastically reduced cost of shipping

• Huge ships can hold thousands of containers!

Containerized Shipping: Pics

• Ships can hold hundreds of containers!

Containerized Shipping: Pics

• Containers allow mechanical loading

Pics: from Maersk Sealand Website

Containerized Shipping: Pics

• Containers can be transferred to trains, trucks

Containerized Shipping

• Question: What does it cost to send a 40 foot shipping container with 10,000 pounds of cargo from Shanghai, China to the port at Long Beach?

• Answer: $3,500• Taxes, tariffs, etc. make it cost a bit more…

• Question: How many pairs of shoes fit in a container?

• Answer: over 10,000!

Containerized Shipping• Consequence: Containerized shipping

resulted in a dramatic increase in global trade• Example: Container holds 10,000 pairs of shoes• Container costs ~$3,500 to ship (including taxes)• Total cost of shipping per pair: 35 cents!

• If cost of making a shoe in China is 36 cents less than in US, then people will ship them…

• Higher costs might come from: more expensive labor, costs of adhering to environmental laws, etc.

• Shipping containers are so cheap that people ship garbage & scrap metal…

• Or even dump hazardous waste in other countries.

International Financial System

• Another barrier to the global economy: Money

• Suppose I build and sell computers…– What if someone from Europe wants to buy one?

• They only have European money: Euros

– Problems:• 1. I don’t want Euros – they are useless to me• 2. How much is my computer worth in Euros money?

– Even if I would accept the money, I don’t know the value…

International Financial System

• In order to conduct trade, there must be an international system to handle currencies

• Example: The Gold Standard– For every dollar the government prints, they hold a

corresponding amount of gold in the bank• Value of all currencies = tied to a common “standard”• Example: US$1 = 1/35 ounce of gold• Other currencies might have a different value:

Example: Euro = 1/20 ounce.

The Gold Standard

• The gold standard is one solution to trade in a world of multiple currencies

• To sell a computer to someone in Europe, I can directly convert price

• US$ 1,000 computer = 35 ounces of gold = 700 Euros• European gives 700 Euros to his bank… converts to

gold• Gold is given to US central bank; US$ 1,000 given to

me

• Result: International trade is possible!

The Gold Standard

• Issue: If trade is one sided, gold drains from one country to another

• A “trade imbalance”, or a “current accounts deficit”

• Consequence– European banks have less gold, issue fewer

Euros• Money supply shrinks

– European economy slows down, imports reduce…• Result: System prevents asymmetric trade; system

stays in equilibrium.

The Gold Standard• The gold standard fell apart in the depression

• Governments wanted to boost their economies…• Governments increased spending (e.g., hired people to

build roads) to increase consumption– This required printing more money… even though gold supply

didn’t expand– Currencies were no longer tied to gold…– Trade became difficult.

Bretton Woods• Plan B: The Bretton Woods agreement

helped to re-establish an international financial system

• New plan: U.S. Dollars would serve as the currency for international transactions

• US dollars would have a fixed value vs. gold• Other currencies would have a fixed exchange rate

versus the dollar

• Everybody was happy again… for a while…

Bretton Woods• The Bretton Woods system also fell apart

• Basic Problem: The fixed exchange rates works only if trade and capital flows are small

• … compared to the size of the US economy• Eventually, when global trade flows harmed the US

economy, the US changed the system…– The process is described by Herman Schwartz:

“International Money, Capital Flows, and Domestic Politics.”

Floating Exchange Rates• Plan C: The system of floating exchange

rates• Value of currencies is determined by market• Like the price of commodities: oil, wheat, etc.

• Selling a computer to someone in Europe:– European goes to the currency market (bank)

to buy US dollars – to pay me for the computer• Current exchange rate: .75

– European pays .75 Euros to get each US$

• Therefore, a US$ 1,000 computer costs 750 Euros…

Currency Value ExamplesCountry Currency Number per US$

Europe Euro 0.748

Canada Dollar .987

China Yuan/RMB 6.60

India Rupee 45.04

Japan Yen 82.71

Mexico Peso 12.09

South Korea Won 1112.06

Thailand Baht 30.38

United Kingdom Pound .63

As of Jan 12, 2011

Trade & Exchange Rates• Currency values affect trade:

• Example: Suppose the Euro becomes more valuable relative to the dollar:

• Value of dollar drops from .70 Euros to .10 Euros– Euro worth 1.44 US$, goes up to 10 US$

• How much would a US$ 1,000 computer cost to a European?

• Answer: Only 100 Euros!

• When a currency goes up relative to others, it is cheap to import

• If currency value drops, imports become expensive.

Trade & Exchange Rates• Who benefits if Euro goes up relative to the

US$?• 1. European consumers – they can buy American

products cheaply• 2. American exporters – they can sell lots more to

Europe

• Who Loses?• 1. American consumers – European imports costs

more• 2. European companies – can’t compete with cheap

US imports

Floating Exchange Rates• Why do currency values “float” (change in

value relative to others)?• Answer: Changes in supply/demand• But: What forces affect supply and demand?

• 1. Asymmetric trade• If a country imports lots more than it exports (“current

accounts deficit”), its currency drops– Ex: If US has a current accounts deficit with Japan

• To purchase Japanese goods, Americans must sell dollars, buy Japanese Yen

– Demand drives up value of Yen relative to the dollar

• Converse is also true… lots of exports cause a currency to float up…

Floating Exchange Rates• Example: The effects of asymmetric trade

on currency values

• Suppose I sell 10,000,000 computers• Europeans will sell 7.5 billion Euros to banks in order

to purchase 10 billion US$…

– If banks (currency markets) are flooded with Euros, supply increases, value drops…

• Currency markets don’t want more Euros

– Changing currency values often result in a trade equilibrium

• Drop in currency limits subsequent imports• But, we’ll discuss exceptions… (ex: China & US)

Floating Exchange Rates• What forces affect currency values?

• 2. Asymmetric capital flows– If capital moves into a country, currency goes up

• Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency

– If capital moves out of a country, its currency goes down

• Investors feared problems in Mexico, Thailand… pulled money out

• Thai Baht and Mexican Peso dropped in value.

Floating Exchange Rates• What causes asymmetric capital flows?

• 2. a. Interest rates• If a country raises interest rates, its currency goes up

– Reason: Foreign investors prefer high rates– The “electronic herd” is attracted to high rates…

• If a country cuts interest rates, its currency drops– Investors would prefer moving money into countries where

banks pay higher interest…

– Important issue: Globalization limits the ability of governments to control their own monetary policy

• Sometimes countries want to lower interest rates to boost the economy…

– But doing so might cause adverse effects on currency…

Floating Exchange Rates• What causes asymmetric capital flows?• 2. b. Anything else that “scares” investors

– Concern that an economy may have problems• Ex: Fears that Thailand was going “bust”

– Policy changes that investors don’t like• Ex: big increase in taxes• Shift away from free-market policies (“golden

straightjacket”)

– Government instability– All of these things can cause investors to pull their

money out of a country quickly, harming currency values.

Floating Exchange Rates• What forces affect currency values?• 4. Countries can intervene strategically to alter

their currency values– Sometimes keeping it at a “fixed” value with the dollar or other

major currency

• Governments can sell their currency to lower its value– They buy other currencies on global markets

• Governments can buy their own currency to raise its value– They spend reserves of gold or other currencies on global markets

– Of course, this requires lots of money• Mainly, big / wealthy countries do this (ex: China)• Small countries sometimes fail (ex: Thailand).

Financial Flows & Exchange Rates

• Issue: Trade & financial flows have a similar impact on currencies

• Asymmetrical flows cause currency values to change

– But remember: Investment flows are larger than trade flows, and they can happen much faster

• Elwood: “pinball capital”• Result: global investors can cause currency values to

change rapidly• Called: market volatility (rapid change in value).

Exchange Rates & Volatility• Capital flows and resulting currency

volatility can produce severe crises

• Example: Mexico in 1994• Global investors bought lots of stock, investments in

Mexico over several years…– This caused a slow rise in the peso. Not a problem.

• A minor political crisis led to panic selling in 1994– The stock market began to plummet

• Global investors rushed to sell stocks, converted pesos to dollars

• Result: Selling of pesos made the value of pesos plummet!

Video

• Commanding Heights, Ep 3, chapter 7• Time: 27:50 – 32:45.

Exchange Rates & Volatility• Why was it bad for the value of pesos to drop

severely, rapidly?– 1. Suddenly, imports were very expensive

• Price of gas shot up• Businesses dependent on imports couldn’t afford

costs; potential for bankruptcies

– 2. Mexican companies had borrowed money from US banks

• US banks must paid in $, not pesos• If pesos are worth less, suddenly you can’t afford to

pay loans• Result: More bankruptcies, economic recession.

Exchange Rates & Volatility• In the case of the 1994 peso crisis, the US

government stepped in• Provided emergency loans, etc., to prevent massive

bankruptcy• But, that was just a small crisis… It is clear that crises

could occur that are too large to stop so easily.

Asian Financial Crisis

• Commanding Heights Video:• In the 1990s, foreign investors moved capital into Asia• And, foreign banks lent money to Asian companies at

very low interest rates

– Consequence: Rapid economic growth• Economies “heated up”• But, capitalism is prone to boom-bust cycles…• Companies built more factories and housing than

needed– The “boom” ended

• But – global dynamics made the “bust” much worse!

Asian Financial Crisis• How did globalization prompt a crisis for Asian

economies in the 1990s?– 1. Investors pulled out quickly – affecting

currencies• Asian currency valued dropped…• Imports became expensive• Companies could no longer pay off loans to foreign

banks– Bankruptcies, unemployment…

Asian Financial Crisis• How did globalization prompt a crisis for Asian

economies in the 1990s?– 2. Contagion

• Worries about Thailand spread to other Asian countries– Self-fulfilling prophecy: fear of problems caused investors to

pull out, creating real problems

• Also, many US companies were invested in Asia (or had made loans)… Now they were losing money

– Lesson: Integrated economies mean that crises tend to spread…

• Example: US financial crisis caused economic disruption around the globe.

More Video: Commanding Heights

• Topic: Asian financial crisis, spillover to other regions…

• Video: 40:48 to 48:10 (8 minutes)– Asian economic miracle

• Video: 48:10-1:14:30 (36 minutes)– Asian financial crisis and contagion