Economic Globalization

Sociology 2, Class 8

Copyright © 2013 by Evan Schofer

Do not copy or distribute without permission

Announcements• Announcements

• Midterm is approaching… less than 2 weeks– Midterm review sheet on website soon (probably tomorrow)

• Midterm review session:– During section on Tues-Friday next week, & following Monday

• Agenda• Midterm info• More on economic globalization

– Currencies & financial crises– Trade & trade agreements

Midterm Info• Exam Format:

• Closed book / closed notes• Mix of short answer/multiple choice, medium length, and

perhaps one short essay question• No bluebook needed

• Topic coverage: • All class lecture material

– Lecture notes on course website

• All readings up through Week 5• Commanding Heights video, Episodes 1 & 3

– Available via course web page…

Review: Economic Globalization• What do you need 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”

• History of the international financial system• Gold Standard: Money equivalent to gold• Bretton Woods: US dollar based on gold, used for trade• Floating exchange rates: supply/demand affect

currencies

Currency Value ExamplesCountry Currency Number per US$

Europe Euro 0.736

Canada Dollar 1.004

China Yuan/RMB 6.22

India Rupee 53.25

Japan Yen 91.32

Mexico Peso 12.71

South Korea Won 1088

Thailand Baht 29.86

United Kingdom Pound .63

As of Jan 31, 2013

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 your currency goes up relative to others, it becomes cheaper to import

• If currency value drops, imports become expensive.

Trade & Exchange Rates• Who benefits if the US dollar goes up relative

to the Euro?• 1. American consumers – they can buy European

products cheaply• 2. European exporters – they can sell lots to the U.S.

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

expensive• 2. American companies – can’t compete with cheap

imports from Europe

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. Changes in 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 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?• 3. 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: Asymmetric trade & capital flows cause currencies to shift

• 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.• Mexican Peso Crisis (also called the “Tequila Crisis”)

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 & government 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– After panic, currency stabilized

• 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

Commanding Heights• Asian financial crisis wrap-up

– Long Term Capital Management (LTCM)• A US-based hedge fund; assets $130 billion in 1998

– Controlled much more

• Used leverage (borrowed funds) to invest globally• Crisis in Asia/Russia caused LTCM to take huge losses

– LTCM was bankrupt (owed more than it had to US banks)

» US banks were threatened with huge losses (like 2008)

– AND: If LTCM was forced to sell remaining assets, markets would fall further – making things worse!

• Strategy: US engineered a private bailout– Banks lent LTCM a huge amount of money to keep going until markets

recovered

– IMF and other lenders also bailed out countries (e.g., Brazil) to end financial crisis.

Asian financial crisis Wrap-up• Remarks:

– The 1998 crisis was ended… but nearly brought down major US banks

• And, caused massive suffering in many countries

– The 2008 crisis DID bring down major US banks• Only government intervention saved the financial

system from a TOTAL disaster• Again, massive suffering

– Recession, 10% unemployment– Lack of funds for government services (including cuts to UC)– Contagion in Europe

– Issue: Is this acceptable? Do we need to regulate markets more aggressively? If so, how?

Participation in Globalization• Question: Given the dangers, why do some

countries want to participate in globalization?• What are the benefits? And for whom?

• International trade and capital flows can increase economic growth

• Corporations often stand to benefit most... So business elites tend to support globalization

• BUT, other groups in society may also benefit– Investment can create new jobs, employment– Consumers can have access to wider array of goods,

cheaper goods– … the “golden” part of the “golden straightjacket”

Benefits of Trade / Investment• Without trade, every country must produce

all kinds of goods – cars, coffee, computers, etc.

• Issue: Countries vary in their ability to produce goods efficiently

• Example: Coffee can be grown in America, but not very efficiently due to climate

• Example: Computers can be built in Columbia, but not very efficiently due to lack of technology, infrastructure

• Result: Without trade, production is less efficient.

Benefits of Trade / Investment• Economists Adam Smith and David

Ricardo argued:• Trade allows nations to specialize in what they do

best… their comparative advantage…– See Stiglitz Ch 3, p. 66-67

– Countries can focus on things they produce efficiently

• And, trade for things they don’t produce efficiently

– Result: Greater efficiency & economic growth• This can produce a win/win situation, where both

countries are better off– Not counting environmental consequences, etc.

Benefits of Trade / Investment• Also, economists predict that foreign capital

will benefit economic growth– Recall: Investment is a major ingredient in long-

term economic growth• Allowing foreigners to invest in a country results in

more overall investment• Example: If Sony builds a TV factory in a country, the

economy will grow

– And, intangible capital flows can have benefits• Example: Foreign banks may lend money at low rates

– Access to capital allows domestic companies to invest

• Lower rates and investment help economic growth.

Benefits of Trade / Investment

• Many people – including sociologists – have criticized the Smith/Ricardo model of trade

• Critics have shown lots of bad side-effects from globalization:

– Increasing inequality, crises, environmental problems, etc…

– BUT, research evidence doesn’t typically find disastrous economic effects of trade/investment

• Extreme fears about the dangers of trade/investment do not seem warranted…

Reading: Rodrik

• The benefits: analogy: Trade = technology• Trade, like new technology, allows nations to convert

some products (e.g., raw materials) into something else• Example: We can magically turn wheat into

electronics… by trading with Japan• Yes, new technologies cause people to lose jobs… but

who wants to go back to a world of manual labor?• Likewise, we shouldn’t resist free trade…

Reading: Rodrik

• Question: So why doesn’t everyone love free trade?– 1. benefits of trade involve large shifts in

production• To reap benefits, we have to shift production toward

things we produce efficiently (e.g., wheat) and away from other stuff

• Lots of transitional (and permanent) unemployment• Rodrik: Ratio = $50 shifted to gain $51 in GDP.

Reading: Rodrik

• So why doesn’t everyone love free trade?– 2. Benefits of trade aren’t quite like technology

• For one thing, they repeatedly put the same people out of work

– Namely, those without high levels of education/skills

– 3. Benefits of trade don’t always work out in practice

• Example: Merchandise trade between Europe/United States & poor countries in Asia may be harming US economic growth (Krugman)

• Some poor countries fare badly in trade with rich countries (more on this later).

Benefits of Trade / Investment• Who benefits from global trade/investment?

– 1. Many benefit from greater economic growth• The wealthy usually benefit a great deal…

– 2. Consumers benefit from cheap imports– 3. Multi-national corporations, because they can

move operations to wherever is cheapest– 4. Highly competitive export-oriented companies

benefit from access to new markets– And, workers in those industries tend to benefit

– 5. Investors can invest where profits are big• Ex: pension funds CalPERS, LTCM

– 6. Companies that can get cheap credit from foreign banks

Problems of Trade / Investment• Who might oppose global trade & investment?

– 1. Corporations in industries that will face greater international competition

• Example: steel & auto industries in the US

– 2. Workers in industries that will face competition• And labor unions more generally…

– 3. People & governments concerned about:• Potential for economic crises• Loss of state autonomy

– Pressure to please foreign capital; loss of domestic ownership

• Difficulty regulating global capitalism– Environmental problems, sweatshops, etc.

Barriers to Trade / Investment• Definition: Protectionism = blocking foreign

imports or capital flows• Opposite: “Liberalization” or “opening up markets” • Note: different from typical use of “liberal” in US

• Reasons to pursue protectionism:– 1. Protect domestic companies or industries

from foreign competition• Prevent bankruptcies, job loss in inefficient industries

– 2. To reduce risk of financial crises.– 3. Prevent foreign ownership and/or control of

the companies or the economy• Example: People get nervous when Chinese

companies buy major US oil or computer companies

Barriers to Trade• Strategies for protectionism

• 1. Tariffs – taxes on imported goods and services

• Example: The US government can impose a $2,000 tax on Japanese cars

• Fewer people will buy Japanese cars, imports will decrease

• 2. Quotas – a government-imposed numeric limit on imports

• Example: The US may allow only 500,000 Japanese cars to be imported in any given year.

Barriers to Trade• Strategies for protectionism (continued)

• 3. “Non-tariff” barriers – A government regulation that indirectly limits trade or makes it more expensive– Example: Strong agricultural subsidies make it

impossible for foreign imports to compete• NOTE: Subsidies block imports, just like tariffs…

– Example: The US may impose complex agricultural inspections that delay or discourage imported fruit

• Could be legitimate, or simply a way of stopping imports.

Barriers to Investment• Strategies for protectionism (continued)

• 4. “Foreign ownership” laws – laws that limit the ability of foreigners to buy companies

• Example: US government could require owners of corporations to be US citizens

• 5. “Capital controls” – laws designed to prevent the rapid withdrawal of capital/investment

• Example: Law requiring invested capital to remain in the country for one year

– Thus, preventing rapid flows in and out.

Removal of Barriers• How do trade/capital barriers get removed?

• “Liberalization” or “opening markets”

• Answer: When governments agree to remove them…

• In direct negotiation with other countries• Or, via international treaties & organizations

– GATT; NAFTA; WTO.

Removal of Barriers• Bi-lateral negotiations & treaties:

• When two countries negotiate trade & investment barriers

• Ex: The US negotiates with China, haggling over barriers

– “You reduce tariffs on American cars, and we’ll reduce import quotas on Chinese textiles”

– Note: Barriers can also be raised as coercion• Example: US threatens to impose quotas on Chinese

steel products, if China doesn’t lower tariff– China might respond by threatening to raise tariffs on the US

• Escalation of this is called a “trade war.”

Example: Bi-Lateral Trade Negotiations

• South Korea, U.S. May Hold Farm Trade Talks in March

• SEOUL (Reuters) - The United States and its seventh-largest trading partner began talks on a free trade agreement in June 2006. It would be the biggest free trade deal for the United States since the North American Free Trade Agreement was signed in 1992.

• Agriculture has been one of the toughest sectors to negotiate in a free trade deal between two countries, especially because of intense opposition from South Korean farmers to market liberalization. South Korea's farm ministry repeated Seoul's position that it would continue to insist on exempting rice under a bilateral free trade deal. ``Rice should be excluded."

• South Korea and the United States recently failed to resolve the dispute over U.S. beef imports, which Washington said could threaten the free trade pact.

– Exceprt: New York Times 2/21/07

Free Trade Agreements• Multilateral agreements

• When groups of countries negotiate together to reduce barriers

• Ex: NAFTA; also negotiations under GATT, WTO

• Quick review of NAFTA consequences:– Schaeffer, p. 242; also Stiglitz Ch 3

– US: • Slight increase in exports; 90-160,000 added jobs;• 140,000 textile jobs lost to Mexico

– Canada• Lost 500,000 jobs

– Given the size of Canada, this was huge

• Canada imports heavily from US; currency devalued.

Free Trade Agreements• Impact of NAFTA (cont’d)

– Mexico• 600,000 new textile jobs; offset by other job losses• Imports from US increase

– This was one factor leading up to the crisis in 1994

– Other losers?• Organized labor (Unions)

– From commanding heights video:

– Other winners?• Consumers• Multi-national corporations• Possible long-term increase in efficiency, growth.

Problems With Trade Agreements

• Rich/powerful countries have numerous advantages in negotiating trade agreements

– See: Stiglitz, Chapter 3

• Some points to consider:

• 1. Advantages of Rich/powerful countries are biggest in bi-lateral trade negotiations

• Example: US vs. a small Latin American country• US can bully, bring great pressure…• Often, those turn out worse for poor countries than large

multilateral agreements.

Problems With Trade Agreements

• 2. Rich/powerful countries disproportionately control the agenda of agreements

• “The United States and Europe have perfected the art of arguing for free trade, while simultaneously working for trade agreements that protect themselves against imports from developing countries.” Stiglitz Ch 3 p. 78.

• Topics addressed by FTAs benefit rich countries– Ex: focus has been on removing barriers for high-value goods

& investment, not farm products or low-tech stuff

• And, rich countries are savvy at using dispute resolution procedures

– They have lots of lawyers, using technicalities to block imports.

Problems With Trade Agreements

• 3. Government trade negotiators are often influenced by powerful groups

• Rather than negotiating for terms that will benefit everyone in a country, negotiators may cater to big corporations

• Example: Suppose Guatemala is negotiating over a tariff that limits big business, but protects jobs?

– Companies may push the government to get rid of the tariff, even if many workers will be harmed…

Stiglitz: Making Trade Fair

• Stiglitz, Chapter 3: Recommendations– 1. Developing countries should be treated

differently from wealthy countries• Previously, most trade agreements focused on equal

treatment, but poor countries can’t really compete…

– 1. A. So, rich countries should simply open their economies to the poorest countries

– This would have a much bigger effect than providing direct aid– NOTE: Europe has started moving in this direction

– 1. B. Poor countries should be allowed to use subsidies to support “infant industries”

• Rich countries have little to lose… but benefits are big.

Stiglitz: Recommendations:• 2. Rich countries should stop MASSIVE

agricultural subsidies– Rich countries give huge amounts of money to

(mainly) industrial farms– Norway: two-thirds of farm income is from subsidies– EU spends 80 billion US$; US spends

– Consequences: • Farmers in rich countries can sell food at LOW prices

and still make a profit– Often below the cost of farmers in poor countries

• Farmers in poor countries can’t compete… go broke.

Stiglitz: Recommendations

• 3. Escalating tariffs should be ended• Escalating tariffs: taxing manufactured products at

higher rates than raw materials– Ex: Having no tariffs on raw agricultural goods, but high tariffs

on higher-value processed goods– No tax on apples; high tax on applesauce

• Issue: This prevents poor countries from industrializing– They are stuck farming– While rich countries have cheap source of produce for their

high-value industries.

Stiglitz: Recommendations

• 4. Remove barriers to unskilled services & migration

• Rich countries have pushed to remove barriers for high-tech services (banking, accounting, software)

• Barriers remain in low-skill services– Example: Shipping/trucking. Foreign companies aren’t

allowed

• This is one area that poor countries could actually compete…

• Also, allowing more labor flows would provide a huge benefit to poor countries.

Stiglitz: Recommendations

• 5. Restrict the use of non-tariff barriers• There are legitimate reasons for having them… • BUT, more often they are used by rich countries to

protect their own markets – Despite claims of supporting free trade

• 6. Restrict bi-lateral agreements• They are rarely advantageous to poor countries

– Due to asymmetry in power between negotiators

• And, they tend to undermine multilateral agreements

Stiglitz: Recommendations

• 7. Reform governance• Change the rules of organizations like the WTO• Issues (p. 97):

– How decisions get made– What gets put on the agenda– How disagreements are resolved– How rules are enforced

• Currently, rules sometimes favor rich countries• System should be more open/transparent, more

democratic, with better enforcement for small countries.