Globalization 2.0 and the Rise of the Rest

Globalization 2.0 and the Rise of the Rest

June 17, 2011

International economic conferences like the one I attended in Rio a few weeks ago can be a little tedious, when experts debate their latest econometric models. Yet, I sat up and listened very intently when an IMF official remarked, almost as an aside, that the world’s emerging economies would account for 48 percent of global GDP this year. That means that by 2013 or so, developing countries will produce a majority of the world’s output. Since the 1980s, globalization has proceeded largely along the lines of American capitalism. These developments, however, herald the beginning of Globalization 2.0, which will present entirely new challenges to the American economy.

Experts will quibble over the numbers. The IMF used “purchasing power parity (PPP)” to produce its numbers, adjusting each country’s official GDP data for its relative cost of living before converting it into US dollars. However, the same pattern holds if we measure each country’s GDP simply in U.S. dollars at current exchange rates. By that measure, the share of global output coming from the advanced economies — that’s us, plus Western and Northern Europe, Canada, Japan and Australia — has fallen from more than three-quarters a decade ago to somewhere between 60 and 65 percent today. Most of that decline has come out of the economic hide of Europe and Japan. Still, our ability to shape globalization in our own economic image — from opening up everyone else’s borders to U.S. investors, and strictly protecting intellectual property rights; to the dollar’s role as the world’s reserve currency — grows weaker, year by year.

The evidence is all around us. China and India scuttled the Doha multilateral trade round, an outcome unimaginable a decade ago when they and most developing nations were much more willing to accept our judgments about the global economy. From Latin America to Africa and parts of Asia, the recent efforts of the international “Financial Action Task Force” to crack down on money laundering and terrorist financing have been openly flouted. And the international financial system’s rules for dealing with sovereign debt defaults, which for decades ensured generally fair compensation for foreign lenders to developing nations, have been openly mocked and discarded by such countries as Argentina and Ecuador. If those nations’ approach were to spread in Europe’s festering sovereign debt crisis — still a remote prospect — it would destabilize German and French banks, with awful consequences for the United States; and dampen future foreign funding for poorer developing nations.

No country can roll back this kind of global economic development. Experts expect China and India alone to account for 40 percent of worldwide growth over the next several years — that used to be our role — with other emerging economies accounting for another 30 percent. Chinese, Indian and Brazilian multinationals will contest with our own for global market shares, and use their home field advantages to good effect — for them. And on the model of the purchase of IBM’s POC division by the Chinese firm Lenovo, emerging market multinationals will begin to claim a real share of our own domestic markets by buying up our companies.

We have our own advantages, especially in developing and applying new technologies, materials and production processes; adopting new ways of financing, marketing and distributing goods and services; and coming up with new ways to manage the workplace and organize a business. But the rise of the developing world will inescapably intensify the dark side of Globalization 1.0, especially pressures on job creation and wages. U.S. job losses from direct off-shoring could become less of a problem, since the new prosperity and rapid modernization of developing economies drive up their wages and other costs. But the squeeze on job creation and wages that we’ve seen for the past decade, as intense global competition collides with fast-rising health care and other costs for U.S. employers, almost certainly will become fiercer.

The policy imperative here is to reduce the cost of creating new jobs. We can start right now by cutting the employer’s side of the payroll tax. And so long as the economy remains weak, we shouldn’t try to replace those revenues. As we recover, however, we can replace the foregone revenues from lower payroll taxes through a new, carbon-based energy fee, a tax shift with the extra benefits of driving greater energy efficiency and addressing climate change. A second step we can take to address the impact of Globalization 2.0 on American jobs would involve expanding and strengthening the cost-saving provisions of the President’s health care reforms. Under the new model of globalization as under the old one, the inescapable fact is that we simply cannot restore strong job creation until we slow the rate of increase in medical insurance costs for both businesses and the rest of us.

The Cost of Playing Games with the Full Faith and Credit of the United States

June 2, 2011

I spent last week in Rio attending a meeting of the IMF’s advisory board for the Western Hemisphere — and returned this week to Washington for the latest round of threats and charges over raising the U.S. debt limit. The contrast was, at once, disturbing and farcical. At the IMF meeting, former finance ministers, prime ministers and other ex-economic policy officials tried to unravel the grim implications for all of us if (when) Greece, Portugal or, in the worst case, Spain is forced to default on their sovereign debts. Back in Washington, congressional Republicans laid out their terms for not driving the United States into a voluntary default on its sovereign debt. Perhaps holding onto a child-like faith that bad things don’t happen to the United States, under God, they spelled out terms which everyone knows will never be accepted by President Obama and a Democratic Senate. The irony is that the GOP gambit of holding out a potential debt default if they don’t get their way could, in itself, make long-term control over deficits much harder.

The reason lies in the powerful influence of worldwide investors on our interest rates. Thankfully, global capital markets still have confidence that our two political parties can settle this dispute on reasonable terms, and that in time the United States will regain control over its deficits and debt. We know that confidence is still there, because the interest rates and yields on U.S. Treasury bills, notes and bonds all remain near historic lows. If there were real doubts about our capacity to control long-term deficits, those interest rates would be rising as investors demanded higher returns to offset the risk that we’ll fail. This confidence makes sense, because we succeeded at the same task twice before, in the 1980s and again in the 1990s. It took several years of squabbling and compromise, but President Reagan and a Democratic House agreed to raise taxes, cut defense and reduce Medicare and Medicaid spending in the 1980s — and the same pattern played out again a decade later with President Clinton and, first, a Democratic House and then a GOP one. That combination of revenues, defense and health care was, and remains today, inevitable, since those are the only pieces of fiscal policy big enough for cuts and reforms that can make a significant difference for deficits.

But neither Reagan nor Clinton faced opponents prepared to hold the full faith and credit of the United States hostage to their own partisan approach to the deficit. To make this gambit appear respectable, House Majority Leader Cantor even claimed last week that major players on Wall Street had assured him that a U.S. default would be a matter of economic indifference. The only explanation is that Mr. Cantor, without realizing it, was talking to short-sellers getting ready to bet billions that U.S. stocks and bonds might crash — as they will if we actually do default.

Happily, worldwide investors are probably correct that the likelihood of a U.S. debt default is still very, very small. If it ever came close to that, the real players on Wall Street would face down the U.S. Congress. But cutting it close may turn out to be very expensive, too.

Let’s perform a small thought experiment. A Tea-Party infused GOP takes us to the edge of default and then pulls back. A really close call, however, would almost certainly make worldwide investors nervous. They would begin to question whether our politics truly are up to the task of dealing with our deficits, so they add a small risk premium to our interest rates. Let’s say — and this would be optimistic in this scenario — that short-term rates on Treasury bills go up one-half of a percentage-point; medium-term rates on Treasury notes rise three-quarters of a percentage-point, and long-term rates on U.S. bonds increase by 1.25 percentage-points.

Now, let’s be optimistic again and assume that Congress and the President eventually agree to cut the 2012 deficit by 10 percent — $108 billion off of the current projection of $1.081 trillion. That will leave a 2012 deficit of $973 billion to be financed. The small increases to interest rates would add about $7 billion just to the first-year interest costs of the 2012 deficit. And that’s just the beginning: All publicly-held Treasury bills also have to be refinanced in 2012 — nearly $2 trillion worth at last count. The tiny 0.50 percentage-point increase in those rates would add another $10 billion to next year’s interest costs. That comes to $17 billion in extra interest costs in just the first year, and just on publically-held debt. Those premiums would become embedded in those interest rates, adding much more to our interest costs, year after year, as additional deficits have to be financed and some $7 trillion in publicly-held Treasury notes and bonds come due for refinancing. A single refinancing of that current stock of publicly-held Treasury notes and bonds, with the new risk premiums, would add more than $50 billion, per-year, to interest costs. And the actual risk premiums demanded by global investors could be significantly higher than we assume here, and so that much more expensive.

These incremental increases in interest rates also wouldn’t be confined to U.S. Treasury rates; they would be transmitted immediately to other interest rates, from mortgages to credit cards. That means the expansion would further slow, American incomes and the government’s revenues would grow less, and, lo and behold, the deficits would be even bigger.

That’s the math. Even if congressional Republicans don’t mean it, the political games they’re playing today with a U.S. debt default, purportedly in the name of fiscal responsibility, could make U.S. deficits and debt even more unmanageable, and U.S. prosperity more problematic.