Dear Reader,
Sometimes, it’s time to step back and look at the big picture. This weekend, here’s a quick potted history of how the global economy got into the mess it is in.
Where to begin the story? Let’s start with the pre-globalised world of the sixties, when social democracy ruled in the West, trade unions were strong, and prosperity trickled down to the western masses, but not to the ‘underdeveloped countries’, as they were known then with brutal frankness. The ghost of Keynes ruled economies and economic policy was seen as a matter of fine-tuning effective demand to ensure full employment. Global financial flows were tightly controlled in accordance with the Keynesian dictum, “Above all, let finance be primarily national”. The surplus in the developed world was shared between local labour and local capital. There were no emerging markets and the nations of the Global South desperately tried to pull themselves up by the bootstraps.
But the Keynesian welfare state had started to hurt the interests of the Western elites. The share of profits in national income was going down and worker militancy was growing. When the price of crude oil shot up in the seventies, and inflation went through the roof thanks to workers demanding higher wages to compensate the higher cost of living, the Keynesian consensus broke down. A new system was sorely needed, one that would serve the interests of capital accumulation and put the workers in their place.
That political revolution, or rather counter-revolution, came about in the Anglo-Saxon West through Margaret Thatcher in the UK and Ronald Reagan in the US. The trade unions were crushed, markets were freed, taxes were slashed, and trade became open. As the British geographer David Harvey put it, it was a project "to re-establish the conditions for capital accumulation and to restore the power of economic elites". The new system soon resulted in the proportion of profits in GDP rising sharply, while the share of wages went down. In the US, the Mecca of the new paradigm, real wages stagnated, while profits multiplied.
But how do you sell things to the masses when their incomes are not rising? One way out is to scout for cheaper locations, such as China, to manufacture your products -- globalisation accordingly got a fillip. Another is to make loans to them to enable them to buy things. That resulted in the wave of financialisation that persists today.
The collapse of the Soviet Union and its satellites and the opening up of countries like China and India accelerated globalisation. The new system resulted in rising profits for companies, as they were able to produce at the lowest cost centres and sell at the highest. It helped keep wages down in the West, as production and even services could be shifted abroad. The resulting inequality was compensated for by high levels of personal indebtedness. As Richard Wolff, professor of economics at the University of Massachusetts said, “In effect, US capitalism… substituted rising loans for rising wages to workers.” British political scientist Colin Crouch called it ‘privatised Keynesianism’ and said that under this system ‘’vast quantities of totally fictitious cake were produced, on the basis of the notional values of which even vaster quantities of such cake were leveraged. Bad debts were funding bad debts, and so on in an exponentially growing mountain.’’
Yet, the globalisation of production and services and the internationalisation of capital flows led to a huge boom in countries like China and India and rescued millions from poverty.
Of course, such a system founded on debt and finance was subject to frequent booms and busts. But with inflation low thanks to globalisation, central banks in the advanced economies thought nothing of throwing money at every crisis, inflating the asset price bubble every time. As economist Sam Gindin pointed out, "A further prerequisite for global accumulation has been the Federal Reserve's central role in the provision of overall global liquidity. By throwing liquidity at every financial tremor and hint of recession in the US since the early 1990s, it has not only sustained American demand, but has kept liquidity high around the world; and this in turn has contributed to bringing vast pools of Asian labour into production—for export to an American market, sustained by the Fed's policy."
In a nutshell, we had a US and Western economy based on over-consumption; a Chinese and East Asian economy based on exports catering to that consumption; a huge build-up of debt in the West to enable that consumption; cheap imports by the West that allowed prices to remain low, thus boosting consumption; high asset prices that increase the value of collateral for borrowing, enabling more consumption; the relocation of production to low-cost centres, to make goods cheaper and thus increase consumption in the West; trade surpluses in East Asia that were invested in US Treasuries, keeping interest rates low there; financial innovation that leads to new financial products that increase leverage which fuelled large increases in asset prices; easy monetary policy that helped rising asset prices; and a deliberate effort to use the wealth effect caused by higher asset prices as a driver of the US economy.
The flaws in this system were savagely exposed by the global financial crisis. But few lessons were learnt, and the overall stance of policy continued to be the same --more liquidity and more debt to rescue the economy and markets.
It wasn’t long before a backlash started. Workers in the Western world started to revolt, voting out the globalising liberals who had feathered their own nests, while watching jobs vanishing over the border. The reaction against hyper-globalisation began with the election of Donald Trump as president of the US. China was made the new scapegoat, just as Japan was one after the Plaza Accord in the eighties. And the pandemic was the straw that broke the neo-liberal camel’s back.
But China is no Japan—it sees itself as a serious competitor to the US, a challenger to US hegemony. It is already the largest economy in the world in Purchasing Power Parity terms, and the IMF says it will be 93 percent of the US economy in dollar terms too by 2027. No wonder US policy makers are worried.
The invasion of Ukraine by Russia is another turning point for globalisation, and security rather than cost-efficiency is increasingly becoming the touchstone of supply chains. Nationalism has become a rallying cry, from Trump’s ‘Make America Great Again’ to the rise of the far right in many European countries. Economists like Zoltan Pozsar are warning that the global economy of the last three decades is on the verge of dramatic change, and de-globalisation, geopolitical fragmentation and uncertainty, and structural inflation will be part of the brave new world.
Of course, not everybody agrees that a radical break will happen. China and the US are still big trade partners. China will be unwilling to throw in its lot with a weak Russia and risk sanctions. Most importantly, central banks are unlikely candidates to rock the boat and they may well pivot if there are signs of a breakdown of markets. Indeed, this is what the markets are hoping for.
But what if we are on the cusp of a new paradigm? Kotak Institutional Equities, in a recent note, calls it ‘The Great Reversal’ and it sees a ‘reversal in four of the major drivers of equities in the past 30 years— (1) global peace, (2) low global interest rates, (3) rise of China and (4) ‘zero’ or low cost of environmental damage’. They add, “We now see (1) greater geopolitical risks versus peaceful coexistence since the early 1990s, (2) higher interest rates as opposed to the steady decline in interest rates from the late-1980s, (3) lower benefits of a maturing Chinese economy and (4) higher environment-related costs due to climate change concerns.”
Economic paradigm shifts are periods of great upheaval. When the first period of globalisation ended and British hegemony crumbled, we had two World Wars and the Great Depression in between. When the post-World War II Bretton Woods regime collapsed, we had the disintegration of the Soviet Union and the rise of China. This time too, there will be big winners and big losers. Perhaps, if we play our cards right, India could emerge as one of the big winners.
As the King told the White Rabbit in ‘Alice’s Adventures in Wonderland’: “Begin at the beginning, then go on till you come to the end: then stop.” I’m stopping here, but while this is probably the end of the extraordinary tale of the last few decades, a new story has just begun.
Cheers,
Manas Chakravarty
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Markets
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IMF projects Chinese economy in 2027 will be 93 percent of the US in dollar terms
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Financial Times
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IMF says consumption to power India’s growth in near-term
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Global Economy
Supply chain bottlenecks now lower than at the beginning of the pandemic
Global food inflation is retreating, but India faces cereal trouble
Financial conditions are tightening, but not in Asia
Banking and finance
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