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Globalization and Stagnation: Background note for a Research Project

Globalization and Stagnation: Background note for a Research Project

Edward J. Nell

These notes start from a presumption, which the research project itself could conceivably cast into doubt – namely, that a modern closed macroeconomic system with a neutral government budget has a tendency to move in a stagnationist dynamic, that is, to fluctuate with a varying measure of underutilized capacity. Such a presumption is based on a “transformational growth” approach to the working of mass production economies. Craft economies tended to be stabilized by a price mechanism, but the development of mass production changed the character of costs in ways that undermined the price mechanism, replacing it, broadly, with the multiplier-accelerator. This understanding accepts a Keynesian view of the weakness and volatility of the propensity to invest, but takes a skeptical view of the alleged stabilizing influence of ‘real-balance’ and other wealth effects. The removal of all trade and capital mobility restrictions – certainly not yet the case today – would convert the world economy into a closed macro system. The world economy would then tend to exhibit stagnation. It will be argued here that the nearer we move to an open world economy – in the absence of a world agency with fiscal and monetary powers – the prominent stagnationist tendencies will become. To correct this would require countercyclical policies at the global level. Such policies are unlikely in the absence of a global government with sovereign taxing and spending powers, and control over the global monetary system. (However a coordinated expansionist programme could be envisioned.)

In fact the world is far from being a simple closed macro-economy. Besides the stagnationist tendencies there may be other forces, tending to promote expansion, and/or greater efficiency in the use of resources. The project’s aim is to explore the consequences of the removal of restrictions on trade and capital mobility, together with the effects of new technologies in enahncing the ability to trade and to shift capital – both financial and real- rapidly. A variety of tendencies can be identified. These will be examined here in the abstract, as issues of market adjustment, analyzed in simple macro models, with little discussion of specific cases or countries. However, the ultimate purpose is to explore and compare the cases of two countries, the US and Germany.

1. The term ‘globalization’ will be taken to indicate three phenomena: first, free trade; second, the removal of restrictions on the mobility of financial capital; and third, the technological ability to disperse production facilities around the world, while maintaining detailed control of the production process. This technological ability has three important features: first, computerized control, making it possible to monitor processes in detail; second, cheaper, faster, more comprehensive communications, making it possible to transmit information about productive processes rapidly and completely [pictures, colors, numerical data, mathematical commands, etc.] and third, reduced transportation costs, together with higher transportation speeds.

2. ‘Stagnation’ will be taken to mean the combination of a low growth rate, low productivity growth, and low capacity utilization. It represents the failure to use and improve the productive facilities available at the optimum level.

3. The claim to be explored is that the development of globalization has brought intensified stagnation in its wake. The context is that of an international system in which there is no ‘public authority’; that is, there is no sovereign power which can regulate, control or stimulate or restrain the activity level of the international system. The argument is that under such conditions globalization will set up forces that reduce capacity utilization and therefore growth, while at the same time driving up interest rates. A number of patterns of market interaction leading to these outcomes will be explored. At the outset, however, a number of countervailing tendencies should be noted:

— removing restrictions on trade should have the effect of increasing specialization, and thus efficiency. Hence productivity should rise among the affected nations.
— removing restrictions on capital mobility should better permit capital to be allocated to its most productive uses, again increasing productivity. As capital leaves less producitve employments, this will temporarily reduce activity, but the reduction will be offset by the rise in the new area of investment – and there will be a net gain in overall potential GNP resulting from the increased efficiency.
— the flow of capital to low-wage areas may lead to reductions in wages or to stagnation in high-wage areas, but it should bid up wages in the low-wage areas.
— similarly the flow of short-run financial capital to high-interest areas will raise interest rates in the regions such capital is leaving, but lower them in those to which it is flowing.

These countervailing tendencies should be borne in mind. The working hypothesis is that they will not prove sufficient to offset the market tendencies outlined below, but the case must be proven.

4. Very broadly, there seem to be two chief competing theories or accounts of globalization at present:

–(Ohmae) globalization will integrate the world, and will permit markets to work their miracles. The result – after some temporary disruptions – will be to disseminate the new trechnologies rapidly, and to raise living standards everywhere. Sometimea it is expected that this will at the same time spread Western enlightenment; others argue that the technologies and ideas will be adapted to local/national cultures, which will then be strengthened and revivified.

–(Reich, and others) globalization will divided the world into literate and illiterate, into corporate-managed advanced economies, and backward service and traditional economies. The former will grow and develop, becoming increasingly ‘one-world’ minded, while the latter will stagnate and retreat into fundamentalisms of various kinds – national and religious. Corporations and corporate managers will progressively lose their sense of identification with any particular nation-state.

Both views overlook the tendency to stagnation. Both also tend to hold that globalization reduces the ability of national government to conduct economic policy. For the first view this is held to be good, since policy tends to reduce the ability of markets to generate progress. This is pollyanna-ish. By contrast the second sees the decline in the policy-making ability of national governments as a serious problem. But while it stresses an important tendency in globalization, but contains little economic analysis, and does not explain adequately why globalization is happening.

Let us therefore turn to an analysis of the economic effects of globalization:

5. In regard to trade, (in conjunction with capital mobility) the argument is based on the view that competitive advantage in the post-War world has depended and still depends importantly on technological superiority. Such superiority not only provides a cost advantage, but also enables production of a better product, sometimes a product that is indispensible to buyers over a wide range of prices. This superiority often arises from economies of scale. The larger advanced countries are able to produce more cheaply and to turn out better goods, the demand for which in world trade is likely to be somewhat inelastic. (It should also be noted that this perspective tends to suggest that capital accumulation – investment – and productivity growth will be correlated, so that a slowdown in the former will bring a slowdown in the latter.)

The contention that a rise in world trade will tend to result in stagnation runs roughly as follows:

— a rise in free trade – removal of trade restrictions – strips away the protection from many smaller markets, enabling import penetration by large-scale advanced firms.
— this creates higher foreign deficits for countries with weaker and/or smaller – and so less competitive – firms.
— this puts pressure on their currencies
— to defend their currencies they must raise interest rates
— to defend their currencies they must reduce capacity utilization, which lowers inflation, raising real interest rates
— the higher interest rates attract short term capital from the stronger countries, while the reduced capacity utilization reduces their import purchases from the stronger countries.
— interest rates will be driven up and demand will be reduced in the stronger economies, leading to a decline in activity levels. Potential growth and GNP may have increased as a result of the superior goods being imported, but actual levels will be reduced because of the effects on interest rates and capacity utilization.

6. With free trade and unrestricted capital mobility relative currency values cannot remain fixed; that is, a regime of fixed exchange rates cannot (plausibly) be sustained.

— trade will increase as technologically advanced firms penetrate the markets of weaker and more backward nations, and/or markets in other advanced nations that, prior to the removal of trade restrictions, were dominated by relatively backward firms
— in these nations imports will rise, but, being relatively backward – uncompetitive – technologcally, they will be unable to increase exports pari passu. Hence their balance of payments will move into deficit.
— the supply of the currency of such a nation on world markets will exceed the demand for it, for use in trade. Conversely their demand for other currencies will exceed what they can earn. Hence their borrowing requirements will rise.
— as a consequence their currency will tend to fall, and the interest rate they must pay will tend to rise – since they are obviously risky, being competitively unable to earn their keep
— to keep the exchange rate fixed would require lending the foreign currencies needed to support the weak nation´s imports
— but the supply of these currencies will be limited (since ex hypothesi) they are the currencies of strong nations running surpluses, whereas no one will be interested in holding the weak currency
— given free capital mobility speculators will bet that, eventually, the value of the weak currency will fall, the strong rise. They will therefore sell the weak and buy the strong.
— to counteract this Central Banks and the strong currency countries must be prepared to issue the strong currency to the extent needed and absorb the weak one – in spite of the evident fact that the latter is useless.
— thus pressure will be exerted, through policy, to make the strong currency tend to circulate, while Central Banks and financial institutions will be encouraged to hold the weaker as reserve. This runs directly counter to Gresham’s Law and is not sustainable.

7. The argument can be stated briefly as follows:

— it is assumed that the international financial system will be willing to fund only a certain level of deficits in relation to world GNP. This willingness will be broadly proportional to world assets, which in turn will reflect world potential GNP
–the US foreign deficit is a special case – but even so, a run on the dollar is possible. The problems of the UK are well-known, and contractionary conditions for finance have been imposed throughout Latin America and Africa. The reasons that world financial markets will not underwrite more than a certain level of deficits need to be explored; also important is whether and why some countries are privileged.
— the acceptable level of world deficits depends on assessments of risk, which in turn depend on judgments as to competitive strength, which will determine the ability of a country to earn the foreign exchange necessary to service ist foreign debt, and to repay (or roll it over)
— the higher the volume of trade in relation to GNP, the higher the risk, moreover, risk may be increasing at a faster rate than GNP

— under these conditions a higher ratio of trade to GNP will have to be accomodated at a lower level of GNP. That is, a rise in trade/GNP – T/Y – would imply a larger volume of trade if GNP continued to expand at the same rate. But if deficits rise in proportion to trade, reflecting the given competitive conditions between nations and firms (based on degrees of technological development), then since only a certain level of deficits can be supported (any higher level will be too risky), the higher ratio of T/Y will require a lower level of Y to bring T down to the point where the implied trade deficits can be financed.

8. The preceding appears to suggest that there is some sort of ‘world financial constraint’, an odd position to take if one also believes that ‘money is endogenous’. But, first, it is evident that many advanced nations have run up against such a constraint – the UK repeatedly, France under Mitterand, etc. Moreover, developing nations constantly face Balance of Payments problems. Second, saying that there are difficulties financing deficits does not imply a shortage of financial resources. Far from it; surpluses equal deficits, and money is endogenous – or would be, if international monetary insitutions were more fully developed. The problem in financing deficits is that the normal working of markets will channel funds away from nations that are in need. International financial markets are unstable in this sense, and far from supplying the finance, will move funds in the opposite direction.

The reasons for this rest on the nature of risk in the international system. The world monetary system is not fully organized; that is, the system has no lender of last resort, nor does it have a regulator with powers of enforcement. Hence risk and uncertainty are bound to be pervasive. Central Banks will be pressured by bond-holders to defend the values of their currencies; even if there is little actual risk of default, a Balance of Payments deficit may be a signal to speculators. Moreover, financial innovation, creating new types of securities, pyramided on other securities and commitments, raises the cost of financial activities. The ratio of FIRE/GDP in all advanced nations has risen – particularly in Germany and the US. But financial institutions have few variable costs; hence a downturn in financial activity or in prices affects earning strongly -operating costs cannot easily be adjusted. Risk therefore rises. But it rises for another, probably more important reason: pyramiding securities means that a default in the underlying commitments may bring down the whole house of cards. The impact of a given default is greatly increased. Derivatives also, arguably, lead to higher risk (although the opposite is sometimes contended.) These various reasons for higher risk mean that basic real interest rates must be higher to compensate for the greater risks.

9. The Bretton Woods fixed exchange rate system was not sustainable, not because of the fixed rates, but because of the relaince on the dollar as the reserve currency. Supplies of dollars to trading nations came principally through the excess of US spending abroad over earnings abroad, in the end such a system had to fail. For the growth of trade depended on the growth of an adequate supply of the reserve currency, the dollar. But the supply of the dollar depended on the US deficit. The size of the deficit could be expected to grow in keeping with the growth of output. But for world trade to expand relative to world output the US foreign deficit would have to expand relative to US output.

— if the increase in the deficit came on capital account, then ‘Gaullists’ everywhere would object that the US had become able to buy up more of the world’s best assets essentially free – by supplying money that no one will or can use.
– if the expansion took place on current account then confidence in the dollar would be weakened.

— hence for T/Y to rise, the US foreign deficit must rise in relation to US GNP, and there will be a point beyond which the US deficit is unsustainable.

10. In the circumstances under examination – in which competitiveness reflects technological development – flexible exchange rates will very likely make the problem of foreign deficits worse. If trade deficits exist because of competitive strength and weakness based on the relative degree of technological development, some sizable fraction of imports will be likely to reflect technological weakness. Such imports will tend to be price inelastic, so that devaluation will raise the import bill. Advanced countries are likely to have exports that are also price-inelastic, so that cheapening them will lose revenue. Such circumstances will make it difficult to meet the Marshall-Lerner conditions. Hence flexible exchange rates are likely to require even greater contraction to bring deficits to an acceptable level..

11. In regard to wages and production, the argument is that the new technologies permit production processes to be broken up, so that parts can be contracted out. They can also be picked up and shifted around the world, because the new technologies have dramatically reduced costs of transportation and communication, while permitting through computers the precise monitoring of technological processes from a distance. The effects on macroeconomic performance are:

— labor markets with the lowest wages, adjusted for productivity, risk – including political risks – and transportation costs, will attract direct foreign investment; that is, these markets will be chosen for the placing of production facilities, by advanced corporations. In addition to being attracted by low wages, capital may be attracted by the prospect of non-union labor, or by local regimes capable of controlling and policing labor.
— because of the improved ability to control production, processes may be broken down into component parts, many of which can be contracted out to low-wage low-cost (and/or non-union) producers in underdeveloped regions of the world, or in backward regions at home.
— corporations will not need to invest in facilities to produce these components, and may dispose of facilities they already have
— investment will therefore be reduced in high wage economies, or high-wage regions, and increased in low wage ones
— capacity utilization and employment levels will fall in high wage economies and regions, but will not necessarily rise in low wage ones, if they are also labor-surplus economies.
— wage stagnation, leading to a reduction of the wage share, in high wage economies and regions, will tend to reduce the growth of demand, which will contribute to the stagnation of investment.
— stagnation and sluggish demand tends to raise risk, leading to higher real interest rates.

12. The capital invested in production processes may usefully be divided into ‘low mobility capital’ (LMK) and ‘high mobility capital’ (HMK). The former is not readily movable; the latter can pull up stakes easily. LMK is capital invested, for example, in traditional mass production processes – heavy long-lasting plant and equipment – which require substantial vertical integration, achieve economies of scale and cannot easily be broken up. To change location, the whole plant would have to be dismantled. It would be difficult or impossible to move it physically and it would be hard to find a buyer. Such capital is immobile. Likewise, capital less phycially encumbered might nevertheless be immobile, because strongly dependent on infrastructure provided by the local community. Or the production processes might be tied into local or antional government activities – as with firms using defense-related technologies. HMK is capital invested in processes that are easily separated, so parts or processes can be contracted out. Also such plants must be possible to dismantle, and/or the equipment be quickly written off or easily sold. (Tom Ferguson)

— the new technologies have raised the proportion of HMK to LMK in the advanced economies
— HMK has little or no long-term interest in the region in which it settles; hence will not spend in that region, nor will it be concerned with community development or improvement. LMK, by contrast, will be concerned with the region, and its managers will be concerned with community development, since they and th4eir families will benefit from the public goods in that region.
— LMK will develop a regionally-based organization; that is, the administrative hierarchy that operates the production processes will be regionally based and will spend locally. HMK will tend to administer the production processes as far as possible from its center, so will not develop a regional base. Nor will the system of administration necessarily take the form of a traditional corporate hierarchy. Hence HMK will tend to spend very little locally.
— LMK therefore will have a greater multiplier effect, and will be more likely to generate local accelerator effects, than HMK.
— raising the ratio of HMK/LMK will therefore weaken the multiplier and accelerator effects of investment and business spending on the economy, tending to accentuate stagnation.

13. The conditions for capital to move to a new low-wage location can be expressed in a formula, balancing the additional current costs of operating abroad against the gains in lower wages from doing so. Here T stands for the additional transportation costs, C for extra communications, S for new software and computing charges, M for management costs, all referring to the excess over such costs required for production at home (so all are in real terms), and R stands for political and other risks associated with the proposed new location. Then we have:

T+C+S+M+R < {wa – wu(u/$)}/P

where the RHS shows the difference between the wage in the advanced area and that in the underdeveloped area, expressed in terms of the advanced area’s currency, and divided by the advanced area’s price level. Assuming that the LHS < RHS the stream of gains from moving should be summed over the expected lifetime of the project, discounted at the rate of interest and compared to capital costs of moving the plant. If the gains are greater, the move should be made.

The first four variables here are all reduced by the new technologies, as are the capital costs of physicall moving a plant or setting up a new one abroad. The effect of capital mobility and greater free trade will reduce the exchange rate u/$. Hence the tendency of technological development will be to encourage the mobility of real capital. Globalization feeds on itself.

14. What can be called the ‘Austerity Dilemma’ can be expressed in the form of a simple ‘game’ between any given country and its trading partners, considered together or separately. Each country can operate policy of Expansion or one of Austerity. If both choose Austerity, both make small losses; if both Expand, then both make small gains. But if one country chooses Austerity, and the other chooses to Expand, then the Austere country will have low imports, but its exports will boom. It will experience an inflow of short-term capital and a strengthening of its currency. The Expanding country will suffer from weak exports, while undergoing an import boom, at a time when short-term capital will be fleeing, as the currency drops. Austerity will produce a large gain, and Expansion a large loss. The game looks like this:

Trading Partners
Austerity Expansion
-l -L
Aus -l G
Country A G g
Exp -L g

Here we see that -l > -L, (i.e. L > l) and G > g. So Austerity will be the favored policy for both sides. Repeated games might lead to an understanding that Expansion should be favored – but who are thedecision-makers: countries or governments? Countries repeat, but governments or regimes are the ones who make the choices. It may not be so easy to define a repeated game.

15. In the early post-war period, the real interest rate tended to lie below the growth rate, in the later years, however, this is reversed, the real interest rate generally lies above the growth rate. When i < g debt, both private and public, tends to decline in relation to GNP; when i > g debt tends to rise relative to GNP. A consequence is that the income distribution tends to shift towards labor in the case of i < g, and towards capital, when i > g. But the first shift is expansionary, the second stagnationist, in each case reinforcing the inequality.

The important point is that all the pressures arising from globalization appear to tend to raise real interest rates, and to lower the growth rate. That is, they tend to generate i > g, where i stands for the real interest rate. To see the significance of this, contrast the regimes. First it is plausible to assume that,

— capital will tend to shift between financial and real positions, depending on the difference between g and i, given the assessments of risk. Given an established relationship between g and i, a change will lead capital to shift in favor of whichever has risen relatively to the other.
— when i < g corporate debt will be falling in relation to Y, when i > g, business debt will be rising
— when i < g, and g varies, inflation, dP/P, will vary strongly in the same direction, but when i > g, and g varies, dP/P will not vary much. (In the first case, it might be said that a normal Phillips Curve exists, in the second case, inflation has other causes, and does not behave ‘normally’.)
— g itself will be a positive function of the difference, g-i, so that g = g(g-i), g’ > 0. But the change in this function will be small when g-i < 0 and large when g-i > 0.
— a change in g, given an initial positive level of g-i, will have an effect on inflation, and on capital arbitrage, and an eventual further effect, depending on what happens to g-i. If g rises, dP/P will rise, lowering i. But capital arbitrage will shift funds out of the financial markets into real investment, enhancing g, but raising nominal interest rates. The result will be a new level of g-i, very likely higher, leading to a further effect on g. If g falls, inflation will fall, raising i, but capital arbitrage will lead to funds flowing out of financial markets, lowering nominal interest rates. The new level of g-i will then lead to a further change in g. In both cases, however, the further change in g will be small, perhaps negligible.
— a change in g, given an initial negative level of g-i, will have a neglible effect on inflation, but will lead to capital arbitrage, moving the nominal interest rate in the same direction as the growth rate. This will lead to a new level of g-i, a change in which can be expected to have a measurable influence on g.

It follows that:

— i > g, and its opposite, i < g, are stable ‘regimes’ in the sense that market caused variations in g will not change the the sign of the difference between i and g.

16. The growth of output is made up of two components – capital accumulation (investment) and the growth of productivity. The real rate of interest is also a compound of two elements – inflation and the nominal rate. Many of the points here can be exhibited by arranging a matrix, with the four components of g – i horizontally, and the three elements of globalization, free trade, financial capital mobility, and real capital mobility, on the horizontal. Each box of the matrix will then show the effect of that aspect of globalization on the economic variables involved in stagnation. The table below shows the relationships that seem plausible on the basis of the discussion above. The subject is a ‘typical’ advanced economy.

cap acc prod growth inflation nominal i

free trade down down ? up

fin cap mob down down ? up

real cap mob down down ? up

Both trade and capital mobility might reduce inflation by leading to lower prices as a result of lower costs. But both might increase inflation by increasing volatility in the Balance of Payments of various countries, leading to devaluations and thus higher prices.

17. It also follows that policy works differently in the two regimes.

— Monetary policy affects i directly, and g indirectly, through g(g-i).
— Fiscal policy affects g directly, and i indirectly, through the effect of g on dP/P. When g-i < 0 this ffect will be negligible, but when g-i >0, it will be important.
— An important distinction must be drawn between two kinds of policies – those which tend to establish and/or support a particular regime, and those which are designed to adjust the levels of growth or capacity utilisation within a regime.
— Given the regime i > g, monetary policy will tend to be effective in adjusting g, because the cahnges due to g(g-i) are relatively large, and because changes in g have only small effects on inflation. Fiscal policy, however, will lead to offsetting capital arbitrage, which will have to be counteracted by monetary policy.
— Given the regime i < g, monetary policy will tend to be ineffective in adjusting g, because changes in g will tend to bring changes in inflation in the same direction, undermining the policy change in the real interest rate. Fiscal policy, however, will lead to changes in real interest rates that will tend to support the policy direction – thus a policy-driven rise in g will raise inflation, lowering real interest rates.

18. In the absence of a world authority, an expansionist policy would require coordination, and policing, to ensure that countries will keep to their agreements. Moreover, countries will need to establish control over the transnational corporations.