About four years ago, the collapse of Lehman Brothers marked the beginning of the Great Recession. The world is still reeling from the consequences of this all-encompassing financial crisis. What, though, were the causes of the crisis? Much has been said about derivatives, failed regulations and greed. These things matter, but here I would like to offer a simpler and maybe deeper explanation: Globalization forces countries to hollow out their social contracts. Reduced real wages promise gains through investment and exports, but ultimately undermine growth everywhere.
If real wages do not sustain growth globally, what can? The answer is that a global credit bubble—from California and Florida to Spain and Ireland—could, until it couldn’t any longer. The underlying trends ultimately catch up: If real wages do not keep up with productivity growth, the labor share of income is falling. The global credit bubble often manifests locally—for example, as a real estate boom in, say, Miami or on the mediterranean coast of Spain—but is propelled by a liberalized global financial market. Thus we can identify three dominant but interdependent drivers in this story: accelerating globalization, increased inequality and financialization.
To trace out very broadly how we got here, consider post World War II economic history split into two periods: the Golden Age of capitalism of the immediate post-World War II era, which ended with the collapse of the Bretton Woods system in the 1970s, and the second era of globalization, which began with the conservative revolution towards the end of that decade. The Golden Age saw fast global growth, including in developing economies. Trade links between economies strengthened, but integration was not as deep as today. Capital account openness was very limited. In many advanced as well as catching-up economies, welfare states deepened. Expanding labor institutions protected jobs and ensured sharing of rapid productivity growth. Generally, these developments supported the labor share of national income. In that manner, global growth was sustained by local demand.
The second era of globalization, in sharp contrast, saw accelerating globalization. Trade integration deepened substantially, international production defragmented into flexible—“footloose”—transnational production networks, and capital accounts were liberalized. All these trends discipline labor through the very real threat of relocation. Indeed, labor contract negotations that are not subject to a threat of offshoring tend to be the exception, partly due to the increased tradeability of services. As a result, real wage growth has lagged productivity growth in many countries, leading to falling labor income shares and increased inequality. Thus, globally, consumption demand cannot absorb what can be produced: global effective demand is lacking and unemployment and stagnation follow.
Open capital accounts take center stage in this narrative. First, countries need to offer low corporate taxes (if not tax exemptions) as well as low wages to attract and hold foreign direct investment of “footloose” multinationals. These tax policies limit fiscal space of the state to support social safety nets, invest in education, and maintain crucial infrastructure systems. Crucially, financialization in combination with open capital accounts tends to produce volatile, pro-cyclical capital flows, which provide fertile ground for unsustainable credit expansion. Such credit growth often feeds into real estate bubbles and debt-led consumption on the way up, but balance-of-payments crises on the way down. In recent years, specifically, financialization—through the presumed innovation in the use of securitization and derivatives—sustained a global credit bubble that served to postpone the day of reckoning: As long as middle and lower class households in advanced countries maintained standards of living through buildup of debt, growth continued despite the underlying “real” lack of demand.
In summary, accelerating globalization and financialization forces nations to dismantle social contracts and welfare states, to suppress wages and weaken labor standards. In the process, inequality rises, demand lacks, and the community of nations undermines itself. To illustrate the issue, consider a scenario originally concocted by Rousseau: Two men are out to hunt. They are on opposite sides of a hill, and can not communicate. Now, they can set off individually to hunt a hare, which will provide food for a day. Alternatively, they can hunt a stag together, which provides food for several days for both of them. Why not go for the stag, every time? Hunting the stag requires trust and cooperation, and institutions that foster and enforce them.
Similarly, it requires trust and cooperation to institute policies that support a thriving middle class—as during the Golden Age. Simply put, two countries benefit if both institute such policies, because it deepens the extent of the market for goods and services. Globalization has made it increasingly difficult for one country to trust that the other won’t give tax breaks to corporations, won’t undermine real wages, won’t manage its exchange rate, all to increase its share of the existing global market.
Joan Robinson called such untrusting tactics beggar-thy-neighbor policies. Many countries pursues these policies since no global economic or political institutions exist that effectively foster and enforce trust and cooperation. But, market economies must be embedded in a web of socio-political institutions that buffer their disruptive effects. The social democracies of the last century managed to do that, to a degree, for the conditions rendered by the Golden Age. It has become clear that globalization destroyed that model—and that renewed efforts at embedment must be pursued on a global scale. Will that be possible?
If real wages do not sustain growth globally, what can? The answer is that a global credit bubble—from California and Florida to Spain and Ireland—could, until it couldn’t any longer. The underlying trends ultimately catch up: If real wages do not keep up with productivity growth, the labor share of income is falling. The global credit bubble often manifests locally—for example, as a real estate boom in, say, Miami or on the mediterranean coast of Spain—but is propelled by a liberalized global financial market. Thus we can identify three dominant but interdependent drivers in this story: accelerating globalization, increased inequality and financialization.
To trace out very broadly how we got here, consider post World War II economic history split into two periods: the Golden Age of capitalism of the immediate post-World War II era, which ended with the collapse of the Bretton Woods system in the 1970s, and the second era of globalization, which began with the conservative revolution towards the end of that decade. The Golden Age saw fast global growth, including in developing economies. Trade links between economies strengthened, but integration was not as deep as today. Capital account openness was very limited. In many advanced as well as catching-up economies, welfare states deepened. Expanding labor institutions protected jobs and ensured sharing of rapid productivity growth. Generally, these developments supported the labor share of national income. In that manner, global growth was sustained by local demand.
The second era of globalization, in sharp contrast, saw accelerating globalization. Trade integration deepened substantially, international production defragmented into flexible—“footloose”—transnational production networks, and capital accounts were liberalized. All these trends discipline labor through the very real threat of relocation. Indeed, labor contract negotations that are not subject to a threat of offshoring tend to be the exception, partly due to the increased tradeability of services. As a result, real wage growth has lagged productivity growth in many countries, leading to falling labor income shares and increased inequality. Thus, globally, consumption demand cannot absorb what can be produced: global effective demand is lacking and unemployment and stagnation follow.
Open capital accounts take center stage in this narrative. First, countries need to offer low corporate taxes (if not tax exemptions) as well as low wages to attract and hold foreign direct investment of “footloose” multinationals. These tax policies limit fiscal space of the state to support social safety nets, invest in education, and maintain crucial infrastructure systems. Crucially, financialization in combination with open capital accounts tends to produce volatile, pro-cyclical capital flows, which provide fertile ground for unsustainable credit expansion. Such credit growth often feeds into real estate bubbles and debt-led consumption on the way up, but balance-of-payments crises on the way down. In recent years, specifically, financialization—through the presumed innovation in the use of securitization and derivatives—sustained a global credit bubble that served to postpone the day of reckoning: As long as middle and lower class households in advanced countries maintained standards of living through buildup of debt, growth continued despite the underlying “real” lack of demand.
In summary, accelerating globalization and financialization forces nations to dismantle social contracts and welfare states, to suppress wages and weaken labor standards. In the process, inequality rises, demand lacks, and the community of nations undermines itself. To illustrate the issue, consider a scenario originally concocted by Rousseau: Two men are out to hunt. They are on opposite sides of a hill, and can not communicate. Now, they can set off individually to hunt a hare, which will provide food for a day. Alternatively, they can hunt a stag together, which provides food for several days for both of them. Why not go for the stag, every time? Hunting the stag requires trust and cooperation, and institutions that foster and enforce them.
Similarly, it requires trust and cooperation to institute policies that support a thriving middle class—as during the Golden Age. Simply put, two countries benefit if both institute such policies, because it deepens the extent of the market for goods and services. Globalization has made it increasingly difficult for one country to trust that the other won’t give tax breaks to corporations, won’t undermine real wages, won’t manage its exchange rate, all to increase its share of the existing global market.
Joan Robinson called such untrusting tactics beggar-thy-neighbor policies. Many countries pursues these policies since no global economic or political institutions exist that effectively foster and enforce trust and cooperation. But, market economies must be embedded in a web of socio-political institutions that buffer their disruptive effects. The social democracies of the last century managed to do that, to a degree, for the conditions rendered by the Golden Age. It has become clear that globalization destroyed that model—and that renewed efforts at embedment must be pursued on a global scale. Will that be possible?
As I think further into my own research, and I think Rudi et al.'s research supports this, traditional wages may be becoming obsolete as a means of socially equitable distribution (or becoming more problematic if they ever worked). My answers, so far, are only glimmers, though the boundaries are to me clearer: maximize both socially equitable distribution and productivity.
ReplyDelete