LOSING CONTROL (15 page)

Third, the Federal Reserve and other developed-world central banks need to spend more time thinking about the global consequences of their monetary policy decisions.
Central bankers may wish for fully flexible exchange rates to provide a guarantee of complete monetary sovereignty, but, in the real world, exchange-rate regimes are a mixture of floating, fixed and every variation in between.
When the Federal Reserve sets interest rates, it’s doing so not just for the US but also for huge chunks of the emerging world, whether it likes it or not.
By ignoring their needs, global monetary conditions can end up either too tight or too loose.

Fourth, monetary sovereignty is a myth.
Whether through currency pegs, carry trades, unexpected price shocks or any one of a number of other examples, central banks are, individually, not as powerful as they’d like to believe.
The gravitational pull being exercised by the emerging markets should change for ever the cosy Western attitudes towards monetary policy.
No longer are developed-world central banks in control.

The key question for policymakers to ask is this: if price stability is all it’s believed to be, why was its achievement during the Great Moderation followed by one of the biggest economic crises of the
past hundred years?
The standard response is to argue that price stability is a necessary but not sufficient guarantee of lasting economic success.
Pursued too blindly, however, it seems to me that the achievement of price stability has, in fact, become a potential source of economic failure.

Central bankers do not take seriously enough the distortions to prices and wages stemming from the emerging world.
These distortions are only going to get bigger over time.
As they do so, the Fed, the European Central Bank and the Bank of England will make more and more monetary mistakes until and unless they begin to recognize the crucial importance of the emerging economies in setting the global inflation agenda.
I fear we are entering a period of economic uncertainty similar to that of the 1970s; not so much because of the sudden reappearance of inflation but, instead, because attempts to control inflation are proving to be the equivalent of the Keynesian demand management policies of the 1960s: well intentioned but, in a changing world, ultimately misconceived.
Some bouts of high or low inflation do require a monetary response but others do not: distinguishing between the two is what ultimately makes central banking an art rather than a science.

Part Two argued that traditional barometers of economic success are giving out faulty readings.
The emerging nations have become an increasingly important destination for Western exporters, but it’s hard to argue that higher exports, on their own, are a sign of Western success.
Capital markets have become significantly bigger, but they have also become increasingly distorted through the dominance of decisions made by sovereign nations as opposed to the decisions of millions of underlying investors.
Inflation targeting is now a cornerstone of Western policymaking, yet is often poorly positioned to deal with the real and monetary shocks stemming from economic developments in the emerging nations.
Indeed, a narrowly based focus on price stability has not provided the guarantees of economic stability many policymakers hoped for.

There is a simple reason why the traditional barometers of economic success have failed.
Many of our economic barometers
now tell us less about macroeconomic health and more about the winners and losers stemming from globalization.
The old economic certainties have gone, while the gravitational pull of the emerging nations has increased.
Globalization doesn’t just lead to a superior allocation of resources and, therefore, to higher levels of global economic activity, as is so often claimed.
It also leads to a redistri-bution of that activity.
For some, globalization leads to a bigger slice of an expanding economic pie.
For others, globalization leads to a smaller slice, either relatively or, in some cases, absolutely.
Moreover, globalization creates a central paradox.
Across nations, income and wealth inequality is narrowing, as the emerging nations catch up with the West.
Within nations, income and wealth inequality is on the rise.
Because our political systems are, for the most part, designed to meet the needs of nation states, this is potentially a big problem.
How do governments defend the concept of globalization when their own populations may include both winners and losers?

In 1960, rising economic wealth was seen to benefit everyone.
As John F.
Kennedy put it, ‘A rising tide lifts all the boats.’
¹
Almost fifty years later, in 2007, Gordon Brown announced, ‘It is time to train British workers for the British jobs that will be available over the coming few years and to make sure that people who are inactive and unemployed are able to get the new jobs on offer in our country.’
²
This protectionist rhetoric betrays a clear anxiety about globalization.
If people from low-income countries can travel across borders more easily than before, what happens to the competitive position and earnings power of relatively wealthy indigenous populations?
And if those indigenous populations do not like the outcome, what economic and political implications might follow?

These are big issues.
They put the politics back into economics.
Governments have to make choices.
Do they use their tax and spending powers to redistribute income from the winners to the losers?
Do they try to use their financial clout to seek controlling
interests in companies to ensure that the benefits of globalization stay at home rather than leak abroad?
Do they erect barriers to the free flow of capital and labour across borders to insulate domestic companies and workers from the full force of global competition?

By ignoring the underlying reasons that are driving prices, capital markets and trade, we are in danger of ignoring one of the biggest political implications of globalization.
The competitive forces disrupting our economic barometers are also responsible for heigh-tened income inequality.
How governments react to this challenge will help determine the future of globalization.
For governments dissatisfied with and uneasy about ‘market’ outcomes, the incentive is surely to intervene, for better or worse.

Part Three offers three perspectives on this return of ‘political economy’.
This chapter explores the reasons behind rising income inequality both in the West and in the emerging nations.
Many explanations for rising inequality are domestically focused, but I contend that one of the most important reasons behind rising inequality, too often ignored, is the integration of previously independent economies.
We are seeing, slowly but surely, the formation of global markets in both labour and capital which are undermining the rent-seeking behaviour of Western workers.

Chapters 7 and 8 examine the ways in which nations are trying to override these market outcomes, either through the growing influence of governments on the ownership and control of capital or through the often ill-conceived attempts to limit the cross-border migration of labour.
The incentives to ignore market mechanisms are enormous.
If governments can control capital, they can extract economic rents for the benefit of their constituents at the expense of people elsewhere in the world (a fabulous example from the 1970s is OPEC).
If governments can control cross-border migration, they might, for a while, protect workers’ incomes in the West.
Tough controls over migration ultimately, however, may be self-defeating.
As the West ages, its greying population will increasingly depend on the support of immigrant workers.
To turn them away will eventually leave the West weaker, not stronger.
The demographic clock is ticking and alarm bells should be ringing for Western nations.

A few years ago, I had encounters with two cab drivers, one of whom had embraced everything good about globalization while the other feared everything bad.
The first was a Romanian Jew who had escaped the clutches of the Ceauşescu regime and had headed for New York.
He was a groundbreaker for globalization, having departed from his home country well before the collapse of Soviet communism.
His experience is becoming increasingly commonplace.
He managed to find work in New York, he paid for his sons’ education and they, in turn, found work in government and the legal profession.
In the space of a generation, opportunities denied to the father were granted to the sons.

The second cab driver was Italian.
I was in Milan for a conference and, on the way back to the airport, got stuck in traffic.
The cab driver became increasingly frustrated.
Eventually, the source of the jam became apparent.
A lorry was having difficulty reversing into a building site, and, through constant manoeuvring, was blocking the road.
A construction worker of North African origin had stepped in to solve the problem.
On seeing the worker, the cab driver opened his window and launched a ferociously racist diatribe.
My Italian colleague was able to translate, but no translation was required.
The message was simple.
The worker should ‘go back from where he came from … he wasn’t up to the task and, frankly, he was stealing jobs from good, hard-working, Italians’.
^*

One cab driver, therefore, took advantage of the opportunities in front of him while the other lived a life of hatred and, perhaps, fear.
Such is human nature.
In the developed world, fear and uncertainty are likely to increase further in the years ahead.
No amount of education, careful financial planning or flexibility is likely to provide insulation against the redistributional forces unleashed as a consequence of the rise of emerging economies.
While some might regard these forces as merely an attack on free-market principles (China is growing quickly because it deliberately maintains a competitive advantage through an undervalued exchange rate), the story is, in fact, much bigger.
The arrival of the emerging world dramatically alters the degree to which individuals are able to extract economic rents.
Some are winners.
Others will lose out.

Market forces allocate resources blindly.
If market conditions shift, there is no reason to believe that everyone benefits equally.
Indeed, it’s perfectly possible that some will lose out.
Even if the economic cake grows bigger as a result of globalization, those who enjoyed big slices before may suddenly find themselves on an unwanted diet.

The ‘enlightened’ political response to these challenges has been twofold.
Economies in the developed world should become more ‘flexible’ and, therefore, more easily able to adapt to changing economic circumstances, consistent with the flexibility required by David Ricardo’s theory of comparative advantage.
Meanwhile, investment in education should be increased, both in an attempt to produce more graduates and, also, to allow people to acquire new skills later in life.

There’s nothing particularly wrong with these ideas, but it’s likely they promise too much.
Flexibility is all very well, but, as argued in Chapter 5, it can just as easily mean pay cuts as pay increases.
Education is desirable in its own right, but with millions of graduates
now pouring out of Chinese and Indian universities, it’s not obvious that education alone will safeguard the living standards of those living in the developed world, even if the quality of US and European graduates may, for the time being, still be higher.

It’s easy to develop a simple theoretical explanation for rising income inequality dependent upon both the increased interconnectedness between the developed and emerging worlds and, within the emerging world, changing consumer preferences, particularly with regard to food.
This model casts doubt on ‘domestic’ explanations of rising income inequality.
It’s consistent with the idea that we’re living in a world of winners and losers, a response to the growing influence of the emerging economies.
Globalization is not lifting all the boats.
Some boats are sinking.

Consider the implications of globalization in a world containing just three countries.
The first, a rich country, I’ll call the US.
The second, a poor country, I’ll call China.
The third is an oil producer, which I’ll call Saudi Arabia.

Pre-globalization, the US is an immensely successful economy whereas China is very poor and, economically, has failed.
China’s backwardness is not the failure of nations stuck in poverty through no fault of their own.
³
Instead, China’s failure stems from (i) a deep suspicion of Western attitudes, leaving it with an insular economy closed off from external influence; (ii) a lack of appropriate information technologies to allow engagement to take place; and (iii) an over-reliance on the state, rather than the market, to allocate resources.
Saudi Arabia might be rich or poor but, crucially, it has monopoly powers over global oil production.
In the pre-globalization world, Saudi Arabia has a strong relationship with the US but much less interest in China, which is too poor to be a big player in the oil market.
Labour and capital cannot flow between the US and China.
All the technologically advanced capital resides in the US and, as a result, US incomes are much higher than those in China.

In the US, there are three primary sources of income: wages in manufacturing, wages in financial services and income from capital in the form of capital gains, dividends and interest.
In China, there is no significant financial sector, and income from capital is minimal.
Labour is either involved in agriculture or manufacturing.
Saudi Arabia produces oil and nothing else.

Imagine that barriers to trade, to capital flows and to labour migration are removed.
What then happens?
Capital should head from the US to China, seeking cheaper labour.
Labour should head from China to the US, seeking higher wages.
American owners of capital should end up richer because the process of ‘off-shoring’ lowers costs.
Workers in the American finance industry are better off because they are able to pinpoint the investment opportunities that will benefit the owners of capital.
Chinese manufacturing workers are better off because they get access to superior capital.
American manufacturing workers are worse off because they are now competing with Chinese workers who are prepared to work for much lower wages.

Because resources are now allocated more efficiently than before, global output is higher.
The price of manufactured goods comes down.
Other prices may rise.
Reflecting higher activity, the most obvious price to go up is that of oil.
Because Chinese manufacturing workers are now experiencing rapid income gains, reflecting their now heightened productivity, food prices may also rise.
The new affluence increases the demand for protein-based meals which may be tastier but which require far more crops to produce.
The resulting rise in crop prices leaves those in China who are still on subsistence incomes worse off.

Now think about this story from a consumer’s point of view.
If you’re a US consumer, are you better off?
The answer isn’t at all obvious.
If you’re in financial services, you’re probably doing fine, but if you’re in manufacturing you have reason to worry.
If you own shares in a company that is now choosing to relocate to China, you
may make a substantial capital gain, but what if you also happen to work for that company on the production line?
If you’re on a low income, and food and energy costs make up a big part of your weekly spending, you may find yourself considerably worse off because, while the price of flat-screen televisions is declining, it’s the rising price of essentials that is likely to have the biggest impact on your living standards.
If you’re a Chinese consumer, you may be enjoying a rapid rise in living standards if you happen to be working in a factory in an urban area (or have managed to move to California), but if you’re still stuck in a rural occupation you may now be worse off because you can no longer afford basic items of food.
Meanwhile, the higher oil price has seemingly left Saudi Arabia better off.
Rising incomes associated with the higher oil price, however, make Saudis uncompetitive in other areas of economic endeavour: the kingdom remains, economically, a one-trick pony unable to diversify from its core – and potentially volatile – competence.