Where next with globalization

1. Where next with globalization? Dani Rodrik November 25, 2008

2. Globalization’s upside: the expanding growth frontier

3. But largest beneficiaries are those with non-standard policies

5. Financial crises are frequent and painful

6. The political underpinnings of globalization are increasingly fragile

7. The political underpinnings of globalization are increasingly fragile

8. The political underpinnings of globalization are increasingly fragile

9. The political underpinnings of globalization are increasingly fragile

10. The political underpinnings of globalization are increasingly fragile

11. Where next? Globalization was already in trouble before the financial crash of 2008 The current crisis presents an even greater challenge… Prevailing model of financial globalization discredited Looming threat of trade and financial protectionism due to protracted recession in advanced economies Or perhaps an opportunity? New-found zeal to reform international institutions Ambitious agenda set out in Nov. 15 G-20 meeting Greater voice for leading emerging markets The beginnings of a new Bretton Woods?

12. The paradox: globalization can be healthy only if we do not push it too far Facing up to the “imperfections” of the world requires that we restrain our ambitions: Economic limits “market failures” Political limits A world of divided sovereignty Neither of these limitations can be wished away by exhortations. Therefore we need a model of globalization that takes these into account, rather than assuming they can be done away with

13. On economic limits: a tale of financial innovation Who wouldn’t want credit markets to serve the cause of home ownership? So: introduce some real competition into the mortgage lending business by allowing non-banks to make home loans let them offer creative, more affordable mortgages to prospective homeowners not well served by conventional lenders. enable these loans to be pooled and packaged into securities that can be sold to investors reducing risk in the process. divvy up the stream of payments on these home loans further into tranches of varying risk compensating holders of the riskier kind with higher interest rates call on credit rating agencies to certify that the less risky of these mortgage-backed securities are safe enough for pension funds and insurance companies to invest in just in case anyone is still nervous, create derivatives that allow investors to purchase insurance against default by issuers of those securities.

14. Who or what is the culprit? (1) unscrupulous mortgage lenders who devised credit terms? such as “teaser” interest rates and prepayment penalties perhaps, but these strategies would not have made sense for lenders unless they believed house prices would keep on rising a housing bubble that developed in the late 1990s? and the reluctance of Alan Greenspan’s Fed to burst it? even so, the explosion in collateralized debt obligations (CDOs) and other securities went far beyond what was needed to sustain mortgage lending especially true of credit default swaps, which became an instrument of speculation instead of insurance and reached into tens of trillions of dollars in volume. irresponsible financial institutions of all types leveraging themselves to the hilt in pursuit of higher returns? credit rating agencies that fell asleep on the job?

15. high-saving Asian households and dollar-hoarding foreign central banks that produced a global savings “glut”? which pushed real interest rates into negative territory, in turn stoking the U.S. housing bubble while sending financiers on ever-riskier ventures macroeconomic policy makers who failed to get their act together and move in time to unwind large and unsustainable current-account imbalances? the U.S. Treasury, which played its hand poorly as the crisis unfolded? bad as things were, what caused credit markets to seize up was Paulson’s decision to make an example of Lehman Brothers by refusing to bail it out. might it have been better to do with Lehman what he had already done with Bear Stearns and would have had to do in a few days with AIG: save them with taxpayer money. all (or none) of the above? We can be certain that no future regulation will prevent similar occurrences unless leverage (i.e., borrowing) itself is directly restrained Who or what is the culprit? (2)

16. The lesson? Financial markets operate in a highly imperfect economic environment information asymmetries agency problems systemic externalities … that can be targeted only imperfectly by supervision and regulation … and therefore cannot be fully neutralized even under the best of circumstances As the financial crash of 2008 has made painfully clear These problems are all the more severe in the international environment given the weakness/impracticality of international regulation

17. When political constraints bite:lessons of history Three interpretations of collapse of earlier wave of globalization, 1815-1913 (from Harold James 2001) Inherent instabilities in global finance Social and political backlash Overloading of institutions that manage globalization What is common in each of these explanations is the imbalance between the global nature of markets and the national nature of institutions of governance.

18. Taking the lessons of history to heart “The ensuing backlash [against globalization] had some predictable properties. Supporters of the classical order had argued that giving priority to international economic ties required downplaying such concerns as social reform, nation building, and national assertion. In the new environment, some of those newly empowered responded that if the choice was between social reform and international economic integration, they would choose social reform – thus leading to the Communists’ option of radical autarky. If the choice was between national assertion and global economic integration, another set of mass movements chose nation-building – thus leading to fascist autarky in Europe and economic nationalism in the developing world.” Jeffry Frieden (2006)

20. A way forward? (1) New “traffic rules” to manage the interface between national regulatory settings and social orders Creation of policy space to allow: rich nations to provide social insurance, address concerns about labor, environmental, health, and safety consequences of trade, and shorten the “chain of delegation” poor nations to position themselves better for globalization through economic restructuring all nations to create financial systems and regulatory structures more attuned to their own conditions and needs

21. Problem: international rules currently overlook the need for such “policy space” (and often prohibit the exercise of safeguards) Example: G-20 statement of November 15 Example: WTO and labor standards or food safety The risk: the pursuit of a more perfect globalization endangers an imperfect, but still remarkable globalization by intensifying the conflicts that the system generates Solution: expanded role for domestic “safeguards” that would allow restrictions on trade in good, service, or asset when multilaterally accepted procedural requirements are met Goal: recreate something akin to the “Bretton Woods compromise” A way forward? (2)