Global governance and domestic political economy

<p><em>Romesh Vaitilingam interviews Jeffry Frieden for Vox</em></p>
<p><em>October 2009</em></p>
<p><em>Transcription of an VoxEU audio interview [http://www.voxeu.org/index.php?q=node/4100</em></p>
<p><strong>Romesh Vaitilingam</strong>: Welcome to Vox Talks, a series of audio interviews with leading economists from around the world. My name is Romesh Vaitilingam, and today's interview is with Jeffry Frieden, Professor of Government at Harvard University. Jeff and I met at the Global Economic Symposium in Germany in mid September 2009, where he had been speaking at a series of sessions on global trading rules, global financial regulation, and global economic governance generally. I began by asking him to give a flavor of the discussions.</p>
<p><strong>Professor Jeffry Frieden</strong>: Much of it has focused on trying to understand what the implications of the current crisis are for the broader development of the international economy, both in the near term, over the next year or two years, but more importantly over the next 5, 7, 10, even 20 years. I think we've come out of a period, with the current crisis, where the world economy was organized around one very important set of macroeconomic relationships.</p>
<p>You had a large group of countries that were running enormous deficits &ndash; that is, borrowing very heavily from the rest of the world &ndash; and another group of countries that was, of course, running very large surpluses and lending to the rest of the world.</p>
<p>And that was, in many ways, a stable relationship over 10, 12 years. It worked reasonably well. It allowed Americans to consume well beyond their means for a decade or so, and also Spaniards and Irishmen and Englishmen and many others around the world.</p>
<p>And it allowed the Chinese and the Japanese and the Germans and other major surplus countries to pursue an export led set of economic policies that they found appropriate to their particular developmental or other economic needs.</p>
<p>But it seems clear now, in the aftermath of the crisis, that that relationship is going to have to be revisited, that we're not going to see a recurrence of these enormous, multi trillion dollar surpluses and deficits over the next 5, 7, 10 years.</p>
<p>We see them today. Let me be clear. We see them today in the current crisis. We see the US continuing to run a fiscal deficit, or running a fiscal deficit of $1.2, $1.3 trillion and financing much of that abroad.</p>
<p>But that's not the long term. That's not even the medium term. Eventually, within a few years, the US will be deep into adjustment, deep into trying to deal with the aftermath of the crisis, the implications of having run up a $5 or $7 or $10 trillion debt to the rest of the world.</p>
<p>I think one of the core questions is how does the world deal with these global imbalances as they are reduced and perhaps even reversed? From my perspective, there's a range of international issues. That is, what does this imply for developments in international trade, international finance? And we can come back to that.</p>
<p>But one of the areas that I'm particularly concerned about, because I think it has been given too little attention, is what these adjustments mean in the domestic political economies of the countries in question.</p>
<p>So, we can start with the former deficit countries first the US, Spain, Ireland, the UK countries that had come to rely, over the course of the decade, on foreign financing for consumption.</p>
<p>In many ways, the US dealt with the fact that income distribution had been deteriorating for many, many years by going on a consumption binge. I have a colleague who put it this way in observing this, saying, &quot;Who needs a social welfare state when everybody's got a credit card?&quot;</p>
<p>And that's a little bit how the US was behaving and other countries as well. We borrowed ourselves into a tremendous surge in consumption. Much of it went into housing, and then fed on itself. As housing prices went up, people borrowed against their more valuable homes. Now we're in the adjustment phase. And like other countries that have gone through debt crises, adjustment is difficult and adjustment is painful. We, the United States, has to reduce consumption. It has to reduce real wages. It has to increase its ability to export.</p>
<p>We have, for many years, consumed more than we've produced, invested more than we've saved, and the government has spent more than it's taken in. And that has to be reversed. We now have to produce more than we consume, and we now have to save more than we invest, and the government's going to have to take in more than it spends in current expenditures.</p>
<p>None of those adjustments is going to be easy. They're all going to be controversial. They're all going to be politically fraught. And so I think that is an area where many aspects of the international political economy are going to be drawn into domestic conflicts over how countries adjust to the new reality.</p>
<p>It's not just the deficit countries, though. The surplus countries, too, are going to go through some major changes. China, for 30 years now, has predicated its entire development strategy on throwing all of its resources into the production of manufactured goods for exports.</p>
<p>And that has been very successful for them. It has come at the expense of domestic consumption and domestic consumers, and it has come at the expense of investment in domestic non tradable and service activities that are under served, in a sense.</p>
<p>China is not going to be able, it seems to me&hellip;there is some disagreement over this, but I think it seems clear that China is not going to be able to rely as heavily on exports, especially to countries like the US that aren't going to be interested in importing as much.</p>
<p>And so what does that mean for China domestically?</p>
<p>It means a downplaying of this very dynamic, very central, very politically powerful export sector in the coastal regions, and a playing up of things like housing, a social safety net, social services, leisure activities, all sorts of things that are very, very underdeveloped in China today.</p>
<p>A major economic shift. And, as we know, major economic shifts involve social and political shifts as well and are never easy.</p>
<p><strong>Romesh</strong>: Jeff, can you talk a little bit more about the domestic political economy in the United States, your own country, and how you think these things will play out in terms of the movement away from being such a big deficit country?</p>
<p><strong>Jeffry</strong>: Right. Well, I think that the overriding reality of the American political economy in the last 30 years is that income distribution has deteriorated continually since 1973. Since 1973, the real wages of low skilled American workers have declined almost continually. And there really are two moments in this. The first is the '70s and '80s.</p>
<p>In the '70s and '80s, you had the bottom falling out of the low skilled labor market. And so there was an increasing gap between the bottom, say, 25 or 30 percent of the labor market and the rest of the society.</p>
<p>And that was very worrisome because it was associated with a lot of other pathologies, including social pathologies, crime and the decay of the inner cities, the collapse of the former industrial cities.</p>
<p>Then the second moment is in the '90s up to today. And in that period, what happens is that the wealthy in America separate more and more from the middle classes.</p>
<p>And so you have, in the first period, a growing gap between the poor and the rest, and now it's a growing gap between the middle class and the rich. This has been at the center of a lot of American politics.</p>
<p>The conflicts were mitigated, to a very large extent, by the consumption boom of the last 10 or 15 years, because when the pie is growing, people don't really argue that much about how the pie is divided. But that consumption boom is now over, and so we're going to have to deal with it.</p>
<p>Now, one aspect of this deterioration of income distribution that I think is very important, both within the United States and to the rest of the world, is that in the minds of many Americans, the deterioration of the income distribution in the US, the growing gap between rich and poor, or between rich and middle class, is closely associated with globalization.</p>
<p>15 years ago globalization was seen as a very positive trend. It was used in euphoric Thomas Friedman-style terms. But that's all changed. Today you almost never hear the word &quot;globalization&quot; used in anything other than sort of a curse word.</p>
<p>Globalization is associated on the one hand with throwing American unskilled and semi skilled workers into competition with two billion very, very low paid Chinese and Indian and other Asian workers. Which means that this is the source of, or a source, of downward pressure on real wages for the poor.</p>
<p>And globalization is associated with outsourcing of middle class jobs, and with the rise of what sometimes is called the &quot;headquarters&quot; society. That is the transition of major American corporations from actually producing things to running global networks, where the good jobs are for accountants and lawyers and patent attorneys and people in R&amp;D, or for that matter investment bankers, back when we had investment banks. All of whom are making millions or zillions.</p>
<p>There's a lot of academic debate over this, and I think the consensus is more tempered, but the reality is that Americans associate globalization with an increasing gap between rich and poor.</p>
<p>Not only that, but there's a very clear relationship between wealth and favorable views on globalization, that the poorer Americans are, the more hostile they are to trade. The richer they are, the more favorable they are to international integration and trade.</p>
<p>I answered your question, or I tried, or I didn't answer your question, I approached your question by saying this is the reality, I think, that we have. The politics of the gap between rich and poor in the US has been important and it's become more and more central.</p>
<p>It is going to be implicated with globalization, with the place of the United States in the world economy. And that's why domestic American politics will be important for the rest of the world.</p>
<p><strong>Romesh</strong>: Let's move on then to talk about the political economy of trade and how you see that playing out. We see trade fall drastically as a result of the financial crisis. And we've seen the emergence of all kinds of different protectionism, &quot;murky&quot; protectionism some people call it. I'd be interested in your reflections on that, and how it fits in with the whole World Trade Organization process and the attempts to finish the Doha Round.</p>
<p><strong>Jeffry</strong>: Of course trade drops dramatically in any recession. It's dropped particularly dramatically in this recession. As Eichengreen and O'Rourke have shown, it's dropped more in this recession than it did during the early years of the Great Depression of the early 1930s, which is very worrisome. On the other hand, we had seen such an extraordinary increase in world trade over the past 20 years that we're declining from a very high level.</p>
<p>I'm guardedly optimistic about world trade in general, because I think today, unlike 25 or 30 years ago, there is a very broad consensus that international trade is a good thing. 30 years ago the consensus on international trade being a good thing extended pretty much to the developed countries.</p>
<p>Developing countries, with a few exceptions, and certainly the communist countries, were unenthusiastic or openly hostile to international trade. And today we see sort of the opposite. We see some of the most enthusiastic proponents of expanding international trade are the developing countries and the former communist countries.</p>
<p>So that, I think, is a good thing. I think that people have gotten their minds around the notion that it's very hard for a country to do well for its own people without playing a major role in the international trading system.</p>
<p>But I think the crisis will introduce a very large number of very important and very worrying tensions into the international trading system. And since we've been talking about the United States, let's stay on that and focus on that. There are a lot of other things we could talk about.</p>
<p>But with respect to the United States, what's the United States going to face? It's going to face a very serious set of macroeconomic pressures to reduce its imports and increase its exports. And in particular to increase its exports.</p>
<p>Many of our major export industries have either disappeared because they've been driven out by imports, or they've really been able to focus on the domestic market because the domestic market has been growing so rapidly.</p>
<p>There's going to have to be a reorientation of American industry, and by industry I don't mean only manufacturing, but of the American economy towards exports.<br />
Now our exports are not in textiles or steel or auto. Our exports are in things like Hollywood movies. They're in capital equipment. They're in commercial aircraft. They're in services, lawyer services, accounting services.</p>
<p>But those are all exports. And they're important exports. They also tend to be extremely controversial. So you think of commercial aircraft, if one of our goals is to increase our exports and one of our principal exports is commercial aircraft, we cannot increase our commercial aircraft exports without running up against Airbus.</p>
<p>And for that matter, against the Brazilians and the Canadians and the Chinese, who are more and more interested in the commercial aircraft market.</p>
<p>So I think the US is going to find itself pushed to export more. And when the US finds itself pushed to export more, it tends to engage in unilateral trade policy measures that the rest of the world finds very troubling.</p>
<p>The super 301 kinds of policies where we slap prohibitive trade barriers on what are regarded as the unfair trading practices of our trading partners. Often things which are frankly illegal under the WTO.</p>
<p>But since we're the 1,000 pound gorilla in the room, we feel that we can push our weight around. I think we're going to see a lot more 1,000 pound gorilla-ing, a lot more of the US pushing its weight around to open markets, and perhaps even to close some of its own.</p>
<p>It's understandable from the standpoint of the US. The US needs to export more. The US needs to improve its ability to compete in world markets. There is a lot of intervention in markets, and sometimes the American complaints about other countries are completely justified.</p>
<p>The method by which the US complains or reacts often is unhelpful in the sense that it tends to enforce unilateralism and reduce or stand in the way of the development of multilateral international institutions.</p>
<p>I think that people are very concerned that with the Doha Round stalled yet again, and with the WTO confronting a whole series of issues like the rise of regionalism in trade, and with the prospects of countries like the US and perhaps China pursuing more unilateralist trading measures, that the trading system will start to fragment.<br />
I think that is a real threat. I tend to be guardedly optimistic, but I think that the aftermath of the crisis will put the international trading system, and in particular the WTO, under real strain.</p>
<p><strong>Romesh</strong>: Let's talk about one of the US's, at least formally, largest export sectors, financial services. What do you see is going to happen there? Are we going to see some real changes in response to the financial crisis and the widespread belief that it was all caused by the bankers?</p>
<p><strong>Jeffry</strong>: Far be it for me to defend bankers, but I think let's go back and step and say where the causes lie. I think we have to be clear, or I would argue that although banking and bank regulation played an important, central role in the crisis, that the underlying macroeconomic trends and underlying macroeconomic policies were the enabling factors. So without the US running a current account deficit and borrowing half a trillion a trillion dollars a year from the rest of the world, the financial shenanigans and the regulatory laxity that we observed as that took place, would have been far less relevant and far less troubling.</p>
<p>So to put blame where blame deserves, American policy-makers deserve a lot of blame not only for the regulations or lack of regulations, but also for the macroeconomic policies that they pursued despite the fact that people from the BIS, the IMF and every economics department in the country saying, &quot;Look, these deficits are unsustainable and something has to be done about them.&quot;</p>
<p>So I would say there's plenty of blame to go around and the to see politicians who refused to sign on to any form of adjustment measure turned around and blamed bankers for having responded to the incentives the policy-makers created is a little bit jarring, but that's politics.</p>
<p>With respect to financial services I think that one thing is crystal clear which is that the American people are now quite adamant that they want the regulators to be far more observant and far more stringent about what goes on in financial markets.</p>
<p>Now whether that will have the desired effect or some undesirable side effects remains to be seen. But certainly regulation will not, for a long time, be as lax as it was over the past 15 years. And I think, generally speaking, that's a good thing.</p>
<p>Financial services themselves, I think, are going to be reduced. A lot of the work that we've seen, and a lot of the analyses that I've seen indicate that the enormous imbalances, and the huge inflows into the US led to an artificial pumping up and inflation of the financial services industry.</p>
<p>Now people in New York might disagree, but the fact is that there were too many people working in finance and finance just was playing too large a role in the US economy.</p>
<p>It wasn't just the US, I mean you can go to Ireland, you can go to Spain, you can go to the UK and you find very similar phenomena. When you're pulling in five percent of GDP a year from the rest of the world in financial assets, or liabilities, the financial services industry is going to expand.</p>
<p>Those countries aren't going to be borrowing from the rest of the world, they have, and the financial services industries are going to have to be reduced in size.</p>
<p>So to paraphrase Winston Churchill, finance will be standing less proud, I think, in the coming years. Both because it'll be smaller, and because it has less to be proud about. There are enduring questions about how finance is organized, both at the micro level and the macro level.</p>
<p>Should bank regulation be fundamentally revised in the US, should Glass-Steagall be reintroduced, should new forms of regulation be implemented? Complicated issues which we can address but the specific thing I sensed under what you were saying is the organization of finance itself.</p>
<p>Even Alan Greenspan, a great believer in efficient markets and in efficient finance, has recognized there was something fundamentally flawed in the business model that financial institutions were using.</p>
<p>That there was a disconnect between the interests and incentives of loan officers up and down the chain, share holders, bank officers, the lenders, the distributors, such that transparency was lost and the reigning reality of American finance became the opacity of a whole series of very complicated financial instruments.</p>
<p>That opacity fed directly into the panic that took place in the summer and fall of last year.</p>
<p>So I think financial institutions will find it in their own interests to pursue more transparency and to try and find more high powered and better incentives for the people that work for them. And the regulators will contribute, I think, by trying to ensure that that is the case that transparency is valued more highly than it has been.</p>
<p><strong>Romesh</strong>: Final question, Jeff, can we talk a little bit about the whole system of global economic governance. There seems to be a shift that has happened as a result of the crisis. We've seen them move away from the G7, G8, towards the G20 and all sorts of other discussions about the reactions to the change in the shift of economic power in the world. What's your reflection on how that's working out?</p>
<p><strong>Jeffry</strong>: I think it's been remarked many times here, and I've been struck over the past couple of days how many people have said that the G7, G8 has become less relevant and the G20 more relevant. Often they then add a footnote saying &quot;well, it's not really the G20, it's really the enhanced G8 G8 plus five&quot; or something like that. I think the idea is that we now understand that there is a group of countries that have to be involved in any discussions over global economic governance. That is the G7, some people will say the G3, it's really the U.S., the E.U, and Japan, from the developed country's standpoint. And then what are sometimes called BRICSAM from the developing country context, that is Brazil, Russia, India, China, South Africa, and Mexico. You can add or subtract a couple of countries, but it's pretty clear that it's hard to talk about global financial governance, for example, without including China.</p>
<p>China was at the center of a lot of the lending, borrowing imbalances that are essential to the crisis. The Chinese exchange rate regime, and Chinese exchange rate policy are central to the adjustment efforts that are undertaken and they are extremely controversial.</p>
<p>So to expect the G7, or the G8 to be the locus of global economic governance is not going to happen, not in the foreseeable future because countries like China, and India, and others, are just too important.</p>
<p>So I think that there is a growing recognition of the desirability of broader consultation among these dozen or so countries. I think the response of central bankers around the world to the crisis initially and as it has gone on has been encouraging in many ways.</p>
<p>Continuing that thought, in the abstract, from a purely theoretical standpoint, we could say markets are now global, when markets were local they were regulated by local authorities, when they became national they were regulated by national authorities, now that they're global they should be regulated by a global authority.</p>
<p>That's a wonderful story, I tell it to my students all the time, it's a nice fairy tale, but we don't have a global government. So people talk about global governance as if it were something that could be done by our existing global government.</p>
<p>We don't have a global government, and the most likely source of global governance, in fact the only possible source of global governance, is national governments.</p>
<p>So although there is an increasing belief in the desirability of consultation among the national governments the only way that will be translated into true global governance &ndash; and what I mean there in the limited sense, that is a global attempt to deal with global problems &ndash; is if national governments, and national publics are willing to sacrifice some portion of their sovereignty and some of their economic benefits in the interest of the world economy.</p>
<p>One of the reasons the world economy collapsed in the 1930's, and it wasn't because countries were predatory, and evil, and trying to do evil to each other. It was that domestic publics were not willing to make the sacrifices necessary to sustain an integrated domestic economy.</p>
<p>The real question about global governance is to what extant are national publics in the major powers willing to pay, that is to make sacrifices whether it's in taxes, or in consumption, or in spending, to make sacrifices in order to contribute to international economic integration.</p>
<p>There are some countries in the world in which there is a broad consensus, domestically, in favor of doing what's necessary to maintain openness to the world economy.</p>
<p>But there are many other countries, such as my own, where that consensus is much less clear. So I think the future of global governance will be determined at the domestic level within the major powers.</p>
<p><strong>Romesh</strong>: Jeff Frieden, thank you very much.</p>
<p><strong>Jeffry</strong>: Thank you.<br />
&nbsp;</p>