Where is our global economy headed in the 1990s? The most fashionable script says that we are moving into an age of unprecedented international economic integration, that market technology, telecommunications, and faster transportation have shrunk the world, that borders are dissolving, and that We are about to see a globalization of business.
I'm reminded of an old South American joke that says Brazil is the country of the future, and always will be. Some now see our global economy as the wave of the future. Well, my great grandchildren may live in that world, but I doubt that my children will.
What I would argue is that we're heading for regionalization, a breaking up of the world economy into blocs. Twenty years from now, we will consider this period the decline of the second global economy.
Let's review some history. All of us have lived in a world in which the trend toward world trade and world capital movement has seemed inexorable. And, indeed, traditional trade flows, as a percentage of our GNP, are about three times what they Were in 1950.
But when you take a longer look at history, you discover not a great upward slope, but a U-shape. As a share of GNP, U.S. imports in 1950 amounted to less than half of what they represented in 1890. A really impressive degree of international integration through trade was achieved back before World War I. But this first global economy disintegrated in, the period between the World Wars. The ratio of trade to total output that was achieved by industrial countries in 1913 was not reached again until the early 1970s.
Moreover, by 19th century standards, the world is still not an exceptionally integrated economy. The U.S. now imports about 12 percent of its GNP. But Great Britain imported more than a third of its GNP under Queen Victoria. We are considerably less dependent on foreign trade, in fact, and probably always will be, than Britain has been since the Napoleonic wars.
International trade isn't the only dimension of economic integration. There are two other categories. Cane is the integration of capital markets. Technology has brought big changes in moving information around. But, while we have increased the volume and complexity of our international transactions, we have not increased our ability to transfer real resources, and that is what capital markets are supposed to do.
Another historical note: We became rather upset recently when Japan began exporting what we considered to be huge amounts of capital. For a couple of years in the 1980s, this was about 4 percent of its GNP. But the United Kingdom during the 40 years before World War I ran an average current account surplus of 4 percent of GNP. To put it another Way, the U.K. exported about 40 percent of its savings abroad, compared to 20 percent for Japan in its peak years.
The third area of economic integration is the mobility of labor. Here, there is no doubt that the world has closed down the international movement of people. Even the Statue of Liberty no longer receives millions of immigrants a year to our shores.
What all of this says is that, while technology can integrate the world, whether it does so depends on politics. Many think that the tremendous slump in economic integration that began in 1913, and which wasn't overcome until about 1975, demonstrates that technology overrides politics. But they have it exactly backwards. Political obstacles to economic integration beat technology every time.
HEADED TOWARD A SLUMP
Those who look back at international integration in the year 2100 will see a series of waves. Each wave is successively higher as technology improves, but there are slumps between the waves. And what I would argue is that we are now headed toward one of those slumps. The first global economy crashed, so to speak, on the shores of World War I. The second global economy is about to crash on new shores. Let me give you two examples that suggest this.
The first one is obvious, the series of international trade negotiations under the aegis of the General Agreement on Tariffs and Trade. In each round, negotiators from a large number of countries have come together to reduce barriers to world trade. The five rounds held in the 1950s were extremely successful. So Was the next series of negotiations, the Kennedy round of the early l96Os. Their success resulted in vast growth of world trade.
Next came the Tokyo round in the 1970s, much of which was undermined by new restrictions to trade. The Tokyo round was a success, but if the Kennedy round was a lion, the Tokyo round was a mouse.
The third round is the Uruguay round, programmed to be a triumphant success, with an announcement in Brussels in late 1990. But, as everyone knows, that is not the way it turned out. The key sticking point was agriculture, the area in which the United States had thought the biggest progress would be achieved. But the Brussels meeting broke up in disarray. This had never happened before, but it continued a trend in which each round was less successful than the previous one.
The second indication that the global economy is about to crash is more offbeat. It is the Third World debt problem. We say today that these countries borrowed vast amounts and ran up huge debt burdens because no one was looking. But that's not the way it was at the time. And, in fact, if we look at the current Latin American debt numbers, they don't look that bad.
Brazil is less heavily indebted today relative to its GNP than the United States was in 1890. None of those major Third World debtors, in fact, has a burden that is more than 3 percent of its national income. It is hard to see that number, or even the cost of servicing it, as a killing burden. So what happened? Economics and politics became intertwined. It wasn't that countries couldn't service their debt. The question was whether they were willing to do so. And because this was unclear, the rolling over of existing obligations collapsed in 1982.
While these countries might have been able to service their debt, thus assuring that it remained constant while their economies improved, they certainly couldn't have met all those cash payments on the short-term debt that was not being rolled over. So there was a financial crisis that sent these countries into a political and economic tailspin. Only after 10 years is the dust settling.
The result was that these levels of debt, while not large in historical terms, ended up being too large for our modern system to bear because the political base wasn't there. Compare the great age of international capital movement before World War I, when many countries ran up debts far higher than those of today's Latin American countries, and then repaid them. Canada should have been a basket case. At various times, it ran current account deficits of 10 percent of its GNP. This was possible, in part, because people didn't keep balance of payments statistics in those days so they didn't worry.
The world today is smaller because of technology, but it is also larger because of fewer links between distant countries. With all our talk that distance no longer matters, given the ease in sending electronic mail or faxes to the other side of the world, if we study where economic integration has occurred between nations in the last 10 years, it is within regions. The two big success stories are the European Community and the North American Free Trade Area.
DISORGANIZED CONSUMERS AND A DEFLOWERED U.S.
Why is this happening? Why are the political reasons for an integrated world economy so much weaker than the technological reasons? In an ideal world, most economists would agree, the free movement of goods, of services, of capital, of multinational enterprises, and probably of people is in the best interests of both the world economy and individual countries. But there is usually little connection between actual trade policy and what's good for a country. Trade policy is made in the real world of politics. And in that world, national welfare doesn't vote. Only interest groups vote.
Thus, well-organized interest groups, like producers, have more influence than disorganized groups like consumers. One example is our import quota on sugar. For the 250 million Americans who eat it, sugar is hidden in a variety of processed foods. Only the producers understand the importance of the quota.
Some might ask why protectionism, or economic nationalism, hasn't prevailed more since World War II. It is because of two factors: leadership and reciprocity.
By leadership, I mean that until recently there was one big kid on the block, and that was us. The United States was prepared to twist people's arms to make things work. It was also prepared to make concessions to grease the wheels of progress. Even the institutions of the post-war era, such as the World Bank, the IMF, and GATT, were institutions run by the United States and its friends.
But that's not going to work anymore, because we're not big enough. In 1960, the United States produced 60 percent of the world's GNP, the nations of Europe, 35 percent, and Japan, 5 percent. By 1989, the U.S. was down to 40 percent of the world's GNP, the Europeans were at 39 percent, and the Japanese, thanks to a rounding error, accounted for 22 percent. The United States has gone from being half again as big as the other blocs combined to their being half again as big as us.
So why cannot these players now get together and agree? We hoped that would happen in the Uruguay round, that the emerging European group would be prepared to take some responsibility for sustaining the system. It wasn't. The votes of the 5 percent of EC workers who are still on the farm carried more weight than those responsible for the rest of the system.
The other factor in limiting protectionism has been reciprocity. Whatever the underlying economics are, it is an accepted principle that if you are going to open your markets to imports, to capital, to foreign direct investment, you need to convince your own domestic interests that you have a reciprocal access to foreign markets. There is one problem with this concept today, however, and it is a one-word problem: Japan.
I would agree that the caricature of Japan as a country to which you can't sell and in which you can't invest is valid. But it really doesn't matter if Japan fits that description. What matters is the perception of Japan. What matters is that trade or investment negotiations with Japan just don't have the same meaning as in the United States. Japan is institutionally different. The same rules of trading don't apply. So even though Japan has no legal barriers to direct investment from abroad, foreign-owned firms today account for only 1 percent of the value added to the Japanese economy. This is the same percentage as 30 years ago and supports my thesis that there is no movement toward a more open world economy.
Also countering any trend toward a global economy will be the collapse of the Soviet Union. Clearly, one of the factors that suppressed economic nationalism in recent years was that Western nations had a common enemy. Free trade was not just a matter of economic efficiency but also a way of binding together the free nations of the world. Now that reason is gone. Is the return to trading wars so far behind?
So what will the next few years bring? I don't visualize a great trade war, nothing that dramatic. But I do see a creeping protectionism on trade, creeping restrictions on foreign investment, and an inward turning of the world into trading blocs. They already exist in North America and the European Community, and, more obscurely, in the investment ties between Japan and some Pacific Rim countries.
Members of these trading blocs will claim that what they have done is not at the expense of their relations with the outside world. The Europeans say they are not creating Fortress Europe. We say that the North American Free Trade Area will not turn into Fortress NAFTA. Nor will the Japanese concede any emerging trade bloc.
But all that is nonsense. For the next 10 to 15 years, those on the inside of these blocs are going to have a stronger voice than those on the outside. When inexpensive garments or electronic goods from South Asia undercut a Mexican export industry in those areas, will the man from New Delhi carry as much weight in U.S. trade counsels as the man from Mexico City? Of course not. Nor will the man from Beijing carry as much weight in the EC as the man from Lisbon.
It is inevitable that we will become more restrictive against trade from the outside. In fact, just by providing preferences for our neighbors, we will divert world trade from trade between blocs to trade inside blocs. As for direct investment in other blocs, my guess is that it has passed its peak. Recent discussions about limiting the sales in the U.S. of Japanese autos made here illustrate this.
My scenario calls for a milder replay in the next decade or so of what happened between the two World Wars. Industrial countries will have a real economic growth of, say, 3 percent in that period. Trade between blocs will grow slower, say at 1 to 2 percent. Trade within the blocs, however, will grow at 5 or 6 percent. There will be fewer multinational firms, counting EC firms as being from one nation. And the movements of long-term capital from north to south or from bloc to bloc will be remarkably small. One saving grace is we're not talking of a balkanization of the world. These trading blocs will be huge entities.
The importance of free trade and the evils of protectionism are both usually overstated. Protectionism, for example, did not cause the Great Depression of the 1930s. And so we should not be swept up by the romance of mega trends, thinking that integration of the world's economy is inevitable. It isn't. A world without borders is a possibility, yes, but it is a possibility that depends on politics. And politics today is moving the wrong Way.
Originally published, 3.92