Global Economic Restructuring

By: Michael Spence

Powerful implications of the Restructuring of the World

A decade after the collapse of Lehman Brothers, the world economy is back on shaky ground. In its latest World Economic Outlook, the International Monetary Fund (IMF) has warned that the world economy is at risk of another financial meltdown, following the failure of governments and regulators to push through all the reforms needed to protect the system from reckless behaviour. The report further states that much has been done to shore up the reserves of banks in the last 10 years and to put in place more rigorous oversight of the financial sector, but “risks tend to rise during good times, such as the current period of low interest rates and subdued volatility, and those risks can always migrate to new areas.” In this article, Michael Spence, a Nobel laureate economist discusses the prospects of restructuring the world economy and the powerful implications it will have. 

The global economy is undergoing a far-reaching transformation. Change is being driven by shifts in countries’ populations, productivity, wealth, power and ambitions, and accelerated by US President Donald Trump’s moves to reshape supply chain structures, alter cross-border investment incentives and limit the movement of people and technology across borders.

The tensions that these changes are producing are most apparent in escalating disputes over trade. Notwithstanding some dislocations in emerging economies, markets’ reaction to the tit-for-tat tariffs so far has been only muted. Investors probably assume that it is all just part of a renegotiation process that will ultimately produce new rules of engagement for global business — rules that are even more favourable to the powerful.

But such assumptions may underestimate the complexity of the issues at play, beginning with the politically salient matter of where investment and employment are created. On their own, tariff and trade barriers, if viewed as transitory negotiating tactics, will not significantly change global investment patterns or the structure of global supply chains and employment.

Protectionists like Trump argue that the power of tariffs and other trade barriers lies in their ability to curb cheating and free-riding. The implication is that such measures can help to eliminate the tensions, imbalances and polarization associated with globalization.

“Cheating,” of course, is in the eye of the beholder. State subsidies for specific sectors, including preferential treatment of state-owned enterprises, may be regarded as cheating. So may requiring technology transfer in exchange for market access, public procurement favouring domestic entities, acceptance of unsafe work environments and exploitative labour practices, and exchange-rate manipulation.

Read More: The State of the Global Economy in 2018

The test of free-riding is whether a country contributes too little, relative to its capacity, to the provision of global public goods, such as defence and security, scientific and technical knowledge, mitigation of climate change and absorption of refugees. The culprits depend on the topic in question.

But, whatever the downsides to cheating or free-riding, tackling these behaviours is unlikely to eliminate the conditions that have contributed to economic, social and political polarization. After all, labour arbitrage has been the core driver of the organization of global supply chains for at least three decades — accelerating, of course, with China’s rise — with significant distributional and employment effects. It seems unlikely that, had China and other emerging economies adhered to the letter of World Trade Organization rules, the distributional effects of their integration into the global economy would have disappeared.

What, then, is the real purpose of the tariffs? Trump could be interested only in levelling the playing field, at which point he will accept global market outcomes. But it is more plausible that this is all part of his strategy — echoed by leaders in a growing number of countries worldwide — to win support by asserting national priorities and sovereignty.

Such efforts are pushing the world toward a more balkanized system. Moreover, the challenges and fears raised by advances in technology, especially digital technology, with regard to both national security and economic performance are also propelling the world toward greater fragmentation.

Fifteen years ago, few would have predicted that mega-platforms like Google or Facebook would become key players in areas like image recognition, artificial intelligence and the development of autonomous vehicles (including military vehicles). Yet that is exactly what has happened. In fact, Google is now a defence contractor (though it may not renew its contract).

Given the security implications of these developments, as well as a host of issues like data privacy and security, social fragmentation and foreign interventions in elections, countries are unwilling to leave the internet unregulated. But, they are also unwilling to delegate regulation to a supra-national body. As a result, many are taking matters into their own hands, leading to a growing divergence among countries regarding internet regulation.

Reflecting the national security tilt of these initiatives, the scope and authority of the Committee on Foreign Investment in the United States — responsible for reviewing the national security implications of foreign ownership of US companies or operations — has recently been expanded.

Despite these efforts, however, the fact remains that innovation cannot easily be blocked by national borders. On the contrary, the diffusion of ideas may well become the most consequential dimension of globalization in the future.

While this may complicate national security planning, it represents powerful new opportunities for business, even as trade faces headwinds. Already, there has been an explosion of innovative, digitally based business models, many of which could become powerful engines of inclusive growth, especially in emerging economies. Digitally enabled ecosystems, with open architecture and low barriers to entry, are one example of an emerging model with considerable economic potential.

There is one more crucial dynamic that will shape how the global economy will develop in the coming decades: the strategic rivalry between China and the US. At this point, it is impossible to say precisely what form this rivalry will take. What is clear is that every part of the global economy will be affected by the mix of cooperation and competition that emerges.

In the face of a powerful rival, one might expect the US to pursue a strategy focused on building, expanding and consolidating alliances with natural allies — that is, countries with similar governance structures and shared views about the benefits of international cooperation and open markets. Instead, Trump has alienated longtime allies and attacked multilateral structures and institutions, all while antagonizing China in what is quickly becoming a two-player game.

This is a bizarre strategy. Whatever advantage Trump thinks he will gain by positioning the US in opposition to its natural allies will be dwarfed by the losses. A split between the US and its traditional allies, if it becomes a permanent feature of the new global order, would lead to deeper fragmentation among the world’s market-oriented democracies. That will surely shift the long-term balance of power in China’s favour, as it moves steadily toward becoming the world’s largest economy.

Growing threats in the global economy

Since 2008, leading central banks have pumped trillions of dollars into the global economy. The big commercial banks at the centre of the crisis have recapitalized; financial markets have rebounded; government spending has been squeezed and wages have stagnated. But, this economic mix has failed to generate robust recoveries in advanced economies, and with debt levels higher than ever and income gaps widening, more and more people feel anxious about future prospects.

Emerging economies were also hit by financial shockwaves but they recovered more quickly. In reality, much of their recovery was dependent on the liquidity splurge in advanced economies, triggering a borrowing spree, particularly by the corporate sector, as investors sacrificed caution in search of yield.

Though advanced economies have not done enough to rebalance the global economy, the worry now is that normalizing monetary policy could send shockwaves through capital and currency markets in developing countries. The damage is already apparent in some emerging economies but there are many others in a vulnerable position. Mitigating the problem is likely to be all the more difficult given the failure of post-crisis reforms.

The financial crisis revealed the difficulties for policymakers when banks become “too big to fail” but in our hyperglobalized world, the accumulation of concentrated economic power is not confined to financial markets. Global trade is dominated by big firms, including through their organisation and control of global value chains. The spread of these chains contributed to a very rapid growth of trade from the mid-1990s up to the financial crisis, with developing countries seeing the fastest growth, including trading more with each other.

Participation in these chains seemed to promise a path to higher value-added tasks and more diversified economies. This has rarely happened, and where it has, notably in the case of China, the policies that made it possible are now being presented as a source of disruption to the trading system, requiring reforms to the World Trade Organization to ensure other developing countries do not follow suit.

Moreover, as less of the value created has been retained in the fabrication links in these chains, rents have flowed to pre- and post-production activities, with the gains skewed in favour of the lead firms, thanks to a mixture of increased market concentration and control of intangible assets. As a result, the profits of larger firms, particularly those operating internationally, are hitting all-time highs as the share going to wages declines.

Many developing countries, nowadays, are putting their faith in disruptive digital technologies, hoping the widespread use of data intelligence will strengthen development prospects. It may well be. However, monopolization is, if anything, an even bigger threat in the digital economy than in the analogue economy. In particular, super platforms have been able, through strengthened intellectual property rights, first-move advantages and sheer market power, to establish a monopolistic hold over data that allows them to create super profits and to close down the possibility of newcomers entering the field. Developing countries are particularly vulnerable on both fronts.

Active policy initiatives combining targeted industrial policies, tailored financing mechanisms and regulatory measures, including support for data localization, will be essential along with South-South Cooperation (a term historically used by policymakers and academics to describe the exchange of resources, technology, and knowledge between developing countries, also known as countries of the Global South) to ensure international agreements preserve policy space.

The uncomfortable truth of our hyperglobalized world is that footloose finance plus unequal trade plus unaccountable corporations are posing challenges for policymakers everywhere. But neither a retreat to nostalgic nationalism nor a doubling down on support for “free trade” provide the right response.

In this world, deploying the big tariff guns will do little to correct the macroeconomic imbalances that lie behind the heightened anxiety of depressed northern communities or to break the Medici vicious circle of corporate political capture and rent-seeking behaviour. Equally, calls for extending free trade will simply provide ideological cover for a world dominated by large, footloose corporations, where free trade agreements, while promising a level playing field and more inclusive outcomes, have curtailed policy space for developing countries and cut away protections for working people and small businesses, even as they have carved out more space for predatory international firms to boost their profits.

Reviving multilateralism will only happen if trust can be restored to the system. That will require rules for managing trade that can support commitments to full employment and rising wages, regulations for curtailing predatory corporate behaviour and guarantees of sufficient policy space to ensure countries can integrate into the global economy without compromising sustainable development goals.