Global Political Economy: Glossary (Part 5) T-Z

Tax Haven: A tax haven generally refers to a country, often an offshore island country, where taxes are very low or near zero. Those wishing to avoid taxes can invest their money in these countries and avoid paying taxes to their home governments.

Taylorism: Techniques of production using discipline and organization in the workplace. Production is based upon the scientific study of human efficiency and how much speed the human body can tolerate in the work place. It also uses incentives to increase the speed of work and exploitation. Used widely in US and Europe. Also used by Lenin and the Bolsheviks to modernizes production in the Soviet Union. See Harry Braverman. Labor and Monopoly Capital.

Technocratic Rule: Technocratic rule or management of the economy is frequently seen under neoliberal regimes when the economy has suffered a recession or is under austerity. For example a technocrat prime minister was appointed as Prime Minister of Greece after the economic crises in 2010. In this way, the country may avoid populist pressures to maintain benefits for the poor, elderly and working classes.

Technological Leapfrogging: Technological leapfrogging can be achieved by developing countries when they adopt technologically advanced methods of production as they industrialize. This means that they avoid going through the stages of older less efficient and polluting technologies and advance to more sophisticated technologies at once. This might provide them an advantage in the global market over countries which are still using less efficient production techniques.

Technological Spillover: Technology spillover happens when new technologies developed by a particular firm or group of firms becomes available for use by other firms or countries. The monopolization of a new technology by a particular firm may be relatively short term as other firms gain access to the technology.

Technology Transfer: Technology transfer happens when knowledge, technologies, skills, manufacturing techniques, and other technologies are learned and adopted by other countries, particularly developing countries. For example the technologies for the production of radio, television and video machines by the United States was quickly transferred to Japan in the l950s and l960s. 

Terms of Trade: The terms of trade indicate the relative price of exports of a country in terms of imports. It is the ratio of export prices to import prices. When the price of exports rise, a country can import more products. If the price of exports fall, the country can import less. The terms of trade generally militate against countries which depend upon the export of primary products such as bananas or coffee, because the price of agricultural products is likely to fluctuate greatly in the global market. For example, if the price of coffee falls, a country will have to export a large amount of coffee to buy a bulldozer.

The Theory of Capitalist Development (1942): A seminal book by the Marxist economist Paul Sweezy which extended the theories of Karl Marx to the twentieth century economy of the United States. Sweezy analyzed the operation of monopoly capitalism as it existed in the United States in the twentieth century.

Time Preference Theory of Interest (Irving Fisher): A concept from Irving Fisher that interest is a reward for not consuming things today, but putting off consumption until a later time.

Tobin Tax:  A tax proposed by the late economist James Tobin on international Financial flows but never established. The tax would provide a fund to help bail out countries in financial crises.

Tokyo Round: Trade talks under GATT which began in September 1973 and lasted for 74 months, involving 102 countries. The talks addressed the issues of tariffs and non-tariff measures. The talks resulted in tariff reductions worth 300 billion dollars in world trade.

Toxic Imperialism: Toxic imperialism happens when nations or firms act in such a way as to pollute other countries and profit from doing so. One form of toxic imperialism is dumping toxic waste in low income countries which lack environmental regulations. This can happen through the trade in toxic waste, often mislabeled. Another form is using countries with lax environmental regulations to produce products.

Trade Barriers: Trade barriers are restrictions on international trade, particularly tariff barriers, for the purpose of protecting the survival and profits and of domestic industries. Other types of trade barriers may include quotas, technical regulations, tax policies, and government subsidies to industries.

Trade Protectionism: Barriers to foreign trade, particularly tariff barriers. The major argument for trade protectionism has traditionally been to protect small industries.

Trade Rounds: Generally refers to the trade rounds carried out under the General Agreement on Tariffs and Trade (GATT) in the late twentieth century. The major trade rounds were the Kennedy Round, the Tokyo Round, and the Uruguay Round. The Doha Round has been carried out under the World Trade Organization. 

Traditional Growth Theory: May refer to the theories developed by Robert Solow and others in the l950s. Traditional growth theory posited that economic growth was a function of labor and capital. Technology and human knowledge were considered as exogenous variables. There were seen to be constant returns to scale.

Transatlantic Trade and Investment Partnership (TTIP) A trade investment agreement between the European Union and the United States which was being secretly negotiated through 2014. Talks began in Washington, DC in July 2013 and continued. Objectives of the trade agreement is to remove barriers which will result in millions of dollars of savings to US and European companies. It is argued by liberal proponents that everyone will benefit. Objectives also include cutting tariffs, standardizing technical regulations on products, opening up markets to services and investment, restricting subsidies to state owned enterprises, ensuring a market for genetically modified foods now restricted in Europe, and coordinating regulations in the financial sector between the EU and the United States.   

Transfer Pricing: Transfer pricing is the setting of prices between different branches or companies of a single corporation which are generally located in different countries. The misuse of transfer pricing involves pricing to lower the profits of a company in high-tax countries and raising the profits of a branch in a low-tax country. Transfer pricing is the major tool for corporate tax avoidance.   

Trans-Pacific Strategic Economic Partnership Agreement (TPSEP): A trade agreement of 2005 among Brunei, Chile, New Zealand and Singapore. The purpose was to liberalize trade in the Asia-Pacific region.

Trans-Pacific Partnership (TPP): A proposed expansion of the Trans-Pacific Strategic Economic Partnership Agreement (TPSEP) which has been negotiated beginning in 2010. The potential members include Australia, Brunei, Chile, Canada, Japan, Malaysia, Mexico, New Zealand, Peru, Singapore, Vietnam and the US. The agreement might also include Taiwan and South Korea. A round of secret negotiations began in August 2013. Information about the large scale deal was leaked to the public and on November 13, 2013, the complete draft of the Intellectual Property Rights chapter of the agreement was published by WikiLeaks. There are many concerns about the potential agreement. Joseph Stiglitz has said that the TPP presents grave risks.

Turkish Financial Crises (2001): The 2001 Turkish Financial Crises broke out in February. Turkey was under an IMF structural adjustment program with the Turkish Lira pegged to the dollar as a crawling peg. In November, 2000, the banks had liquidity problems with a loss of confidence in the system. The central bank injected a large amount of liquidity into the system, violating its own rules. But this had little effect as a large amount of money flowed out of the country. The current account deficit rose sharply due to high imports. Interest rates rose. On February 19, the President of Turkey, Ahmet Necdet Sezer, warned the Prime Minister, Bulent Ecevit, about corruption in his ministry. Following this, the currency peg collapsed on February 21. The currency was floated, leading to a thirty percent devaluation. The currency crashed further in subsequent days with extremely high interest rates. The Turkish Banking system was badly in need of reform and a large amount of hot money had flowed into the country to take advantage of high interest rates on Turkish liras. Turkey received a loan of 11.5 billion US dollars from the IMF. However there were many strings attached. The government had to embark on a privatization of state economic enterprises and change many laws. Kemal Dervis, a World Bank former vice president was brought into the government to carry out an extensive reorganization of the banks and the country’s economy.

Uneven Development and Combined Development: A complex theory developed by Leon Trotsky to understand global development and the potential for development in Russia under the Czar. Trotsky’s analysis led to the theory of the permanent revolution. He noted that in human history, different countries do not modernize in the same way through linear stages of growth. Also countries are affected by each other with a spill-over effect. This means that countries could skip stages, telescope development, or compress development stages in the transition to modernization. He also noted how imperialism affected the way countries under the rule of another country were changed and modernized or impeded from development.   

Uruguay Round: A round of trade talks which resulted in the establishment of the World Trade Organization. The talks began in September 1986 and continued for 87 months, involving 123 countries. Issues addressed include tariffs, non-tariff measures, rules, services, intellectual property rights, dispute settlement, textiles and agriculture. Besides establishing the WTO, the talks resulted in major reductions in tariffs and agricultural subsidies, an agreement to allow full access for textiles and garments from developing countries, and the extension of intellectual property rights.  

Use Value: Use value is a concept which was developed by classical political economists in the eighteenth and nineteenth centuries. Use value is a measure of the utility which a commodity contains as opposed to its exchange value. For example, paper money contains little use value but only exchange value. 

Utilitarianism (Jeremy Bentham): Utilitarianism says that policies are best which produce the greatest good to the greatest number of people. The theory is sometimes seen to be unethical, as it could allow the weak members of society to perish without any help if the resources used could produce greater happiness elsewhere.    

Variable Capital (Karl Marx): A concept used by Karl Marx to describe labor as a factor of production in which the cost of labor was not fixed, but subject to change according to the conditions of production.  

Virginia School of Economics: A school of economics characterized by the Public Choice approach. Major architects of the school include James M. Buchanan, Gordon Tullock, G. Warren Nutter, and Mancur Olson. A major work was The Calculus of Consent: Logical Foundations of Constitutional Democracy (1962) by James M. Buchanan and Gordon Tullock. First located at the University of Virginia, in 1969 the Center for the Study of Public Choice was established at Virginia Tech University. This center was moved to George Mason University in 1983. Theorists share the “free market” approach with the Austrian and Chicago schools. They apply economic analysis to national constitutions. Mancur Olson studied collective action and special interest groups. They have published a body of literature on rent seeking behavior.

Volatility: Volatility may refer to the rapid and unpredictable changes in the market values of major currencies in the global market. This makes it difficult to predict the prices of imports and exports and impedes international trade.

Wage Fund Doctrine: This principle says that employers must have a fund of capital available to pay the workers during the production process.

Washington Consensus: The assertion made by such organizations as the IMF and the World Bank in the l990s that countries around the world agreed with the approach of the United States that there was no alternative to instituting neoliberal economic management in countries in the age of globalization of production and marketing and that the rollback of interventionist governments along with privatization was necessary. In reality, there is little evidence of such a consensus.  

The Wealth of Nations: The famous book by Adam Smith published in 1776. Adam Smith argued that a more free market and liberal policies had an advantage over statist policies such as those advocated by Friedrich List. The book contained the idea that the free market functioned as if there was an invisible hand operating to produce a favorable result for all parties. The book also promoted the idea of free trade between countries, but noted that sometimes the worst enemies of the free market were the capitalists themselves who tended to form a monopoly in order to control the market.

Welfare Maximizing: Welfare maximizing may refer to devising economic policies which are designed to increase the social welfare of members of a society by the optimal allocation of resources to different segments of the population.

Welfare State: Welfare state may refer to the Western governments which began to provide a range of social services and benefits under Keynesian economic management after the early l930s. Social spending served as a government tool to increase effective demand and stimulate capitalist economies.  

World Bank: The World Bank includes The International Bank for Reconstruction and Development (IBRD) and the International Development Association (IDA). The World Bank is an international financial institution which was set up at the Bretton Woods Conference in the United States in 1944. It provides loans to developing countries. The official goal of the World Bank is the reduction of poverty. The first World Bank loan was made to France for 250 million US dollars, half of what was asked for. The US State Department refused to approve the loan until the French Government expelled the Communist Party members from the Government.  

World Trade Organization(WTO): The organization established in l995 under the Uruguay Round of Trade negotiations. It replaced the General Agreement on Tariffs and Trade (GATT). As of 2013, there were 159 member states in the WTO.

Zaibatsu: A zaibatsu is a type of business firm which existed in Japan before World War II. The US occupation sought to destroy the Zaibatsus but they were reorganized as keiretsus. These large firms are interlocking and their presidents cooperate in formulating joint policies. They also share in financial matters, R&D, and marketing. They form the backbone of Japanese monopoly capitalism.

 

Sources:

Amin, Samir, The Liberal Virus: Permanent War and the Americanization of the World. New York: Monthly Review, 2004.

Block, Fred L. The Origins of International Economic Disorder. Berkeley: University of California Press, 1977.

Coll, Steve, Private Empire: ExxonMobil and American Power. New York: The Penguin Press, 2012.

Dasgupta, Biplap. “The New Political Economy: A Critical Analysis,” Economic and Political Weekly, 32 (4), 1997.

Foster, John Bellamy and Fred Magdoff. The Great Financial Crises: Causes and Consequences. New York: Monthly Review Press, 2009.

Gilpin, Robert. Global Political Economy. Princeton: Princeton University Press, 2001.

Girdner, Eddie J. and Jack Smith, Killing Me Softly: Toxic Waste, Corporate Profit, and the Struggle for Environmental Justice. New York: Monthly Review Press, 2002.

Girdner, Eddie J., USA and the New Middle East. New Delhi: Gyan Publishing House, 2008.

Girdner, Eddie J. People and Power: An Introduction to Politics (third edition). Istanbul: Literature, 2013.

Heilbroner, Robert L. The Worldly Philosophers (Fourth Edition). New York: Simon and Schuster, 1972,

Hunt, E. K. and Howard J. Sherman. Economics: An Introduction to Traditional and Radical Views (Third Ed.). New York: Harper and Row, l978.

Krugman, Paul, “How the Case for Austerity Has Crumbled,” The New York Review of Books, June 6, 2013.

Krugman, Paul, “Talking Troubled Turkey,” New York Times, Jan. 30, 2014.

London, Jack, The People of the Abyss. London: Pluto Press, 1998. (First published in 1903).

Magdoff, Harry. The Age of Imperialism: The Economics of U.S. Foreign Policy. New York: Monthly Review Press, 1966.

Marx, Karl. Grundrisse: Foundations of the Critique of Political Economy. New York: Penguin Books, 1993.

Marx, Karl. Theories of Surplus Value: Books I, II, and III. New York: Prometheus Books, 2000.

Marx, Karl and Frederick Engels. The German Ideology. New York: International Publishers, 1970.

Medema, Steven G. and Warren J. Samuels, eds., Lionel Robbins, A History of Economic Thought: The LSE Lectures. Princeton: Princeton University Press, 1998.

Payer, Cheryl, The Debt Trap: The International Monetary Fund and the Third World. New York: Monthly Review Press, 1974.

Peritore, Norman Patrick, Adventures in Political Theory. Denver, Colorado: Outskirts Press, 2010.

Pressman, Steven. Fifty Major Economists (Second Ed.). London: Routledge, 2006.

Stiglitz, Joseph, Globalization and its Discontents. London: Allen Lane, 2002.

Tabb, William K. The Amoral Elephant: Globalization and the Struggle for Social Justice in the Twenty-First Century. New York: Monthly Review, 2001.

Terkel, Studs, Working. New York: The New Press, 1972.

Veblen, Thorstein. The Theory of the Leisure Class. New York: Macmillan, 1899.

Veblen, Thorstein. The Theory of Business Enterprise. Mansfield Centre, CT: Martino Publishing, 2013. (First published 1904)

 

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Global Political Economy: Chapter Twenty

 

Chapter Twenty: Conclusion: Global Political Economy

The great dialectical struggle over which ideological system of thought would control the world economy and the world’s wealth has been seen in the history of economic thought since the classical period of political economy. It is a matter of the division of the spoils between capital and labor. This historical dynamic has produced the world as it exists today. A critical dimension includes increasing inequality both globally and domestically. Another critical dimension is the ecological one with increasing environmental destruction. The struggle goes on and no one has a crystal ball to tell what the future holds. It is the task of political economy to attempt to understand the complex nature of the global political economy. Attempting to predict the future is a more risky enterprise. Political economists have made many such attempts but have generally not been successful.

We have seen since the seventeenth century the evolution of economic thought has resulted in two great camps. One says that the world as it exists is natural and approved by God. The market and capital are neutral. Inequality is also said to be natural and reflect an equilibrium or Pareto Optimality.

The other perspective is a denaturalization of the world. The world is not natural but rather man-made, a product of history. The first, mainstream economics, has served as an example of an ideology to underwrite the capitalist system even going so far as to say that there is only one possible system of economics. There is no alternative (TINA). The idea comes from Herbert Spencer, but was popularized famously by British Prime Minister Margaret Thatcher.

Today, after the failure of socialist societies to provide their promised benefits, the capitalist ideology has strengthened and essentially rules the global political economy. Since the l970s, the myths of classical political economy, such as laissez faire, have been reinforced. The Austrian School trend in the market and public choice theories in the area of public policy have largely taken over. This has produced a new condition in the world since the middle of the twentieth century. The open global economy generally serves the interests of international capital and the financial sector at the expense of the working classes around the world.

More than half of the world’s people live in conditions in which Jack London called “The People of the Abyss.” Dispossessed. At the same time, they produce the wealth for those who do not have to work. The world precariat, those who barely survive on the edge of existence, and do not know from where their next meal is coming, is increasing. The global ruling ideology is neoliberalism. It is based upon running the world by a technocratic elite and the bankers that serve the interests of global capital. This ideology has become the ruling ideology as even those at the bottom tend to buy into it with effective right-wing propaganda. The world’s leaders talk about democracy but generally do not give the masses a voice. Democracy has been rejected outright by the rational choice theorists. The majority of the people must survive in the underground informal economy just to live and breathe. The underground informal economy, it seems, is the real free market and the underbelly of the global class struggle. The official economy is a monopoly capitalist economy controlled by oligopolistic global corporations.

The Physiocrats saw the rural life as natural and productive of wealth. They promoted agricultural interests and an anti-urban agrarian ideology similar to the Jeffersonian ideal in America. Their ideas were largely pre-capitalist. The eighteenth century saw the beginning of industrial capitalism and the extension of colonialism by European powers. The industrial revolution based upon enclosure, disfranchisement, and colonialism produced wealth for the rising capitalist class in England. Adam Smith and David Ricardo constructed an ideology of free market capitalism. However this approach showed that the wealth and profits of capitalism came from the exploitation of labor.

Two streams of critique emerged in the nineteenth century: the utopian socialists and the scientific socialists. The utopian socialists wanted to use the emerging technology, the means of production, to construct an ideal society. The emergence of science and technology would serve the interests of the whole society and the public good.

With the emergence of industrial capitalism, the proletariat struggled just to live. And many did not live very long, as the brutal exploitation of early factory work meant death at a fairly young age. Marx and Engels explored their condition in England. This provided a critique and platform for the working class in the middle of the nineteenth century. These thinkers set out to shed light upon “the laws of motion of modern capitalist society.” They built upon the insights into capitalism by Adam Smith and David Ricardo, showing that profits came from the exploitation of labor. Their work became a powerful tool for the working classes in the historical struggle for a living wage.

The classical capitalist ideology was forced to shift gears as the theory of surplus value was apparently too revealing. Adam Smith and David Ricardo had clearly exposed the exploitation of labor in capitalist production as the source of profit. The marginalist school emerged. This provided the ideological basis for neoclassical economics. The veil was thrown over the capitalist productive process. Historical reality was obscured, partly by obscure mathematical formulas. The neoclassical approach tended to hide the nature of capitalist exploitation beneath vague concepts and mathematical equations. Presented as economic science, it also hid the fact that it was an ideology of capital. Perhaps it was smoke and mirrors, a way to pull the wool over the eyes of society and defeat the efforts of the working classes for decent wages. The various schools of thought which emerged in the nineteenth century to repair the damage done by the deep insight of Karl Marx into capitalism in the Grundrisse and Capital were consolidated in the work of Alfred Marshall at the end of the nineteenth century. It was to be a water tight proof that capitalism was moral and ethical and that society was in equilibrium. God is in his heaven and all is right with the world. It was all explained by supply and demand, Marshall’s cross. This has become the mainstream approach to economics ever since.

In the late 1920s, a critical problem arose in the system. The internal contradictions were bringing the system down. The system was modified by Keynesianism when neoclassical economic theory could not account for how the real economy worked in the great depression. John Maynard Keynes criticized economists for teaching wrong doctrines to students rather than facing the truth. Economics was political. It was being used as an ideology. With insights from the classical political economists, Keynes devised an approach which would save the capitalist system from itself while providing for the public good. The system must divide a portion of the spoils with the working class. This would be more of a stakeholder approach, rather than harsh class struggle from above for maximum profits. The working class would be cut into the system for a greater share of the spoils. At least for a period of time.

The problem was that the owners of wealth were not willing to share the spoils. The world had been divided up under an imperialist system. For profits, capital needed an open world economy for markets and resources. Those with capital were interested in profits. They fell back on classical ideology for an open world economy which would serve the interests of capital over the interests of the working class. A controlled economy was more compatible with the interests of labor.

After World War II, the Bretton Woods Monetary system put some controls upon capital but the interests of capital won out over the interests of labor. The US pushed for an open global political economy. This was to come about fully only in the l970s, with the strengthening of conservative economics and the attack upon Keynes. It was as Joseph Schumpeter had seen, namely that the capitalist class would not tolerate the gains of the working classes. So it was a struggle from above to remove controls on capital on a global basis. However, the system did not become socialist, as Schumpeter feared. The capitalists were winning with the help of the Nobel Laureates at the University of Chicago.

By the l970s, the US was faced with competition from Western Europe and Japan. The Bretton Woods Monetary System had collapsed, but the dollar was still the global currency. American capitalism, along with European and Japanese capitalism, were oligopolistic systems of political economy. They began to spread and operate on a global basis with strategic management. It became rational for the capitalist class to deconstruct the industrial state in the United States. The deindustrialization of America was carried out. Most industrial jobs shifted overseas. Under the ideology of conservative economists this was said to be good for everybody. Another shift in the ideology was in order.

The ideology of the new political economy based upon public choice theory began to emerge. For the justification for the new phase of global rule, it had to be explained why the stockholders would rule and why there was no need for the stakeholders to be included. It had to be explained why democracy could be simply be dismissed. It came to be said that the problem with democracy and grass-roots interest groups were that they were in conflict with capitalism. The interests of the global population everywhere were in conflict with the interests of capital. The Public Choice school set about to construct an ideology which explained why democracy and political participation on the part of the people must be rejected and society run by technocrats. Getting a share of the spoils was “rent seeking” and this went against the interests of capital. It simply wasted capital. The traditional pluralist theory of American democracy, based on interest group theory, had to be modified.

Marginal utility theory of the nineteenth century was extended beyond economics to every phase of society. It was said that economic methodological individualism could be used to explain all of human behavior by the rational choice theorists. The ideology began to take over all of social science. This pushed both economics and politics to the right.

The liberal doctrines and marginal utility theory had provided an ideology of capitalism. Globally, it was an imperialist political and economic order. The United States, Europe and Japan ruled the world after the war.

After World War II, the US set up a new world order. Theories of trade and development followed traditional liberal doctrines. But these theories did not describe the real world. Multinational corporations arose protected by states to control the economy. America was a global empire, Europe a sub-empire, along with Japan. Samir Amin called this collective imperialism.

By the l970s, American capitalism had stagnated. Greater profits could be made abroad. So the deindustrialization of the US began. This was a dialectic that led to development in some areas, such as China and the big emerging markets, while the American empire declined. America fought wars for the control of markets and resources and for the control of oil in Afghanistan and Iraq, but the empire was declining.

Financialization of the US economy proceeded as manufacturing jobs were exported. Multinational corporations gained great political power. Public choice ideology took hold to roll back Keynesianism. The defense industry preferred military Keynesianism which generated greater profits. The new political economy became the ideology of neoliberalism. The result has been greater struggle and increasing inequality both in the US and in the wider world.

Today, the picture is complex, but clearly, the financial elites have taken over the global economy. They have imposed their ideology on global development to slow economic growth through the structural adjustment programs of the IMF. The official institutions, particularly, the World Trade Organization, serve their interests.

The idea of global development with social dimensions providing for social welfare, the public good and democracy, has largely been lost. Since public choice theory says that democracy does not work and is impossible, it is logical to let technocrats control the economy. This is the new political economy. Since democracy holds back capitalist profits and wastes capital it is not desirable.

Lost sight of as well is the critical dimension of ecological destruction.

In the underground economy, System D, we see the precariat struggling to make a living. If lucky, they work in sweat shops, garbage dumps, ship recycling, and polluting industries. They are street sellers and drug smugglers. The rise of religious politics, in part, may be a result of this struggle that alienates a large section of the society. Socialism failed, but liberal democracies have also failed to meet most people’s needs. The system results in a colossal waste of human resources, human brains and human talent. Western youth sometimes turn against the system and become militants.

The world is becoming increasingly turbulent. The existing system is not serving at least three-quarters of humanity. Today the global political economy is exceedingly complex. It will continue to be a challenge to political economists to understand what is happening. It is an even bigger challenge to change the world for the better for the people. First one must understand as much as possible. Global political economy is a matter of lifting the veil on the real world.

 

Global Political Economy: Chapter Nineteen

 

Chapter Nineteen: The Global Economy Today

The GDP of the global economy in 2013 was 74.9 trillion US dollars (also called Gross World Product). This is 101.93 trillion US dollars in purchasing power parity (PPP). The global population had grown to 7.095 billion.   There were only nine countries with a GDP of over 2 trillion US dollars. These were the USA, China, Japan, Germany, France, the UK, Brazil, Russia, and Italy. However, in terms of purchasing power parity (PPP), India would be included.

By historical standards, the world economy was seen to be limping along at the slow annual economic growth rate of 2.1 percent. The days of six percent growth had ended when neoliberalism began in the l980s. After the recent era of globalization under corporate neoliberalism, world growth rates slowed to some three percent. But recent growth had slumped even further. This was of some concern to the leaders of the G-20 group of nations, although their expectations were not very high. In February 2014 they declared that they would work to increase global GDP by some two trillion dollars in the coming year. However, this was a quite modest goal. The IMF predicted that the world economy would grow by about 3.7 percent in 2014, or by 2.7 trillion dollars. However, no one could be sure if this could be accomplished.

The world economy had been in a slump since the financial crises in the United States in 2008 and the spread of the crises to Europe. In Western Europe, there was no economic growth at all in 2013, except in Germany where growth was just one half of one percent. Eastern Europe also had only a tiny growth rate of one percent. Even Asian economic growth had slowed to 3.9 percent for the year.

Some economists, like Paul Krugman, believed that part of this was due to wrong economic policies in Western countries. For example, austerity policies to cut government spending and debt in the United States and Western Europe had resulted in record unemployment in Europe. This meant that disposable income was less and less consumption affected other regions of the world. There was little investment in Eastern Europe so there was little growth.

At the same time, economic growth slowed in the engine of growth in Asia, China. The Japanese economy had been stagnant for some twenty years. The Indian economy also slowed down just as the current account deficit was rising. At the same time, the Federal Reserve in the United States began a tapering program to cut back on its program of quantitative easing. This led to the fall in the value of currencies in developing countries such as India, Turkey, and Argentina.

The global standard of living was hurt with the rise of food prices, even while the global economy slumped. The real price rises are generally not reflected in official inflation figures. Much of the world’s population of 7.1 billion would be paying more for food, while their real incomes were shrinking.

The IMF projected that in 2014 China would lead economic growth and contribute about a quarter of the increase in global GDP. Today, China was the world’s great workhouse.

Global exports were $12.4 trillion US dollars. And derivatives valued at $601 trillion US dollars.

On the other hand, the absolute number of people living in poverty was increasing. About one billion people lived in slums and this number was growing.

 

 

 

 

 

 

 

The Global Leaders:

1. USA 16.8 Trillion
2. China 9.24 Trillion
3. Japan 4.90 Trillion
4. Germany 3.63 Trillion
5. France 2.73 Trillion
6. United Kingdom 2.52 Trillion
7. Brazil 2.24 Trillion
8. Russia 2.09 Trillion
9. Italy 2.07 Trillion
10. India 1.87 Trillion
11. Canada 1.82 Trillion
12. Australia 1.56 Trillion
13. Spain 1.35 Trillion
14. South Korea 1.30 Trillion
15. Mexico 1.26 Trillion
16. Indonesia 868  Billion
17. Turkey 820  Billion
18. Netherlands 800  Billion
19. Saudi Arabia 745  Billion
20. Switzerland 650  Billion

 

Figure 4: Nominal GDP for the top twenty nations in 2013 (US Dollars)

Source: World Bank

In 2012, the GDP of the state of California in the United States was about equal to the GDP in India. The GDP of Turkey was about equal to the GDP of the city of Los Angeles.

 

  European Union 18.4   Trillion 23.7 %
1. United States 17.41 Trillion 22.4 %
2. China 10.35 Trillion 13.3 %
3. Japan 4.76  Trillion 6.1 %
4. Germany 3.82  Trillion 4.9 %
5. France 2.90  Trillion 3.7 %
6. United Kingdom 2.85  Trillion 3.7 %
7. Brazil 2.24  Trillion 2.9 %
8. Italy 2.13 Trillion 2.7 %
9. Russia 2.06 Trillion 2.7 %
10. India 2.05 Trillion 2.6 %
  World (2013) 74.7 Trillion 100 %

 

Figure 5: 2014 Estimates of GDP (Nominal)

Source: IMF World Economic Outlook Databases (WEO)

 

  World 101.93 Trillion
  European Union 17.57    Trillion
1. United States 16.76    Trillion
2. China 16.15    Trillion
3. India 6.77      Trillion
4. Japan 4.67      Trillion
5. Germany 3.51      Trillion
6. Russia 3.49      Trillion
7. Brazil 3.01      Trillion
8. France 2.53      Trillion
9. Indonesia 2.39      Trillion
10. United Kingdom 2.32      Trillion
11. Mexico 2.06      Trillion
12. Italy 2.03      Trillion
13. South Korea 1.69      Trillion
14. Saudi Arabia 1.55      Trillion
15. Canada 1.52      Trillion
16. Spain 1.49      Trillion
17. Turkey 1.44      Trillion
18. Iran 1.24      Trillion
19. Australia 1.05      Trillion
20. Nigeria 972       Billion

 

Figure 6: GDP in Purchasing Price Parity (PPP) 2013

Source: IMF

 

1. China 17.6 Trillion
2. United States 17.4 Trillion
3. India 7.27 Trillion
4. Japan 4.79 Trillion
5. Germany 3.62 Trillion
6. Russia 3.65 Trillion
7. Brazil 3.07 Trillion
8. France 2.58 Trillion
9. Indonesia 2.55 Trillion
10. United Kingdom 2.43 Trillion
11. Mexico 2.14 Trillion
12 Italy 2.06 Trillion

 

 

Figure 7: GDP Purchasing Power Parity (PPP) Estimates for 2014

Source: IMF

For the first time, China was number one in the world in GDP measured in PPP according to estimates released by the IMF in October 2014.

The G-8:

The G-8 was previously known as the leading group of “industrialized countries.” In 2014, they had about half the worlds’ nominal GDP and 36 percent of World GDP (according to purchasing power parity). Russia was added to the G-7 in 1998 to make the group the G-8. However, in 2014, the G-8 was being replaced by the G-20 as the main economic council of wealthy nations. The reason is that China and India should now be included in the industrialized countries according to either their nominal GDP or GDP (according to PPP).

The G-8 included Canada, France, Germany, Italy, Japan, Russia, the UK, and the United States.

The G-20:

The G-20 countries have about 85 percent of global GDP.

Countries in G-20: Argentina, Australia, Brazil, Britain, Canada, China, France, Germany, India, Indonesia, Italy, Japan, Mexico, South Korea, Russia, Saudi Arabia, South Africa, Turkey, the United States and the European Union. In other words there are 43 countries in the G-20 when the European Union is includud. The G-20 had 85 percent of world industrial output in 2014.

The BRICS: Brazil, Russia, India, China and South Africa

The BRICS have large fast-growing economies and an influence on regional and global affairs. All five are members of the G-20. Together they had a population of three billion people with a GDP of 16.04 trillion US dollars in 2013. They had 4 trillion US dollars in foreign reserves. Exports were 256 billion US dollars in 2012. The main trading partners were China, the USA and Argentina.

The Brazilian Economy:

Brazil was the seventh largest economy in the world in 2013 with a GDP of 2.25 trillion US dollars. Some 21.4 percent of the population of 190 million was below the poverty level. The country had 378 billion US dollars in foreign currency reserves.

The Russian Economy:

In 2013, Russia had the eighth largest economy in the world and was classified as a “developing country.” Its GDP was 2.03 trillion US dollars in 2012. There were 11.2 percent of the people below the poverty line. Exports reached 543 billion US dollars in 2012. Foreign currency reserves were 561 billion US dollars.

The Indian Economy:

India had the tenth largest economy in the world in terms of nominal GDP of 1.87 trillion US dollars in 2012. However in terms of GDP (PPP), India was the third largest economy in the world. Economic growth was about five percent, but the number below the poverty line was 22 percent. The country had an average gross salary of 1580 US dollars per year. India had a huge work force of 498 million people, which included child laborers. The country had 47 billion US dollars in Foreign Direct Investment (FDI) and foreign exchange reserves of 292 billion US dollars.

The Chinese Economy:

China ranked second in world in GDP at 9.24 Trillion US dollars in 2013.

Average salary: $457 per month.

Exports: $2.2 trillion. The main export market is the US (17 percent). Hong Kong was second with 16 percent. China had $116 Billion FDI stock. Gross external debt us $694 billion. China had $3.44 trillion in Forex (March 2013).

The South African Economy:

According to the IMF, South Africa was the thirty-third largest economy in the world in 2013 with a nominal GDP of 351 billion US dollars. It was included in the BRICS group of countries as it was the top country on the African continent with 24 percent of Africa’s GDP. About 31 percent of the people were below the poverty line with a quarter of all people living on less than $1.25 a day. South Africa had a labor force of 18 million. Exports reached 101 billion US dollars. The main trade partners were China, the USA, Germany and Japan. The country had 55 billion US dollars in foreign exchange.

In 2011, the BRICS Forum was formed, an international organization of the members. By 2014 arrangements for a new development bank was planned. This would set up a $100 billion fund to stabilize currency markets. However it might take up to five years to create the bank. There remained some disputes between members, including territorial issues between India and China. There is also a disagreement among members over UN Security Council reform.

In 2014, some seventy-five percent of the world’s currency reserves were in the East. The BRICS countries held $4.4 trillion in export earnings. The BRICS were subsidizing the US economy by holding US dollars. Some countries, particularly Russia wanted an alternative reserve currency, other than the US dollar.

Developing Countries:

The International Statistical Institute defines a developing country as one with gross per capital national income of less than $11,905. This included 139 countries in 2013.

Least Developed Countries (LDCs):

Least developed countries are countries which lack socioeconomic development and have a low human development index. The three criteria for least developed countries include poverty, lack of human resources and economic vulnerability. LDCs have a gross national income (GNI) per capita of less that US $992 as of 2012. Human resources are weak in terms of nutrition, health, education, and adult literacy. They also demonstrate economic vulnerability based upon the instability of agricultural production, the instability of exports of goods and services, merchandise export concentration, the handicap of smallness, and a significant proportion of the population affected by natural disasters. These criteria are set by the Committee for Development Policy of the UN Economic and Social Council (ECOSOC). There were 50 LDCs in 2014, including 34 in Africa, 10 in Asia, five in Australia and the Pacific, and one in the Caribbean. LDCs included some 880 million people or about 12 percent of the global population.

The Shanghai Cooperation Organization (SCO):

By 2013, emerging markets accounted for more than half of world GDP on purchasing power parity (PPP). Clearly, the world wealth was shifting to the East, including China, India, and Southeast Asia.

The Shanghai Cooperation Organization was founded in 2001 in Shanghai by the leaders of China, Kazakhstan, Kyrgyzstan, Russia, Tajikistan, and Uzbekistan. These countries had one-quarter of the world’s population. They intended to launch large scale projects in transport, energy, telecommunications, and military cooperation. They were involved in setting up a new banking system. These arrangements tend to undermine the role of the USA and the US dollar in the global economy.

A Picture from Life’s Other Side:

At the center of the global economy, the US economy seemed to be way out in front of everyone else in 2014. This could be deceptive, however, when one looks at what was happening to the people. Officially, economic growth was 2.8 percent annually in 2013, but this seemed to exaggerate the true figure. Five years after the US financial crisis, the economy had yet to recover. Consumer confidence was low. The labor market was weak and hundreds of thousands of people had simply given up finding employment.

The trend toward hiring people on a part time and contingent basis with no benefits continued. Two-thirds of jobs opening up were part time or temporary positions. Wages were stagnant and in some cases falling. Much of consumer spending was on credit cards. At the same time, the top ten percent were doing well. The stock market and bond markets had surged to record levels while the economy remained stagnant.

Veterans returning from the wars in Afghanistan and Iraq faced high levels of unemployment as well as post-traumatic stress and homelessness. Since the year 2000, there had been at least 6000 traumatic amputations from IEDs and other accidents. One million had mental health disorders and there were 22 veteran suicides happening every day according to the Department of Veterans Affairs. There were more suicides than soldiers killed in war in 2013.

At the same time, while corporate profits soared, food stamps were being cut. The Fed was printing 75 billion dollars a month in quantitative easing to stimulate the economy in 2013 while the rich put money in overseas banks. Under the previous five years under President Obama, ninety-five percent of new income had gone to the rich. Corporations were using a practice called “pass throughs” or pseudo-legal partnership structures to avoid corporate taxes. Since profits were being passed through to shareholders, they did not have to pay corporate taxes. They could make huge profits and avoid taxes. One example was Richard Kinder who made 376 million dollars in dividends in one year. Some 63 percent of corporate profits in 2008 were pass throughs. Private equity firms were also making big profits with the Fed policy of providing cheap money.

Many big corporations paid no taxes at all or got rebates by using accounting techniques, such as Wells Fargo Bank, Boeing, Verizon, and General Electric. At least 280 billion in tax revenues was saved by using overseas tax havens. Apple made 74 billion dollars in profits and declared their profits in Ireland to save on taxes. Such corporate practices were starving public services of funds as politicians protected the corporations.

Stress due to poverty and unemployment, financial stress, among ordinary Americans was leading to health problems for many. Some 68 percent of people now had to depend upon private pension plans, which made corporations money and did not provide for a good retirement. Twenty-four million Americans were receiving food stamps, but the $78 billion budget was being cut back so that the Government provided only $1.40 for each meal, instead of $1.50. The food stamp budget was equal to the investment earnings of the 20 richest Americans.

In one year corporate profits doubled while millions of jobs were lost. Taxes were cut for corporations. Americans were becoming less healthy partly due to financial stress. Some 45,000 Americans were dying in a year for lack of health insurance and one out of five adults had mental illness. Under the Obama health plan, people had to buy health insurance from a private company. However, even this was an improvement over the past. The suicide rate in America had increased since 2008. More people were dying of suicides than in auto accidents.

The neoliberal economic policies that the US worked to implement around the world were creating greater poverty in America. Officially, 15 percent, or 46.5 million Americans were living in poverty. In 2012, the poverty line was considered to be an income of $23, 050 yearly for a family of four. Many had fallen into deep poverty, which is half of this amount. At the same time, the United States had the highest GDP on the globe.

The World Bank is continuously launching and running programs to end world poverty. Still, the absolute number of people in poverty is at an all-time high. This is in spite of the figures given about how many people are being “lifted out of poverty” every year under neoliberal development.

In the United States in 2010, there were ten million millionaires. In 2014, the United States had 492 billionaires. But world median income was only $1040.

Some of the facts in 2014 are as follows. Some twenty percent of the global population, or 1.2 billion people, lived below the poverty line of one dollar and twenty-five cents per day. ($1.25 per day) Some 3.25 billion people lived on less than two dollars ($2) per day. This was about half of the world’s population. Some 1.3 billion people had no electricity. Another 2.5 billion had no safe sanitation. There were 783 million with no safe drinking water. And three billion used wood, coal, or dung for cooking and heating.

The World Bank officials said that they wanted to reduce this poverty to three percent by 2030. They said that this could be done through rapid growth for some forty percent of the population in developing and transitional countries. China was seen as one of the few successes in poverty alleviation. But perhaps it was being achieved through a sort of slave-labor capitalism. The World Bank said that China had rescued 680 million people from poverty since l981. They said that extreme poverty had fallen from 84 percent to ten percent. They did not see the Mao era of a mixed economy and import substitution industrialization as contributing significantly to the development of China.

The World Bank said that through the private sector China would be green, with more environmental protection. But, on the other hand, the World Bank was almost seventy years old and pushing private sector growth all this time had not yet eliminated poverty.

The disparity between the richest and poorest nations had greatly increased, which seems to be a feature of modernization and progress. In 1820, the richest nation was about three times wealthier than the poorest. In l998, the richest nation was 74 times as rich as the poorest.

More people were living in cities. About half the world’s population lived in cities in 2014 and with urbanization there were more than 500 cities with over a million people. A billion people or one-seventh of the global population lived in slums. In the next twenty years, two billion more would be added to urban populations. Ninety percent of this urban growth was happening in developing countries and cities had 70 percent of global GDP.

Urban population living in slums included 174 million in China; 110 million in India; 46 million in Brazil; 45 million in Nigeria; 30 million in Bangladesh; and 12 million in Mexico. The absolute number of people living in slums was also rising, while at the same time developing countries like China and India claimed to be raising millions out of poverty. Half of the people in South Asian cities lacked sanitation facilities. It is no wonder that many side streets smell of urine a short distance from the city center in Delhi.

On the other hand, the richest 8.3 million people in the world had 31 trillion US dollars in wealth. This was $3,735,000 per person. Clearly a large amount of global wealth was hidden in offshore tax havens.

The Global Underground Economy:

It is necessary to dive beneath the surface to get a better idea of the real global economy. A huge amount of wealth is not in the official statistics. This is the underground economy.

There are at least five specific underground economies.

One: Criminal Drugs

Two: The illegal Economy

Three: The Unreported Economy

Four: The Unrecorded Economy

Five: The World’s Fastest Growing Economy: The Informal Sector

Each of these sectors was very large and required a separate study. The most important here is the informal economy. The informal economy generated some ten trillion US dollars in GDP globally, but did not appear in the official statistics. This means that if it was a country, it would be the second largest economy in the world. This is the part of the economy that is off the books, not monitored and not reported in GDP and employment statistics. There are both good and bad sides to this. In some ways, one can say that this is the real free economy, the real “free market,” if there is such a thing. It is perhaps the closest thing to Adam Smith’s classical idea of laissez faire that one finds in the global economy and the world’s governments do not even know what is going on there, for the most part. It was outside of the view and control of governments.

Robert Neuwirth, a journalist, has researched and written on this part of the global economy. It is known as “System D” from the French word “debrouillard” which means resourceful or making do with what one has. He reports that half the world’s workers, some 1.8 billion, were working in System D, off the books, in 2011. They were paid in cash and reported no income and paid no taxes. System D produces many types of machinery, mobile telephones, computers, foods, and many other items and these are transported around the world. Many are produced in China and slipped into other countries past the eyes of customs officials using various devious techniques to slip them into countries undetected.

This economy is huge and increasing so much that the OECD estimates that by 2020, two-thirds of the world’s workers will be off the books. In that sense, the world economy is truly moving toward a laissez faire economy. This economy is completely outside of trade agreements, labor laws, copyright agreements, product safety regulations, environmental regulations, and pollution laws. Anything goes. It spreads even high technology around the world at prices that even the poor can afford. They cannot afford to buy the same items legally through MNCs observing intellectual property rights. Most in the world cannot afford software prices charged by Microsoft and other companies, but they can get cheap bootlegged copies. They can get music and films and books, all bootlegged in the informal economy. Simply, the informal economy gives opportunities to the poor, which are not provided by the formal economy, both in terms of jobs and in terms of trade and business, entrepreneurship.

The informal economy does much of the recycling in developing countries. These people do not set out to be environmentalists, but they do more for the environment than most environmentalists. Also trash pickup and many public services, including inexpensive lunches to millions of office workers in cities like Delhi, Bombay and Calcutta are provided. This part of the global economy is so large that by 2014, eighty-five percent of new employment opportunities were in the informal economy. Also sixty to eighty percent of informal workers were women.

The informal economy is also an efficient system of distribution of products, many of which are produced by big corporations in the formal economy. The big companies like Procter and Gamble have developed a way to get their products into the thousands of small unlicensed stores. Food companies can use the same techniques.

The informal economy even works in the Unites States, as it is ten to twenty percent of the US economy. In India, it is estimated at twenty to thirty percent of the economy and in Turkey thirty to forty percent. In Russia forty to fifty percent of the economy is in the informal sector and in some African countries, it reaches sixty percent. The informal economy also provides a safety net when the formal sector is hit by a financial crisis. In Greece it was thirty percent of the economy which saved many in the economic crisis.

The unreported economy is also very large. Edgar Feige has estimated that twenty-five percent of income in the United States is unreported, resulting in an income tax loss to the government of 500 billion US dollars.

Offshore Tax Havens:

It has been estimated that half the world’s capital flows through offshore tax havens. The main venues are Switzerland and the Cayman Islands. Others include Jersey, Guernsey and the Isle of Man. According to the IMF, between 600 billion and 1.5 trillion US dollars illicit money was being laundered annually. This was two to five percent of global output. Up to 500 billion dollars drug money may be laundered off shore in a year, more than the income of the world’s poorest twenty percent. There are also links between offshore banks and standard banks.

Another estimate is that one-third of the wealth of high net worth individuals is hidden offshore. This is some six trillion dollars out of 17.5 trillion. Some 6.3 trillion pounds sterling is owned by the richest 92,000 individuals, or 0.001 percent of the population. Over thirty percent of the net profits of MNCs may be hidden offshore. The estimate of the amount hidden offshore is between 13 and 20 million pounds sterling. Another estimate says 32 trillion US dollars. Some three trillion dollars is in deposits in tax haven banks and the rest in securities held by international business companies and trusts. Swiss banks have an estimated thirty-five percent of the world’s private institutional funds worth three trillion Swiss Francs. The Cayman Islands have 1.9 trillion US dollars in deposits.  Some 1.2 percent or the population has a quarter of the world’s wealth.

Where is the money? Edgar Feige has tried to figure out where the money is. It seems that the location of 85 percent of the US currency supply is unknown. Currency in circulation in 2010 was some 920 billion US dollars. This is 2950 dollars for everyone in the US. A lot of it is abroad. The illicit drug industry was estimated to be 300 to 400 billion dollars a year and the US was the biggest market in the world for illegal drugs. There was also a global illegal market in oil. Other prominent global illicit industries included human trafficking, and prostitution.

It was estimated that a huge amount of black money from India was hidden in Swiss bank accounts, but it was not possible to know the amount.

That’s the way the global cookie crumbles. Some get the goodies and some get the crumbs, like the sparrows in the road.

 

Global Political Economy: Chapter Eighteen

 

Chapter Eighteen: The Neoliberal Revolution and New Political Economy

The Basis of Capitalism

While theoretically the classical political economists promised universal prosperity, based upon capitalism, the actual history of capitalism has been a different story. It has been observed that the basis for the operation of capitalism is a source of free labor. Without a ready supply of workers with no prospect of making a living without selling their labor power, capitalism could not exist. Workers would not be found to man the factories and businesses and run the system.

Marxists understood this by going back to the “rosy dawn” of capitalism. The birth of capitalism was brought about to a considerable extent by the enclosure movement in England. The English population in the traditional village did not find it necessary to sell their labor power to make a living. The products in the market were made by local craftsmen and most made their living though subsistence agriculture. Once the land was enclosed, the peasants were forced into the city where they lived in poverty and were forced to sell their labor power for a living.

As industrial capitalism developed in England and the continent, and later in the United States, workers with great struggle were able to use the democratic tools to gradually improve their lot and gain higher real wages and worker benefits and improve their lives. Nevertheless, this progress militated against the profits of businesses over time. However, as technology developed, more productivity could be gained from the worker. This process was greatly accelerated by the emergence of the assembly line which could control the pace of work through the working day.

There was ever the search for cheaper labor which encouraged investment abroad. Today in the areas of the world where the workers have gained rights and benefits, they increasingly find themselves out of work as their jobs are exported to cheap labor countries. These are often slave labor countries, such as China, India, and Bangladesh. More labor can be squeezed out of the worker for less pay. If wages rise in China, capitalists seek labor in India and Bangladesh. Profits are often based upon the availability of cheap labor.

New Political Economy:

New political economy is the contemporary ideology of neoliberalism that has basically become the system of capitalism prevailing around the globe. New Political economy overlaps with and is based upon rational choice theories, public choice theories, and collective choice. It says that rational political and social choices result in irrational economic outcomes. The bottom line is that it tends to deny democracy. Democracy is seen as problematical for the capitalist economy. If one wants to have a healthy capitalist economy, one must curb much of the worker’s democracy.

The political system can simply be run by elites and technocrats rather than decided in a democratic way. It can be seen how this system has been in operation in several countries of Europe. By the same token, the bankers and businessmen are allowed to run the economic system in the United States. The bankers cause a collapse of the system but get their bonuses anyway. This is seen as economically rational. When people seek to save their houses this is seen as irrational.

Today New Political Economy is the mainstream academic approach, based upon methodological individualism and a market approach. It serves as the basis for Structural Adjustment Packages (SAPS) of the World Bank, such as privatization and cutting back on social welfare programs, education, health and government employment. New Political Economy turns traditional American political science theory on its head. Interest groups are seen as bad for society. They are generally seen as “special interest groups.” However, they do not include big business and corporate heads that are seen to have a right to run the government. “Special interests” generally is a code-word which refers to labor unions, minorities, women, environmentalists, students and people in general, rather than big business.

Borrowing from Anthony Downs and the Chicago School of Economics and also from the Virginia School of Public Choice, New Political Economy (NPE) sees all decisions as individual decisions made on the basis of maximizing utility. It is said that this methodological individualism can be used to understand every institution in society. While individuals make decisions, self-interest applies to groups as well, borrowing from the work of Mancur Olson on group behavior.

Central to NPE is the concept of “rent seeking.” This happens when individuals and groups seek to gain utility at the expense of the market and economic growth. Or they gain at the expense of the accumulation of capital from a Marxist perspective. An individual would rather have a free ride than pay taxes unless the costs are greater than paying taxes. This theory works better in small groups where interests are nearly the same. In larger groups interests are more diverse or heterogeneous.

Groups form distributional coalitions and engage in political activity to achieve their goals, such as lobbying, forming coalitions, and taking legal and illegal actions. Traditional neoclassical economics and political interest group theory from David Truman, believed that such activity led to utility maximization and social welfare. It was also seen as the heart of American political democracy. People struggled to make things better for themselves in the political arena. Public choice theorists like Mancur Olson disagreed and turned interest group theory on its head. Olson said that rational political activity, in other words democracy, leads to an irrational result. It also distorts the market, makes prices higher, and hurts the economy. That is, democracy results in a negative outcome for society.

Interest groups force the government to pass laws which help them only. This is “rent seeking.” For example, farmers engage in a lobby to get subsidies on prices of their crops from the government. This tends to make prices higher for everyone. Groups in society try to capture the largest possible share of national income at the cost of the majority. Most people do not fight against this as the cost to each individual is small. In New Political Economy, the question is never asked whether the demands of such coalitional distributions (special interest groups) are in the public interest.

Public choice theorists argue that labor unions are a negative coalitional distribution because when they lobby for higher wages they keep wages too high. This hurts consumers and creates unemployment. If wages are left to the market, then wages will fall to their natural price and more people will have jobs, according to this theory. For Olson, all subsidies and shelters should be eliminated, including social security benefits to those retired. Distributional coalitions harm society, except in the cases where positive distributional coalitions engage in productive investment and grow the economy. That is, business groups are treated favorably but political action by the people is seen as a problem. They should leave both politics and the economy to technicians and the market, which can get along just fine without interference from the people.

Traditional American political theory on interest groups has been turned upside down by the New Political Economy. Traditionally interest group activity was seen as democratic input from the people. There was competition in the political market place for policies. The policies which emerged would then be compromises and quite moderate, rather than radical. New Political Economy says that interest groups are an impediment to the interests of society. In general, these interests seem to be those of the capitalist elites.

Labor unions are especially targeted by NPE as the worst of the rent seekers, as they are seen as responsible for the “stickiness of wages,” which means that they keep wages too high. They say that this means that many young people are kept from getting jobs. They say that it also causes inflation because wages cannot fall under the union contracts.

When interest groups, whether labor unions, farmers, teachers, students, or environmentalists, engage in politics it hurts the economy. Social welfare is seen as wasting capital. Voting is also seen as a useless and futile exercise. This is because voters are rationally ignorant. The cost of informing themselves of the issues is too high and the worth of one vote is much less than the cost of gaining enough information to vote rationally. It is relatively easy for political parties to just tell people how they should vote, even when it goes against their own interests.

In many third world societies, civil society is much less developed than in Western countries. The state has relative autonomy and can act in authoritarian ways. Neoliberal policies can usually be imposed with a minimum of resistance. Or if there is resistance it can be crushed relatively easily through the brutality of the police or the military.

Rent Seeking Behavior:

New Political Economy argues that losses caused by the rent seeking of special interest groups is very high. According to Arnold Harberger, however, it is only 0.5 percent. Mancur Olson, Ann Krueger and Jagdish Bhagwati have argued that losses are high and that these lost resources could be better used elsewhere.

New Political Economy holds that rent-seeking is different from rent creation. Rent seeking diverts resources to unproductive areas. Jagdish Bhagwati speaks of directly unproductive profit-seeking activities (DUPs) such as tariffs, monopolies and smuggling. Types of rent-seeking include preparing for government positions, where much of what is learned to pass a civil service examination is not relevant to the job. Under privatization the jobs could just be sold and traded and become more efficient. Therefore, privatization is said to reduce rent-seeking. Also if one uses technocrats to run government, they can be isolated from interest groups. That is, they can be protected from democratic political pressures. Other ways of reducing rent-seeking is military coups, revolution, invasion and war.

Justifiable Coalitions:

However, NPE holds that there are also justifiable distributional coalitions. For example, those who want to implement structural adjustment programs are justified. Those who would benefit might be large firms producing for export. It is also argued that SAPs could benefit the rural masses by allowing agricultural prices to be determined by the market. It is argued that the urban bias in developmentalist countries tends to exploit the countryside.

Also for NPE, the state is not a neutral force, as in pluralism, but rather the vehicle for implementing new agendas such as neoliberalism and privatization that goes along with structural adjustment programs. The state may need to be authoritarian to carry out reforms and democracy is not an issue. According to Anthony Downs, state elites generally have no ideological principles and are mostly interested in staying in power. State officials are the enemy and can do no right. They encourage DUP activities that make the economy less efficient. “The state is the fountain of privileges of all sorts,” they say.

State bureaucrats are dangerous for the economy, according to NPE. Bureaucrats and the state are not neutral, but are also engaged in rational utility maximizing that feather their own nests and distort the economy. They care nothing about the country and the welfare of the people. They are generally involved in crony capitalism, kickbacks, and corruption. The preferred state for NPE is an authoritarian one, because more democratic states encourage consumption, populism, and so on. What is needed is investment to promote economic growth.

Since civil society is not very well developed in developing states, an authoritarian government can be effective in crushing democratic interest groups, such as trade unions seeking higher wages, industrial interests seeking import controls, urban interests seeking price controls on food, and farmers seeking government subsidies in agriculture. It takes a strong authoritarian regime to control these political groups. Democracy and government bureaucrats are major enemies. Implementation of neoliberalism is painful for most, and so a strong government is needed to withstand the unpopularity. It takes an autocracy. Seymour Martin Lipsett has said that authoritarian regimes can help sustain the drive toward growth and cut public expenditures by suppressing civil liberties. NPE clearly rejects democratization. It is also thought that the duty of the universities is not to socialization students to practice democracy, but to encourage them to support the rule of society by elites.

Enter the Technocrats: 

The next step is to bring in the technocrats. Let the streets go wild with chaos and riots. Who cares? The technocrats will make their decisions calmly behind closed doors isolated from the winds of politics. This process has been seen in many countries around the world in recent years, not just Brazil and Argentina, but in Greece and Turkey. The bureaucratic technocratic elites care nothing about interest groups. They will just meet pepper spray and go to jail, if they survive the police beatings in the street. The bureaucrats are backed by the World Bank and the IMF.

NPE also prefers a strong executive who can ignore pressures from elsewhere, such as the legislature. They would like to give the finance department control over government spending, letting technocrats run the economy. The secret of NPE is that liberal neoclassical economics requires an illiberal authoritarian government to be successful. Politically, it is not liberal at all.

Also NPE prefers the “big-bang” approach to reform. Reforms should be implemented quickly in the “honeymoon period” of the government to preempt the opposition which is emerging. However, along with this shock treatment, it is important that foreign capital flow into the country quickly. Otherwise, the brutal reforms could precipitate a coup or bring about a revolution.

From the perspective of the IMF and World Bank, it is important that the programs appear to come from the politicians, rather than from the outside. The government can use sweeteners to gain support while the pain is being administered. These can take the form of a “safety net,” retraining of workers laid off, loans from Western governments, and increased funding for health and education. These are often more for appearance than substance and are frequently on a token basis.

The ruling political regime will proceed to put all the blame for the pain on the previous government and plead that the harsh measures are not their desire but are unavoidable. Reforms can be carried out more easily after a deep financial crisis as the government can argue that policies must change. The government can more quickly orient the economy to the outside world and bring in foreign capital. Labor legislation can be dismantled, state factories closed, and exchange rates floated on the market. Everything, including democracy, must be cleared away so that the market can work. This, in a nutshell, is New Political Economy.         

The Neoliberal Era:

By the l970s, a new model had begun to emerge. Large corporations were becoming multinational corporations operating in many countries around the world. They began to use a global strategy of production to maximize profits on a world-wide basis. The US began a program of deindustrialization, whereby factories in the US were dismantled and the production sent to cheap labor countries, usually in Asia. In this way, corporations could escape domestic regulatory laws and greatly increase their profits. This began the era of intensified globalization. At the same time, exporting jobs and importing cheap goods from Asian countries created greater levels of unemployment and inequality. Real wages fell and most people became poorer and less secure in their jobs. Further, the nature of work changed from full time jobs with benefits to more part time and temporary jobs. Corporations were benefiting at the expense of the working class, which included most of the people in the United States.

The economic crisis produced was also predictable, as the country shifted from manufacturing production to an economy in which most profits were being made from the financial sector. With fewer jobs that paid less, families had to borrow more money to live, usually putting the debt on their credit cards. Household debt continued to grow as household incomes shrank.

The era of globalization or neoliberalism also caused problems in many other countries around the world. First as populations grew, global growth slowed from more than four percent earlier to around two and a half percent annually. Neoliberalism is not liberal, in fact. To put it in a nutshell, it uses the state to help big business rather than the people. It is a sort of social welfare program for big capital and the free market for the people.

The most notable proof of this was the bail out of the big banks in the US financial crises in 2008 and later in Europe. Some three million Americans were allowed to lose their homes through foreclosures when they could not pay their mortgages. The government did very little and in most cases nothing to help these families stay in their homes. It was said that the banks were too big to fail. By the same token, the common people were too little to save. And the bankers were too important to jail.

On a global basis, the spread of neoliberalism around the world is resulting in an unsustainable global economy in the twenty-first century.

Critique of New Political Economy:

First, the perspective on democracy: Rational Choice theory rejects democracy outright. It says that democracy is impossible to achieve. Therefore society must be directed by an oligarchy.  It is doubtful if this is a viable model for global development and political stability in the age of broadening information and education. The people demand a voice in politics.

Second, the utility maximization assumption: Rational Choice theorists have sometimes had to admit that rational utility maximization does not explain all human behavior. Even in a selfish society, it does not explain such things as cooperation, ethnicity, and nationalism.

Third, perspectives on voting:  If voting is not rational, it is hard to explain why so many people vote, far more than half in most countries.

Fourth, the myth of the disinterested technocrat:  NPE assumes that bureaucrats selfishly feather their own nests, yet believe that technocrats, who are also bureaucrats, can see beyond their own self-interests. It is unlikely the World Bank is going to find such honest and efficient authoritarian regimes. The most typical situation in oligarchies is crony capitalism with corruption and kickbacks to the technocrats.

Fifth, the disparaging of all politicians: Not all politicians are corrupt and rent-seeking. Some have an idea of the public good, which does not exist in NPE. If NPE sets up regimes that have no political base of support, it will be difficult if not impossible for authoritarian regimes to isolate themselves from the political pressures of society.

Sixth, private rent-seeking: Privatization can do nothing about private rent seeking by businesses and other groups. Egypt, Tunisia, Morocco, and Turkey show that privatization does not root out rent-seeking.

Seventh, democracy and development: Is democracy incompatible with development? Authoritarianism does not necessarily lead to development. No strong empirical evidence has been found linking regime type to policy performance. Political pluralism might lead to faster growth.

Eighth, the elimination of politics: Politics is the principle means to resolve disputes. It is not possible to eliminate politics from society.

Ninth, the limits of the market: State policy extends beyond the market to nation building, national cohesion and foreign policies. History, culture, and tradition are important.

Tenth, market failure: Rational Choice theorists only talk about political failure. But markets fail too in producing externalities in society, waste and pollution, inequality, financial crises, housing crises, and famines.

Eleventh, the concept of political markets: Public policies are not produced by supply and demand. Policies do not change just because there is a demand.

Twelfth, New Political Economy is ahistorical: NPE says that principles are universal, regardless of the historical, social, cultural, and political context. Whether a country was ruled under colonialism, like India, or never ruled like Japan and Turkey, history and culture influence public policies. There is a strong state tradition in Turkey, unlike in the US.

Thirteenth, the lack of a social dimension: For NPE, there is no such thing as society. It is said that the best macroeconomic policy is a good microeconomic policy. That is, getting the prices right. But classical economists, such as Adam Smith, David Ricardo and Karl Marx, dealt with the social division of the national product. Capitalism tends to create ever greater inequality in society.

Fourteenth, the public good and Pareto Optimality: Rational Choice Theory substitutes Pareto Optimality for the Public Good. But Pareto Optimality can exist where there is great inequality and exploitation in society. Yet redistribution is not an option under Pareto Optimality. Nothing can be done about inequality, which Pareto considered to be a natural part of society.

Fifteenth, the Developmentalist Economics contradiction: If Japan and other East Asian economies had followed the NPE model of relying upon the market they would probably never have developed into powerful exporting countries. Import Substitution Industrialization has been successful in many countries, including India and Turkey in early phases of industrialization.

Sixteenth, traditional institutions and infrastructure:  Modernization Theory laid down prerequisites for development. But NPE does not worry about the lack of infrastructure and feudal institutions which are a restraint upon development. In India, Brazil, Egypt, and China, import substitution industrialization built up consumer industries as a basis for further phases of industrialization.

Seventeenth, The State and Development:  The state can intervene to promote higher and more equitable growth, not just rent-seeking. For East Asia, including China, this was the case. There are multiple paths to growth.

Summary:

New Political Economy is the ideology of global corporate capitalism today. Based upon public choice theory, it rejects democracy and claims that economic growth can best be promoted by restricting political participation and allowing technocrats to rule under authoritarian regimes. Capitalist profits and accumulation of capital are the underlying objective.

This contemporary agenda, promoted by conservative economists, political scientists, and bankers has led to slow global economic growth and greater global inequality. It replaces the social good with Pareto Optimality to serve the interests of international capital.

Key Terms:

Neoclassical Economics

New Political Economy

Anthony Downs

An Economic Theory of Democracy (1957)

Interest Group Theory

Pluralism

Structural Adjustment Package (SAP)

Distributional Coalitions

Rent-Seeking Behavior

Rent Creation

Welfare Maximizing

Mancur Olson

Jagdish Bhagwati

Directly Unproductive Profit-Seeking Activity (DUP)

Justifiable Coalition

Seymour Martin Lipsett

Big Bank Approach

Macroeconomic Policy

Microeconomic Policy

Global Political Economy: Chapter Seventeen

 

Chapter Seventeen: The Multinational Corporation and the Global Economy

“What is good for General Motors is good for the Country.” US Secretary of State, “Engine Charlie” Wilson. (1953-1957)

To a great extent, the global economy is run by the multinational corporations. They are more powerful than all but a handful of governments. They function as virtual parliaments and control people’s lives around the globe even though they are not democratic organizations. The mode of operation of the world’s corporations is new, but they have historical roots in the beginnings of colonialism. Firms like the British East India Company founded in 1600 and the Dutch East India Company founded in 1602 were the forerunners of today’s multinational corporations.

Profile of MNCs Today:

The top 1000 multinational corporations account for eighty percent of world industrial output. They produce twenty-five percent of the world’s gross output. With revenues of 228 billion US dollars, ExxonMobil is ranked twenty first among world economies. Of the 100 largest economic entities in the world, fifty-three are MNCs and these are wealthier than 120 nation states.

The number of MNCs has mushroomed. In 1990, there were some 3000 MNCs. The number in 2014 has surpassed 63,000 with 821,000 subsidiaries. They employ 90 million people, including 20 million in developing countries. The country with the most MNCs is not the Unites States, England, or Japan. Denmark is the home location for some 9356 MNCs. Germany is second. However, 93 of the top 100 MNCs are located in the United States, Europe or Japan.

America’s domination has changed greatly, however. In 1962, sixty percent of the top 500 MNCs were American. In l999, only 36 percent were American.

In contrast to popular belief, most MNCs are not huge companies. Most of them employ less than 250 people. The United States has some 3390 MNCs, while there are 7460 in South Korea and 4334 in Japan.

The Study of Multinational Corporations:

Mainstream economic theories do not deal with multinational corporations as a separate entity. They are primarily studied by business economists, political economists, and radical political economists. From the perspective of mainstream economists, a firm’s behavior is controlled by the market whether it operates in the domestic or the international arena. Following the principle of the Mundell Equivalency, economists generally argue that foreign direct investment in multinational corporations is equivalent to the flow of trade in the real world. It means that trade and investment are perfect substitutes for each other.

Those political economists who stress the strategic behavior of multinational corporations point out that many multinational corporations are oligopolies. They function in very imperfect markets and have various relationships with the governments of the countries where they operate. Corporations can benefit from many strategies including tax breaks, using offshore havens to conceal their profits, and using transfer pricing to avoid paying taxes. They routinely seek countries where they do not have to worry about restrictive labor and environmental laws. Theories relevant to understanding the nature of multinational corporations include strategic trade theory (STT), industrial organization theory, technological advances through R & D, and the control of assets, such as trade-marks and particularly technologies.

The Product Cycle Theory (Raymond Vernon):

Raymond Vernon argued in his book, Sovereignty at Bay (1971), that every product follows a life-cycle from innovation to maturity to eventual decline and obsolescence. Initially, American products have an advantage internationally since US firms have excelled in R & D. This has not always been true in relation to Japanese firms, however. Another advantage enjoyed by American firms is the large domestic market.

In the first phase, the products are produced in the United States and exported to foreign markets. Once production techniques are established and standardized, firms export the means of production and produce the product abroad. Not only can the American firms flood the market, they can better compete with foreign imitators which begin to enter the market. This serves to preempt the competition. The goal of the firm is to maintain a monopoly in the market for the particular product.

Vernon’s theory was useful in explaining the behavior of American multinational corporations in the l960s between the US and Western Europe. American firms could not penetrate the Japanese market as easily, so the theory mainly applied to Europe. By the end of the l960s, Europe had recovered economically, as had Japan, and the US began to lose some of its advantage in the international market. European and Japanese firms began to compete with American firms and take over the markets by the mid l960s. The Japanese were also able to produce superior quality products which began to become popular in the US market. First in electronics, cameras and so on, and later in automobiles, the Japanese took over the American market to a great extent.

John Dunning and the Eclectic Theory of the Reading School:

John Dunning studied business strategy at the University of Reading in England. Dunning stressed several important factors in international business behavior. First, multinational corporations rely upon the development of technology to establish their place in the market. Secondly, MNCs organize themselves on a global basis in order to minimize the costs of production and distribution. Third, the location of the firm, ownership, and brand name are important to give the firm an advantage in the market. If one could buy any car they wanted, perhaps most would go for a Mercedes. Part of the appeal is simply the name, although few cars can come up to the sophisticated technology. This allows firms to extract high rents, that is, higher prices. Fourth, successful MNCs try to monopolize specific technology as long as possible. Fifth, internalization includes establishing branches in other countries. Sixth, as oligopolies, they seek to keep technology out of the hands of rival firms. Seventh, new branches can take advantage of cheap labor, and lack of labor unions, such as Daimler Benz locating in the south of the United States. With financial liberalization, it is easier for firms to move capital to new countries and leap over trade barriers. Management extends across borders to a world-wide scale.

Michael Porter’s Strategic Theory: 

In his book, Comparative Advantage of Nations (1990), Michael Porter argued that multinational corporations engage in strategic management. They establish a “value chain of activities” all the way from extraction, in the case of oil and minerals, to production and marketing. The firm uses a strategy to plan which activities it will pursue and in which countries it will locate around the globe. This is a theory of strategic management. The firm chooses the optimal location for each activity around the globe. This is a true transnational strategy and gives the firm great advantage over domestic firms. HP produces some of its printers in Vietnam, perhaps because the labor is so cheap, and Hanoi is next to a convenient sea port.

Marxist or Radical Theories (Stephen Hymer):  

There is a huge body of work on multinational corporations by Marxist writers. One of the early writers was Stephen Hymer.  Hymer challenged the conventional wisdom of economists that there was no significant difference between foreign direct investment (FDI) and portfolio investment in the l960s. For Hymer, FDI was part of a strategy to control the markets. Firms wanted to control production in foreign countries. This was a strategy to help firms control their monopolistic advantage.

Hymer’s work was ignored by mainstream economists because he was a Marxist. However, later business economists came to see that he was right. Organizational theorists came to the same conclusion as Hymer, although they were not Marxists.

Hymer said that monopoly capitalism is driven by two fundamental laws:

First, firms attempt to increase the size of the firm in the core and the periphery. Second, is the law of uneven development. Firms have considerable power in the global market. So they can exploit countries around the world to their advantage. It is relatively easy for the countries in the rich north to exploit less developed countries in the South. Much work has been done along this line by William Tabb, Harry Magdoff, Paul Sweezy and others at the Monthly Review School. They too, however, have largely been ignored by the mainstream. They were never likely to win the Nobel Prize.

Multinational Corporations: Benefits and their Downsides

Benefits of MNCs are said to include paying increasing tax revenues, providing employment, providing needed goods and services, and bringing in capital, technology and management skills.

On the negative side, Noam Chomsky has referred to MNCs as totalitarian organizations which increasingly control the global economy. Their leaders increasingly control people’s lives, even though they are not elected. MNCs are accused of enabling cultural imperialism. Some eighty percent of all recorded music is sold by just six MNCs. There are huge media corporations such as that owned by Rupert Murdoch. MNCs sometimes bring unwanted ideas and images to countries and have a powerful effect, either positive or negative, depending upon one’s point of view. MNCs have also been accused of promoting unhealthy diets with fast-food outlets. McDonalds has more than 29,000 hamburger restaurants in 120 countries.

MNCs also often threaten democracy. They can skew politics with political contributions, bribery and influence peddling. They repatriate profits from countries around the world, rather than invest them locally. In this way, they contribute to global inequality.

Intrafirm Trade:

We see that much of what goes as global trade is actually just transfers between divisions of the same MNC. In the United States, forty-six percent of imports are transfers between related parties. Some seven-forty percent of imports from Japan are intrafirm. On the other hand, only two percent of goods from Bangladesh are intrafirm. In the case of US imports of autos and medical equipment, seventy percent is intrafirm. The percentage of trade which is intrafirm also increases with increasing concentration of capital.

Transfer Pricing Between Divisions of MNCs:

Transfer pricing is the major tool used by MNCs for tax avoidance. Transfer pricing can be used to lower profits in high-tax countries and increase profits in countries where taxes are low or zero. The latter indicates tax havens. Between divisions of an MNC, prices may be set so as to allocate worldwide profits to low tax countries. In this way a large amount of taxes may be avoided.

Rules for transfer pricing are based upon the “arms-length principle.” This means essentially that prices should be the same as if the company was selling to an outside party. However, there are many techniques which may be used to avoid taxes. Legally, tax authorities may adjust prices, but often it is not easy to determine the correct price.

This mechanism allows corporations to shift much of their profits to tax havens and avoid taxes. It is estimated that sixty percent of capital flight from Africa is through improper transfer pricing. This sort of capital flight from the developing world is estimated to be ten times the size of aid received by these countries. According to the African Union, at lease thirty percent of the GDP of sub-Saharan has been moved to off-shore tax havens.

An International Regime for MNCs and Foreign Direct Investment:

There is no international agreement governing MNCs and FDI. Various attempts have been made to establish freedom for MNCs to operate and make profits in any country of the world. This agenda is primarily being pursued through the World Trade Organization dispute settlement bodies.

The Multilateral Agreement on Investment (MAI) was a draft agreement negotiated between members of the Organization for Economic Cooperation and Development (OECD) between 1995 and l998 on international investment. It was launched in May 1995 and negotiated in secret. In March l997, a draft of the agreement was leaked. NGOs and developing countries launched a campaign of criticism of the draft agreement because it would largely prevent countries from regulating foreign companies. Due to this pressure, the negotiations were suspended in April 1998 and France withdrew from the negotiations in October. The negotiations were then canceled on December 3, 1998. However, similar measures to serve the interests of corporate investors and prevent their regulation are being established under the World Trade Organization.

Other elements desired by MNCs in an international agreement on FDI include the right of establishment, national treatment, and nondiscrimination. The “right of establishment” means that the firms of any nation would have the right to invest anywhere in the world. National treatment means that national governments must treat subsidiaries of foreign firms as if they were their own firms. Nondiscrimination means that countries must not discriminate against foreign subsidiaries. The firms of every nation must be treated the same. For example, the US would not be able to prevent companies based in an Arab country from purchasing companies and operating in the United States. The same rules would apply to all countries in the agreement.

However, most countries would insist on areas of restrictions for the purposes of national security. For example an alarm was raised in the United States when it became known that the George W. Bush Administration planned to sell several US port facilities to a company from an Arab country. Also there is the question of whether a country could protect its cultural possessions from foreign encroachment. For example, the French have insisted that their wine industry stay in the hands of French. National security is another area of large concern. It is not likely that the US is going to agree to sell military drones to any country whatsoever.

The question arises in relation to US restrictions on American firms doing business with certain regimes such as Iran, Cuba, and North Korea, which are considered political enemies. Also the question of whether developing countries should be able to put restrictions upon powerful MNCs arises.

Another example of an attempt of the US Government to impose its domestic laws on other countries was seen in the Helms-Burton Act. This law punished foreign firms, for example from Europe, which did business with Cuba. But it is the US which has political problems with Cuba and not the European countries.

Lacking an international agreement, the dispute settlement facility of the World Trade Organization has begun to deal with these issues. In some cases, national legislatures can be overridden by this body. This is another example of how the MNCs in practice threaten democracy around the world.

Case Study: The Largest Private Multinational Corporation in the US, ExxonMobil:

ExxonMobil became the largest private corporation in the United States after the merger of Exxon with Mobil in l998. It is also the most profitable company with huge annual profits in the range of thirty billion dollars. The company is responsible for the Exxon Valdez oil spill in Alaska in l989. The BP Deepwater Horizon oil spill in the Gulf of Mexico in 2010 was much larger. The BP oil spill dumped twenty times more oil in the environment than the Exxon Valdez accident but by this time, people were getting used to seeing the environment polluted by the oil giants.

ExxonMobil is a company which Americans love to hate, but which is at the very heart of the American system of capitalism and global power. ExxonMobil operates globally in some 200 countries.

The ExxonMobil oil spill that dumped a quarter of a million barrels of oil into Prince William Sound stamped major oil corporations as reckless despoilers of the environment in the American psyche. It was a landmark event that would not soon be forgotten by Americans, seeing wildlife drenched and drowning in sticky black oil. In contrast, the ExxonMobil pipeline leak that dumped four times as much oil in Eastern Nigeria just ten days after the Deepwater Horizon production platform burned and sank, was hardly reported. It would not figure highly in the American press, nor cause the corporation a major headache. ExxonMobil conducts operations in the United States and around the globe. As the largest American corporation ExxonMobil generates some thirty billion dollars of profit a year.

The actually existing system of global capitalism is a threat to the global environment. This system is deeply institutionalized and this current era of ecological stress is going to continue long into the future. Global warming is likely to become a more serious problem.

ExxonMobil is a great corporation, a model of excellence, in terms of the criteria of business schools across the world. It is the purpose of every business school to train individuals to emulate this behavior. Those who work for ExxonMobil are generally serious and hard-working people. They deserve credit for excellence in their line of work in the pursuit of efficiency and maximizing the return on employed capital. Many of them genuinely believe in what they are doing and ground their pursuit of profit in the Judeo-Christian tradition of their upbringing. Many of them were Boy Scouts, which teaches a strict sense of discipline and morality.

What really happened that night when the huge tanker with one and a quarter barrels of oil ran aground off the coast of Alaska? A fifth of the load leaked into Prince William Sound, creating massive ecological damage. The captain of the ship had been drinking and left the bridge saying he needed to take care of some paperwork. It was a wake-up call for Exxon. The company tightened up its operations and emphasized safety. The Operations Integrity Management System (OIMS) emphasized discipline and accountability. The company was inflexible, focused upon performance, and driven by numbers. A culture of discipline ruled. And the bottom line was financial performance.

ExxonMobil is a corporate state within the American state, operating under secrecy, forcefully protecting itself from competition and lawsuits. It is geared to breaking all records in terms of profits. The company produced one and a half billion barrels of oil and gas each year and sold 50 billion gallons of petrol worldwide.

A senior Exxon executive was kidnapped and killed in 1992 after which the company moved to politically conservative Irving, Texas from Manhattan.

The company under Lee Raymond was exceptionally profitable when oil prices were high and also when they were low. Operating in 200 countries with some 80,000 employees, of which only two percent were Americans, it was also a powerful political actor that could act against the interests of the US Government. But the corporation was seen as lacking human factors. It was set aside from even other major oil corporations in this respect. And there was no attempt to adapt to the concerns of environmentalists after the l970s. This only changed marginally when Rex Tillerson took over from Raymond.  Middle and upper managers of the firm could expect to become millionaires over their long career.

For Lee Raymond, the focus was on ROCE, return on capital employed, which was around twenty-two percent a year. Globally, ExxonMobil had to deal with increasing resource nationalism. Many countries, including those in the Middle East, seized back oil fields from Western companies. This happened in Saudi Arabia too. By the 1990s, almost all the oil in the Middle East was off limits to private corporate ownership.

A major concern of companies was the need to replace their booked oil reserves each year. Otherwise, their stock values would suffer and they risked falling into liquidation. One problem was that ExxonMobil owned a large amount of the tar sands in Canada, which contained oil. Technically, these could not be counted as booked reserves, according to the rules of the US Securities and Exchange Commission. The company counted them anyway in their reports to stock owners to enhance the value of their stock.

Interestingly, most Americans do not even know where their oil comes from. Surely, to some extent this is a function of the severe depoliticization that is endemic in America. Americans think that most oil used in the United States comes from Saudi Arabia. Actually, Canada, Mexico and Venezuela supply more oil.

ExxonMobil had another problem: too much cash. This reached eighty-one billion dollars in l998. When Exxon merged with Mobil, the company cut 20,000 jobs and reduced operating costs by $8 billion. It became the largest corporation in the United States with $228 billion in revenue the first year. This is more than the GDP of Norway. Only 20 states in the world have a larger GNP. It ranks forty-fifth among the top economic entities of the world.

While Americans generally have a domestic view, the transnational corporation has a global view to making profit quite independent of the US Government. The Washington office of the corporation is a sort of embassy. It engages in much lobbying of Congress.

Lobbying takes place through the American Petroleum Institute as well as through the efforts of other company staff on Capitol Hill and the White House. Votes are tracked and the money handed out for political campaigns according to who votes in the interests of the corporation.

The corporation is so powerful, that it generally wants the US Government to stay out of its affairs. But for serious help, the company can turn to the White House. The Chairman could simply pick up the phone and talk to Vice President, Dick Cheney during the George W. Bush Presidency.

The corporation typically opposes all government regulation and fears the spread of European ideas, particularly curbs on carbon emissions and the precautionary principle of passing laws to preserve the environment. Researchers were paid to write papers which sowed confusion among the public about global warming. The polls show that it worked, with a majority of Americans believing that global warming was not happening. Still there came a point, when a change in policy was called for, after the departure of Lee Raymond. This did not go so far as to admit that there was actual man-made global warming. It was largely a public relations exercise.

Raymond even advised the Chinese to resist Washington’s attempt to get them to lower greenhouse gas emissions. The corporation formed a Global Climate Coalition, a front group to block climate change legislation in the US, and spent some eight million dollars on research.

The company faced major problems in getting the gas and oil out in such places as Indonesia, West Africa, Chad, Nigeria, Equatorial Guinea, Russia, Venezuela and Iraq. The company faced the difficulty of extracting gas and oil where local populations can become hostile and attack. One case happened in the province of Aceh in Indonesia. The Free Aceh Movement (The Gerakan Aceh Merdeka or GAM) carried out violence against the company. Indonesian Government troops from the TNI (Tentara Nasional Indonesia) patrolled the LNG plant and were paid by ExxonMobil. They carried out many human rights violations.

During the Clinton Administration, there was an effort to address this issue with the launching of the Voluntary Principles on Security and Human Rights. Many corporations signed up, but Lee Raymond refused. He said that ExxonMobil had its own principles. Of course, every effort was being made to avoid lawsuits. When the company lost, it appealed. Company executives feared that they would be sued for the brutality carried out in Aceh. They were, in Washington, DC, and fought bitterly against compensation for those wronged. The Bush Administration was on the verge of listing the GAM leaders as terrorists.

In Equatorial Guinea, ExxonMobil operates in the offshore Zafro and Alba Oil Fields. The country was seen as “politically toxic.” The US government distanced itself from dealings and the US Embassy was closed down for some time. The dictator, Teodoro Obiang Nguema, came to power and controlled the economy through his family. The corporation did not consider that the way the country was being run was their concern. They were there to get the oil and make money. They followed Dick Cheney who once said that companies had to go where the oil was and not where there were good governments. The good Lord did not see fit to put the oil in places that were safe and well governed.

President Obiang visited Washington, on various shopping trips and fell in love with the impressive façade of the Riggs Bank in Washington. He decided to deposit his country’s oil money there. There were soon some $200 million in the account with an additional $20 million expected monthly. Eventually, the President persuaded the George W. Bush Government to open a new US Embassy in the country. But the windfall for the bank soon resulted in trouble with the government, when unaccountable amounts of money were disappearing.

In southern Chad, a pipeline was built to carry ExxonMobil oil overland to the west coast of Africa. Chad is a terribly poor country, twice the size of Texas with a literacy rate of less than fifty percent. Idriss Deby had come to power and ran the country with his relatives and cronies. He later ran into trouble with the World Bank over the lack of social spending.

One reason why ExxonMobil did not worry greatly about what local governments did was the “stability clause” in its contracts, such as in Chad. This device grandfathers in provisions for the company that no future government could change in the future. This might even mean that social spending by the government could be illegal under the clause if it cost the corporation money. This meant that Exxon ruled over its own affairs in the country, effectively stripping Chad of sovereignty. Exxon’s profits in Chad in l988 reached 5.3 billion dollars.

To address the “resource curse,” of oil-rich weak states like Chad, the World Bank had been made a partner to the deal. The Government would be required to spend a certain portion of its oil revenues on education, health and social welfare. This constituted a double standard, of course, as states such as Saudi Arabia were free to spend the money as they desired. For ExxonMobil, their interests were largely confined to the oil and regional political stability.

After 9-11, twenty-five percent of American oil imports were coming from West Africa so terrorism was also a concern.

When George W. Bush entered the White House in 2001, global warming was becoming a larger concern to environmentalists. The Bush Government was top heavy with Texas oil men who were not going to address the issue of carbon emissions. Vice President Cheney’s model was primarily to get the oil men together and let them write their own policies. To ward off potential danger coming from the scientific community, ExxonMobil funded their own research on global warming with an energy project at Stanford University along with General Electric and Toyota. One hundred million dollars of the $225 million came from ExxonMobil.

For Greenpeace, big oil seemed the perfect target in 2001. ExxonMobil’s position was that there was no such thing as global warming. The company wanted to prevent any legislation requiring caps on carbon emissions. So ExxonMobil funded skepticism, to increase doubt in the public mind. ExxonMobil funded right wing groups such as the CATO Institute for Public Policy Research and the American Enterprise Institute. A US Senator from Oklahoma, James Inhofe, called the idea of man-made global warming a “hoax.” Behind the scenes, in fact, ExxonMobil not only believed in global warming but was trying to use it to gain insight into oil exploration.

Lee Raymond would demonstrate no flexibility on the issue of global warming as long as he led the company. He doubted the scientific validity of public opinion surveys. In any event, he saw no reason to allow public opinion to drive decision making. The public was naturally skeptical of big oil and big corporations in general. There was a strong perception that the company was “hostile to social responsibility” as charged by Human Rights Watch. But there was also the perception that when the company decided to do something, it did it well.

The company tended to sneer at the efforts of BP to engage in green washing with its sun and flower symbols on petrol stations. This kind of stuff was not for ExxonMobil. ExxonMobil was seen as having an authoritarian top-down culture and was most popular in only one country, Singapore.

Even with all their money, knowledge, and expertise, a company like ExxonMobil could sometimes get it wrong. Lee Raymond decided that it was futile to try to predict the future price of oil. This depended too much upon unforeseen global events, wars and political instability. On the other hand, the company should be able to predict trends in supply and production. But in the case of natural gas, the company failed.

ExxonMobil operated Qatar’s North Field where they owned an estimated 800 trillion cubic feet of natural gas. They built a production facility to produce Liquified Natural Gas (LNG). The company’s projections were that the gas production in the United States had peaked. This would turn out to be wrong with new technology to extract gas from rock formations in a few years.

With resource nationalism, acquiring booked reserves was getting more difficult. The only possible places in the world were Russia, Iran, Iraq and Saudi Arabia. The Texas oil men in the George W. Bush Government had their eye on Iraq. Some, who knew little about the country, even dreamed of the privatization of oil in the country.

The American and British governments claimed that the invasion and occupation of Iraq was not about oil. One saw the same sort of blanket denials on both sides of the Atlantic. Defense Secretary Donald Rumsfeld scoffed that the war had “literally nothing to do with oil.” However, the concern of oil corporations with keeping up their booked reserves in order to keep their stock prices high was a detail which was hidden from the public. Iraq surely seemed to be an exciting opportunity in this aspect if the US could carry out its plans to totally make over the laws of the entire country. For people in the Bush Government, the invasion of Iraq seemed to be a cost effective way to “expand booked oil reserves.” If oil companies could use the country to bank reserves, their profits would greatly benefit, even if they did not pump a drop of oil. As it turned out, it was not so easy, and resource nationalism asserted itself in Iraq after the war. The US could not even push the country into passing an oil law, with dire threats. Nevertheless, even with all the legal uncertainty, the oil firms rushed in. The Kurdish Regional Government in Northern Iraq was friendly to foreign companies and ExxonMobil signed deals, which Baghdad saw as illegal. The company found plenty of reserves to book. A deal was also signed between Turkey and ExxonMobil to explore for oil in northern Iraq.

There were cross-cutting interests and contradictions. Some neoconservatives in the Bush Administration wanted to get Iraq out of OPEC, increase production, and cheapen the price of oil with Iraqi oil. This would benefit the US economy, provide cheaper oil for the vast needs of the US military machine, and help the balance of payments. For the oil majors, like ExxonMobil, they were enjoying windfall profit because of high oil prices.

Philip Carroll, who had run Shell-USA, was sent to Iraq to restructure the oil industry. As an oil man, he was aware that privatization was a pipe dream of those at AEI that could not work. He thought that Iraqis could be sent to the US for training in the oil industry. Ironically, due to the sanctions and the war, most of Iraq’s expert technicians had left the country long ago.

For Lee Raymond at ExxonMobil, with his eyes turned to profit, the entire world was a unified oil market. Let the market work on a global basis and keep banking the profits. This was not the way oil was viewed in China and Russia. Access to oil was a part of national power and these countries did not want to depend totally upon foreign oil. For the Russian President, Vladimir Putin, Russia would use its oil and gas to control and punish other countries. ExxonMobil was set to clash with Russia over this approach.

Oil executives and politicians in the United States did not understand Putin’s thinking on oil. Again, it was resource nationalism, state power, and Putin would use it to preserve and expand Russian state power. He was not just pumping oil into the global market, as ExxonMobil saw it, rather as a corporate business empire independent of the state. Exxon was fully prepared to go against the interests of the United States for profits and did not hesitate to do so. Their bottom line was profits and not the United States of America.

Russia was no longer a communist country. The country had huge oil and gas reserves. George W. Bush and his oil men brought Putin to the Texas ranch and began to envision US-Russian cooperation on oil. Russia might be a place where American companies could book huge reserves if things worked out. But they were not dealing with a banana republic.

Previously, under President Boris Yeltsin, the Sakhalin 1 project had been signed with Russia, which was a production sharing agreement, and allowed for foreign ownership of oil in the ground. This was what the Texas oil men, including ExxonMobil were looking for.

Rex Tillerson went to Moscow in 2002 to try to make a deal. BP was also interested. The Russian oligarch Mikhail Khodorkovsky wanted to sell part of Yukos to a western firm for cash. He had by then amassed an $8 billion fortune and donated a million dollars to the Library of Congress. But Khodorkovsky was coming into conflict with Putin. The Russian President was consolidating his power through bringing old KGB conservatives back into the government. They did not have a free market view of the world. Putin was not going to see Russia sold off to the Americans and British.

Khodorkovsky would only sell a quarter of the company. Perhaps that was as much as he could get by with, given Putin’s objections. This would not have interested ExxonMobil, however, whose executives wanted nothing except a controlling interest. Putin met Lee Raymond and disliked his rough and overbearing ways.

On October 25, 2003, Khodorkovsky was arrested and charged with income tax evasion, forgery, theft, and other crimes. Putin was also threatened by his trying to buy allies in the Duma. This sort of thing would have been business as usual in the United States of America. The ExxonMobil deal with Russia fell through.

In Russia, companies were subordinate to the state. In the US, it was just the opposite. It would have been difficult for Putin to have understood this.

For ExxonMobil, oil and gas were here to stay, at least up until 2030. They were realists about changing the world. They did not believe in the possibility of transforming other nations. The stuff of the neoconservative’s naive dreams in the Middle East was now lying in dust. Their business was to pump oil and bank the profits. They saw the world, to some extent like Chuck Hagel, who became US Secretary of Defense.

ExxonMobile’s vision of the future, up until at least 2030, sees global energy demand growing by thirty-five percent. There is nothing in the cards that is going to prevent this. By 2005, the world’s 6.4 billion people consumed 245 million barrels of oil, equivalent energy, including natural gas, coal, hydropower, nuclear, biomass, wind, and solar sources. The global population is projected to reach eight billion by 2030 with an average three percent economic growth per year until then.

The poor countries of the world are going to burn more fossil fuels as they industrialize and use more autos. ExxonMobil saw no end in sight to the rise in demand for oil and gas. It was not going to be in the interests of governments to take the needed action to limit global warming.

In the last year of Lee Raymond’s leadership, the company made $36 billion dollars in profits. The value of shares was $360 billion dollars with $68 billion dollars paid out in dividends between 1993 and 2005. The company had 83,700 employees and 2.5 million share holders. When Lee Raymond retired, he was given a $400 million retirement package.

The company was heavily into politics. The ExxonMobil Political Action Committee distributed $700,000 to those politicians who voted their way every two years. But only five percent of this money was going to Democrats. It was eleven percent when Obama ran in 2008. It was simple. Under the Key Vote System, members of Congress were ranked according to the favorable votes they cast. There were no Democrats who ranked higher than fifty percent. So they got little or none of the money that went to the pro-business Republicans.

ExxonMobil also came into conflict with Hugo Chavez in Venezuela and pulled out of the country for a second time. Chavez wanted more royalties for the oil for social spending, but ExxonMobil would not go back on its contracts, which largely stripped the host country of sovereignty over its own oil.

Problems in Nigeria involved the kidnapping of ex patriot workers and the theft of oil, assisted by the local navy.

In the United States, the company fought battles against the regulation of plastic toys and President Barack Obama’s threats to impose a windfall profits tax on the company.

Developments in the oil industry continued. Particularly important was the extraction of oil from the tar sands in Canada, of which ExxonMobil was a major owner and producer. The other major development was producing rock gas from hydraulic fracturing. These developments meant that the US would get more of its gas from domestic sources and more of its oil from Canada. These processes are severely environmentally damaging.

These developments greatly increased the estimates of how much oil and gas was available outside of the Middle East, Russia and Venezuela. The down side was that greenhouse gas production was going to continue producing more global warming. The concept of peak oil became more elusive with these developments. There seems to be plenty of oil, gas, and coal for a number of decades into the future.

The lack of political will to reduce carbon emissions was bound to produce a heavy toll on the earth and society in future. The US was clearly behind the curve in enacting a carbon tax. Americans were not concerned with global warming, partly due to ExxonMobil propaganda. India and China would not reduce emissions as they used more energy, along with the other big emerging markets of the world.

Summary:

Multinational corporations are a global empire in themselves. They control global resources and wield great economic and political power. Their leaders are not elected. The top 1000 MNCs account for eighty percent of the world’s industrial output. The biggest MNCs have economies larger than all but a few nation states. Of the largest 100 economic entities in the world, fifty three are MNCs. These corporations are wealthier than 120 nation states.

While America’s domination of MNCs has declined, the power of the top MNCs is still concentrated in the United States, Europe and Japan, reflecting the post-war economic structure and global economic and political power. Today the strategic behavior of MNCs in their global operations is important to understand. They structure their operations to maximize profits and minimize taxes and obligations to the states and people where they operate.

In the l960s, Marxist scholars set the pace for later generations of business economists in understanding the behavior of MNCs. ExxonMobil is a paradigm example of the global corporation. It owes its loyalty not to the United States but to the company and profits for shareholders. Profits are the bottom line while MNCs ignore ecological damage and fight environmentalists and the interests of society with the inordinate power they wield.

Key Terms:

Charlie Wilson

Mundell Equivalency

Strategic Behavior

Appropriability

Internalization

Strategic Trade Theory

Raymond Vernon

Product Cycle

John Dunning

The Reading School

Michael Porter

Strategic theory

Strategic Management

Stephen Hymer

Uneven Development

State-Centric Approach

Transfer Prices

Intercorporate Alliances

Regionalization

Kenichi Ohmae

The Borderless World

The Triad

Samir Amin

International Regime

Rights of Establishment

National Treatment

Non-Discrimination

Helms-Burton Act

British East India Company

Dutch East India Company

Return of Capital Employed

Securities and Exchange Commission

Global View

Lobbying

Carbon Tax

Global Warming

Voluntary Principles on Security and Human Rights

Stability Clause

Greenwashing

Peak Oil

 

Global Political Economy: Chapter Sixteen

Chapter Sixteen: The International Financial System

Financial Liberalization:

A major development came about in the l970s with the financial revolution, the global liberalization of financial flows. The removal of capital controls freed up the global movement of capital. The result was the increased integration of national capital markets and the creation of a global financial system. The international financial market which emerged, however, greatly increased the instability of the international economy and increased the risk of financial crises. The interval between financial crises has been getting shorter and their impact on the global economy has been getting worse. In Mexico the l981 financial crisis resulted in a four percent drop in output. In Indonesia in 1998, output dropped by fourteen percent. In Greece in 2010, output plummeted by twenty-three percent. Between 1945 and 1975, on the other hand, the world financial system was practically crisis-free. This was mostly due to the limits on financial flows.

In the late 1970s, bankers pushed for financial liberalization. Financial flows were freed up and Eurodollars were recycled to Latin American countries as loans. The problem came with the sudden stop. When the money stopped coming, financial crises emerged. The same pattern was seen in the East Asian Financial Crisis in l997. Again this was seen in Greece, Spain and Portugal in 2010.

Liberal economists argue that the financial revolution has made the use of capital resources more efficient. This argument is disputed by those who see the global economy increasingly as a casino economy and vulnerable to financial crises.

Global financial flows have increased by leaps and bounds since the l970s. The rate of daily turnover in currency exchanges has jumped from only 15 billion US dollars in l973 to 1.2 trillion dollars in 1995 and 5.3 trillion dollars in 2013. In the l980s, financial flows were some five percent of advanced country GDP. This increased to twenty-five percent by 2008, but fell back to ten percent in 2010, after the financial crises in the United States and Europe. Financial flows had become some 100 times the volume of trade flows by 2013. Billions of dollars were being moved from one economy to another at the touch of a button. The equity and bond markets have also become global. This is an extension of the financialization of the US economy which has taken place since the l970s. Great profits are being made in the financial sector of the economy.

Historically, financial flows from Great Britain between 1880 and 1910 averaged about five percent of GNP. Before World War I, British investments funded universities and railroads, port facilities and other infrastructural projects in the United States. Financial flows from the British Empire helped to increase growth in the United States in the form of long-term investment in the late nineteenth century. Today, in contrast, international financial flows tend to be short term and highly speculative. Much of this volume of capital flow is what is known as “hot money,” capital seeking higher interest rates, or arbitrage, in the global economy. When the danger of economic crisis seems eminent, this capital can flee a country overnight, consolidating the crisis.

In this global financial casino, some countries such as Japan, China and India still maintain controls on financial flows. Turkey is more liberal than these three countries and so the Turkish Lira is more vulnerable to financial flows. The central bank can manage exchange rates in normal times, but can easily lose control with wide fluctuations in the financial markets. While Turkey has benefited from the US policy of quantitative easing (QE) between 2008 and 2014, this puts more pressure on the currency when the US eases back on this policy, as in 2014. The US began a tapering policy in early 2014 which caused emerging country currencies to drop sharply in relation to the dollar and the Euro.

Financial Crises: 

There are several conditions which are frequently associated with a financial crisis. The most vulnerable countries are in the developing world. However, not even the United States, Greece, Spain, the East Asian tigers, or other countries are immune from the increasingly volatile global financial market.

First: A high amount of government spending, in which the government builds up a large debt puts a country at risk. This frequently comes as a result of populism, or government hand-outs to the people, especially before national elections.

The United States national government has an enormous national debt of eighteen trillion dollars in late 2014, which continues to increase alarmingly. One can see the numbers rolling up and up, ever up, on the debt counter on the internet.  However, since the US has seigniorage of the world’s currency and can simply create dollars, this does not restrict the US economy as much as in other countries. This gives the US the ability to largely ignore the rules of the global economy which every other country has to obey to a considerable extent or face the consequences.

Second: A large current account deficit and lack of foreign exchange to finance this deficit means that a country will have to borrow foreign exchange from the IMF or private banks to finance the deficit if policy measures are not taken. The country could raise interest rates, for example, and try to attract more capital. However, this is often too little too late to stem the tide.

Third: The country runs out of foreign exchange and cannot pay its international debts. Again, since the country cannot print its own dollars, it will have to borrow dollars or Euros.

Fourth: A speculative and inflationary bubble due to good times. La Dolce Vita lasts while it lasts. But the good times do not roll on forever. Bubbles usually happen in the housing market in which people buy and speculate on property, often with mortgages. Household consumption and household debt increases.

Fifth: Political Instability. The government collapses or a series of governments collapse leading to uncertainties in the economy. A political scandal may bring down the government causing hot money to flee the country overnight and sending interest rates through the roof. The currency then sinks like a rock.

Sixth: Corruption and Crony Capitalism: This is typical of developing countries in which the top leaders help their friends and relatives dominate the economy, gain control of companies, and get richer and richer while corruption flourishes. While ruling elites often consider it their right to get themselves and their families rich at the expense of the country, the economy does not necessarily agree. The real condition of the economy is hidden, while government bureaucrats pay lip service to their masters and lie to the press. But it is harder to fool the market.

Seventh: A large inflow of foreign capital, followed by a sudden stop and then a sharp outflow of foreign capital (hot money) from the country due to an expected economic downturn or political crises. The currency comes under pressure, and the only possible solution is a devaluation of the local currency. Businesses with foreign debts may go bankrupt as their debt mushrooms.

Once the economy hits the bottom, a lot of businesses go bankrupt and a lot of people lose their jobs. Economies usually take about three years to recover from an economic crisis.

Hyman Minsky and the Minsky Model of Financial Crises: 

While mainstream neoclassical economists do not believe that a crisis can be caused by the workings of the capitalist system, nevertheless, someone has to explain where they come from and why they happen. In liberal economic models, decisions made in the marketplace are rational by definition. Nevertheless, Alan Greenspan could talk about “excessive exuberance.” For radicals, on the other hand, the nature of the capitalist system tends toward crises, and indeed, the normal state of capitalism is crisis. This brings us to the model of an economic crisis proposed by Hyman Minsky. The Minsky Moment or the moment of truth.

Minsky’s Theory of Economic Crisis:

First: There is a displacement or external shock to the economy. This must be something large, such as the start of a war, a bumper crop or a crop failure, or the innovation and diffusion of a new technology. For example, the so-called dot-com revolution in the internet in the l990s.

Second: Profits increase in at least one important area, resulting in an investment boom.

Third: The expansion of credit greatly increases the money supply. Credit expands both in business and in family purchases and consumption.

Fourth: The expansion of the economy continues until it reaches a “euphoria stage.” This results in a “bubble economy.” More investors rush into the profitable areas of the economy.

Fifth: At some point in this expansion, some investors get cold feet and decide that the expansion is about to top out. They take their profits and get out of the market. They put their money in less risky investments.

Sixth: More businessmen begin to feel that the expansion is over and start to get out. This continues until it reaches a panic stage.  The panic may be set off with the collapse of a major bank, such as the Lehman Brothers Bank collapse in the US, a corporate bankruptcy or other such event.

Seventh: Major Bankruptcies increase.

Eighth: Finally, the bubble bursts. Panic sets in seriously. There is a credit crunch. There is a liquidity trap with firms holding onto their cash. A recession or depression follows. Economic output drops sharply from five percent up to twenty-five percent or more.

Ninth: Eventually, the economy recovers and returns to equilibrium. The average time is around three years. Some players in the market emerge much richer. Many more lose most of what they had. Consumers’ standard of living decreases. For some, who are always poor, it does not make much difference. They are always in a financial crisis, no matter what happens in the economy.

Such a crisis is also called a “Minsky Moment.”

Mainstream Economists and the Minsky Model:

Mainstream economists reject the Minsky Model outright. They say that there can be no general model of an economic crisis. Every economic crisis has its particular features. Minsky’s model is based upon the idea that the crisis is generated by speculation in the market. Milton Friedman argued that there is no such thing as “speculation.” This sounds very much like an argument from the Austrian School.

For Minsky, on the other hand, euphoria, irrationality and financial crises are all just normal parts of capitalism. History shows that financial mania can be caused by “mob psychology” or a “herd mentality.” Charles Kindleberger, for example, agrees with Minsky that financial crises are an inherent feature of international capitalism.

Economic Crises:

An economic crisis is a complex event and it is true that they are different. However, they share a general pattern. Something serious has to happen to affect the currency. Four real world events happened as below.

The Mexican Peso Crisis (December 1994):

A new President, Ernesto Zedillo had just been elected. Carlos Salinas de Gortari was the outgoing President. Zedillo moved quickly to change economic policy.

First, Zedillo reversed the tight money controls. That is, he brought financial liberalization. Salinas’s policies while in office had strained the finances with government debt.

Second, Salinas used populism to stimulate the economy just before the election, but this policy was unsustainable due the weak economy.

Third, a low interest rate led to risky domestic loans. The quality of loans fell.

Fourth, the armed rebellion in Chiapas broke out during l994 just before the election.

Fifth, the Chiapas revolution or revolt by the poor helped cause foreign investment to drop.

Sixth. high government spending during l985-1993 had led to high inflation.

Seventh, the price of oil dropped making it more difficult for the government to pay its high debts. The current account deficit increased as it was difficult to finance the debts.

Eighth, Salinas then issued bonds to finance the debt.

Ninth, one of the presidential candidates, Luis Donaldo Colosio was assassinated in l994 just before the election.

Tenth, the current account deficit rose with dollars flowing out of the country.

On December 1, 1994, Zedillo took office. The Mexican Peso was four to a dollar. It then quickly crashed to seven to a dollar. The United States bought pesos to help out and provided Mexico with a fifty billion US dollar loan but the damage had been done. The country recovered from the crises by about 1997. This is the normal time that it takes a country to recover from a financial crisis on average.

The Asian Financial Crisis (1997):

This was the worst economic collapse since the l930s in East Asia. The countries most affected by this crisis were Thailand, Indonesia, and South Korea. However, all of the countries in Asia were affected to some degree. It was feared that it could lead to a world-wide crisis without quick action.

First, the crisis started in Thailand in July of l997. The Thai baht was allowed

to float in the market due to a lack of foreign exchange. Thailand was short of US dollars.

Second, there was a real estate bubble. There was also financial over-extension with too many loans.

Third, Thailand had a high foreign debt and was effectively bankrupt.

Fourth, the crisis then spread to all of Southeast Asia. The Japanese yen declined. Stock markets fell. Private debt rose.

Fifth, Hong Kong, Malaysia, Laos, and the Philippines were also hurt. Less affected were China, Taiwan, Singapore and Vietnam.

Sixth, the IMF launched a bail-out package of 40 billion US dollars for Thailand, South Korea and Indonesia.

Seventh, on 21 May 1998, Suharto was forced to resign as President of Indonesia after thirty years in power. There was massive crony capitalism as Suharto had divided up the economy among his close relatives.

Eighth, growth in the Philippines dropped to zero.

Ninth, by 1999, the recovery was beginning. So again, the crisis lasted about three years.

Causes of the Asian Financial Crisis:

First, there was a lot of hot money in the Asian economies. Foreign capital flowed in and then there was a sudden stop. Paul Krugman had written that there was no economic miracle in these countries. He noted that productivity was not high and the technology was mainly owned by foreign countries. But there was a high capital inflow of short-term finance due to high interest rates (arbitrage). This money was not invested in the real economy.

Second, prices had risen sharply for several years. This had created a bubble, especially in the housing market.

Third, there had been a high economic growth-rate, said to be the East Asian “economic miracle.” This growth rate was due more to the Asian developmentalist state-guided model than free-market capitalism.

Fourth, Thailand had an asset bubble in housing, stocks and other commodities.

Fifth, there was rampant crony capitalism in Malaysia and Indonesia under authoritarian regimes.

Sixth, the development money flowed to those in power under this model of crony capitalism.

Seventh, the countries were running high current account deficits. Once started, there was a domino effect as the debt defaults in one country led to defaults in other countries and affected the whole region.

Following the crisis, there was a debate about whether the crisis was caused by the new system of global financial liberalization or the strong role of the state in Asian economies. Joseph Stiglitz and Chalmers Johnson argued that the Asian model of state-led growth could not have caused the crisis. The state developmentalist model had a solid record since the l950s. No one imagined the onset of the crisis as the economies seemed to be sound. However, the governments seemed to be the logical place to put the blame. This was the view of free-market economists. Those critical of financial liberalization and leftists said that the crisis was due to allowing the free flow of global financial capital, roaming the world for short-term profits. They were inclined to argue that financial liberalization was the root cause, because this system had made the international financial system unstable and said that this unstable international financial market could bring down even strong economies under certain circumstances.

The Turkish Financial Crisis (February 2001):

First, Turkey was under an IMF structural adjustment program (SAP). The Turkish Lira was pegged to the dollar but adjustable by a crawling peg.

Second, in February 2001, the currency crashed by thirty percent, a sharp devaluation.

Third, the Turkish banking system was under political control and badly needed reform.

Fourth, there was much hot money and much corruption in the country.

Fifth, in November, before the crises, the Turkish banks experienced liquidity problems. There was a general loss of confidence in both the political and economic systems.

Sixth, the Turkish Central Bank responded by printing money massively, violating its own rules.

Seventh, some six billion US dollars flowed out of the country almost overnight. This raised the current account deficit.

Eighth, Turkey got an 11.5 billion US dollar loan from the IMF as an emergency package to bail out the sinking economy.

Ninth, meanwhile privatization was forced upon the country and the sale of state economic enterprises proceeded.

Tenth, interest rates rose sharply in early 2001.

Eleventh, on February 19, 2001, Ahmet Necder Sezer, the Turkish President, and Prime Minister Bulent Ecevit, had a fight over corruption.

Twelfth, the Turkish lira collapsed from the peg on February 21. The Turkish Lira was floated under lack of confidence in the Government.

Thirteenth, Prime Minister, Bulent Ecevit brought in Kemal Dervis, a former World Bank official, to reorganize the Turkish banking system and carry out reforms. The Turkish economy recovered after the banks were reformed and recapitalized.

In December 2013, Turkey was starting to feel some of the effects of rapid growth over the past decade, as the Fed began its tapering program, to cut back on quantitative easing. At the same time pressure was put on the currencies of India, Brazil, Russia and several other big emerging markets. When global economies are fragile, the actions of the Fed can be felt around the world at once.

Case Study: The US Financial Crisis (2007-2008):

The US financial crisis began in July 2007 when two Bear Stearns hedge funds collapsed. They had invested in mortgage-backed securities. The Fed began to flood the financial sector with hundreds of billions of dollars. By April 2009, the Fed had committed around $8.5 trillion dollars to salvaging the US financial system.

On September 18, 2008, Senator Chris Dodd announced that the US was just days away from a complete financial meltdown without a huge US Government bailout. A bill for $700 billion for the bail-out was quickly written but initially failed to pass in the US House of Representatives. The financial community was shocked at the rebuff. A few days later with sharp warnings by President George W. Bush and the Secretary of the Treasury Henry Paulson, the package for the banks was pushed through Congress. Some called it a financial coup d’ etat.

This money would buy toxic assets, that is, worthless assets, also called “toxic waste.” There was a lot of anger among the American people about the bailout and financial panic spread. This was similar to what Hyman Minsky’s theory of a crisis predicted. Stocks fell sharply. The Fed responded by pumping more dollars into the economy and the Government announced that it would buy more toxic assets. It became a buyer of last resort. The Fed would buy all commercial paper, up to $1.3 trillion, if necessary. Commercial paper is loans issued by corporations to other businesses.

Nevertheless, the system went into a liquidity trap. This happens when banks and businesses will not loan money to other banks and businesses because they do not trust that it can be paid back. They hoard money. Interest rates fell to near zero. This is what Keynes called the “propensity to hoard.”  This included cash and Treasury bills. The “Financial Ice Age” had started. There was no lending between banks and businesses.

The G-7 countries announced that they would partially nationalize the banks. They would do this by buying shares and so injecting money into the banks. They expanded deposit insurance. The US Government would guarantee $1.5 trillion debt to be issued by banks. The cost of the bailout package came to $2.5 trillion by the time of the Lehman Brothers Bank Collapse.

Funds were also committed to bail out Fannie Mae, Freddie Mac, the Wall Street Firm Bear Sterns and American International Group (AIG). The total bailout at that point was estimated at $5.1 trillion.

The contraction of the economy continued. Auto companies, Ford, Chrysler and General Motors, got a $25 billion bailout, with more low interest loans promised later. Some 600,000 to 700,000 jobs were lost in December 2008 and January 2009 as the crises began to hit the real economy.

There were two major theories about the crisis. First is the Milton Friedman, Ben Bernanke, monetarist theory, that it was a liquidity crisis. Secondly, the Monthly Review School argued that it was a structural crisis of capitalism.

According to monetarist theory, the crisis could be solved by just pouring a lot more money into the banks and the financial sector. Ben Bernanke, who became the Fed Chair, and was a monetarist, had said that one could just fly over the country and drop money from a helicopter to solve the crisis. After this he was called “helicopter Ben.”

The second theory from Monthly Review would mean that financial sector debt would have to be squeezed out of the system before the markets could recover and get back to production in the real economy. It was a structural crisis.

By the end of 2008, most banks were insolvent. They could not pay their debts because all their assets had been wiped out by the declining values of the loans which they owned. It was clear that many of these loans could not be paid back. Several bank mergers quickly took place. JP Morgan Chase bought Washington Mutual and Bear Stearns. Bank of America bought Country Wide and Merrill Lynch. Wells Fargo bought Wachovia Bank.

Banks became more monopolistic and the US Government purchased more shares to help liquidate the loans and get the banks back to solvency. At the same time, people lost jobs and were unable to pay their debts.

The Great Depression and the Lender of Last resort:

The confidence in the system is underwritten by the Government, as the “lender of last resort.”

For Bernanke, it was just a liquidity crisis which could be fixed by pumping massive money into the economy. You just fly over and drop money (helicopter Ben). Bernanke had argued that economists had figured out how to keep a depression from ever happening again. He thought the Federal Reserve could always reflate the economy by pumping in more dollars. When the interest rate gets down to near zero, the Fed can buy government securities to pump money into the economy. This was quantitative easing which is just another name for printing dollars.

So Bernanke argued that the Fed only had to look at monetary factors and not at the real economy. Nothing was done until the housing bubble burst in 2007. Then money was pumped into the economy massively.

The Financial explosion and implosion:

The are two parts to the economy: The real economy (base) and the financial superstructure. The US economy had started to generate most of its profits from the financial superstructure, rather than the underlying real economy. The Monthly Review School (Harry Magdoff and Paul Sweezy) had always argued that the normal state of the underlying capitalist economy was stagnation. They argued that the root problem when the bubble burst was not the mortgage problem but the real economy.

Most profits were being made in speculation in the financial sector of the economy with ever expanding debt. This increased from 1.5 trillion in 1970 to almost 48 trillion in 2007. And private debt had skyrocketed relative to national income from the l960s. This stimulated the economy, boosted economic growth, and provided large financial profits, but was not sustainable. There was a large gap between the financial superstructure of the economy and the underlying real economy, where surplus value is generated. The profit from speculation in the superstructure is just an advance on the exploitation of surplus value in future, but the gap had become too large.

The US financial system was a giant casino with leveraging debts thirty to one. It was bound to collapse unless the system kept expanding indefinitely, which could never happen. This was a contradiction associated with speculative bubbles.

When the bubble finally burst, the economy could not recover until the debt was liquidated, written off, or more likely taken over by the tax payers. It became a “debt overhang.” However, some economists had started to believe in the theory of the “New Economy” and thought that with enough financial management tools such a crisis could be prevented from ever happening again. Alan Greenspan, the former Fed Chief, said that he was absolutely shocked that the bank crises happened so quickly.

Paul Sweeney and Harry Mag doff in their book, Monopoly Capital, had pointed out that the US economy could absorb excess capital through government spending on the military, advertising, new innovations and so on and this would promote economic growth. However, these enterprises were never enough to get the economy out of the essential problem of stagnation. The normal state of a capitalist economy, in their view is stagnation. Financialization of the economy became necessary to provide the necessary growth. However, this was speculative and ran the risk of financial crisis and collapse.

The real stimulus to demand in the US economy, in this view, was the growth of debt. Credit cards, mortgages, student loans and so on kept piling up higher and higher to keep the economy going. Government spending, national, state and local and so on, was also increasingly based on debt. This was going on in other economies as well.

According to the Monthly Review School, some $1.2 trillion of excess profits had been made by financial speculation. They argued that this must be squeezed out of the system by “mean reversion.” The long-term trend in financial markets must return to a mean projection or trend line of normal profit, according to this theory. This $1.2 trillion of excess profits would have to be wiped out before the system returned to the long term trend in growth.

The system would need to undergo a major economic downturn to return to the normal growth.

The attempt to solve the normal stagnation problem by pumping up paper profits in the financial sector had failed.

After World War II, the US was in a special situation and was able to stimulate the economy. US prosperity benefited from savings from the war period, automobilization, people moving to suburbia, increasing consumption, housing developments, the interstate highway system, the glass, steel and rubber industries, the rebuilding of the Japanese and European economies, the Cold War arms race, advertising, TV expansion, insurance, and the US dollar. This was the “golden age” of American capitalism. However, this ended with the recovery of Japan, East Asia and Europe. US GDP fell from about six percent during the war to 2.6 percent. With economic stagnation, came financialization and neoliberalism. It was financial Keynesianism and produced asset bubbles which were subject to bursting.

A new class war set in. Real wages fell as profits rose largely in the financial sector. Labor costs were pushed down. Wages peaked in the US in l972 at about $9 dollars an hour. They had fallen to $8.24 in 2006. There was a massive redistribution of income upwards and greater inequality. This increased during the Reagan years in the l980s. Those at the top got richer while most got poorer.

But household consumption rose, not through greater wages, but as a result in the rise in equity values in houses. But this also meant that household debt increased on new mortgages from forty percent of GDP in l960 to 100 percent of GDP by the l990s. People borrowed money on the value of their house in order to keep consuming. They were told that their house was a bank and that they owned their own bank. An increasing number of house owners owed more on their house than it was worth. They were “under water.”

At the same time, there was less investment in the real economy and so less capital formation. In the dot-com revolution in the l990s, this was not seen as important. Investment was expanding through speculative financial instruments. More and more, profits had nothing to do with production as most production was sent offshore to Mexico and China. Stagnation in the domestic economy was certain to remain.

The economic slow-down in the US spread the crisis to the rest of the world, first to Europe. There would be slow growth and high unemployment around the world as a result of the US crisis. The economy of Iceland melted down where the banks had invested in speculation abroad under a right-wing government for years. Iceland refused to pay and defaulted on the loan.

The cost of bailing out the rich was put on the backs of the poor. People were angry. Rather than to create jobs, the government used monetarism or quantitative easing. This kept the economy afloat, but did not serve to create jobs as was done after the great depression in the l930s. The government could have spent up to 13.5 percent of GDP to put people back to work.

Instead, the monetarist solution was to return to business as usual and the same kind of financial speculative system. The critics argued that it was not a sustainable system and just created more wealth for the rich and inequality.

The Dynamics of the Mortgage Crisis in the US: Monopoly Finance Capitalism

The housing bubble was crucial to US capitalism because this was providing much of the income for spending in the last few years, with job creation weak. Higher interest rates could generate stagnation, leading to defaults and foreclosures. There was a rapid growth of hedge funds and credit derivatives. The panic spread after the collapse of the sub-prime mortgage market in July 2007 and all sectors were affected. Adjustable rate mortgages, commercial paper (unsecured short-term corporate debt), insured bonds, commercial mortgages, corporate bonds, auto loans, credit card debt, student loans are all forms of money that are traded on the markets on an international scale. This financial unwinding soon reached the real economy resulting in falling employment, weakening consumption and investment, and decreasing production and profit.  

By February 28, 2008 the US growth rate had fallen to zero. The recession had begun.

Over the last four decades, there had been a shift from production under Fordism to finance with a rapid growth in financial profit.

The Five Phases of the bubble and the Minksy Model:

The housing bubble expanded to trigger the crisis. Capital flowed into the housing market causing hyper-speculation. The five phases include a novel offering, credit expansion, speculative mania, distress, and crash/panic.

First, the novel offering was the “collateralized debt obligation” (CDO). The collateral is the house for which the mortgage loan was made. The cash from these loans, after pooling them, was a basis for more loans to generate “mortgage backed securities.” These mortgage backed securities were repackaged in the form of “Collateralized Mortgage Obligations (CMO). They were packaged so that they were a mix of low-risk, middle-risk and high-risk (subprime) mortgages. The ones with more risk were “junk bonds.” They were rated according to risk of default. Some were investment grade. And banks were allowed to invest in them. Mixing sub-prime with other mortgages would make almost all of them into “safe bets,” theoretically. They were also insured by bond agencies. Some were even AAA rated. All this vastly expanded the market for mortgage lending. So people with poor credit histories could get mortgage loans.

These new securities could be sold through new global financial markets. Structured Investment Vehicles (SIVs) were set up to hold CDOs .These were virtual banks. They drew on the commercial paper market for short term funds to buy the mortgages. Short-term funds were borrowed to invest in long-term securities. Credit default swaps were made with banks. This meant that the SIVs made quarterly payments to banks, like Bank of America. In return banks promised to make a large payment if the SIVs found their assets declining and their credit drying up. This would prevent them from being forced into default. This left the banks exposed to risks that they had tried to transfer elsewhere.

The second phase was credit expansion. Credit is required to feed the asset bubble. The Fed lowered the interest rate to one percent in June 2003, so interest was very low. Mortgages expanded. House prices increased. But jobs paid low salaries. Many loans for houses were adjustable rate mortgages. Low “teaser” interest rates were given to begin with that would go up in three to five years. This made the homes affordable as long as one’s income held out and increased. People believed house prices would continue to rise. A huge rise from $56 billion in loans in 2000 mushroomed to $508 billion in 2005.

The third phase is speculative mania. In this phase there is a rapid rise in debt and a rapid decrease in its quality. It is assumed that house prices will continue to rise. It is Ponzi finance or hyper-speculation. The debt is not based on income streams but merely on what the value of the assets may be in future. CDOs increasingly took this toxic form. Real estate speculators got into the business. Mortgages were used for consumption. Mortgage borrowing increased by $1.1 trillion between October 2005 and December 2005. Total mortgage debt went up to $8.6 trillion, which was equal to seventy percent of the US GDP.

The fourth phase is distress. Something caused the speculative bubble to be pricked. In 2006, interest rates rose. Housing prices declined in California, Arizona and Florida. Mortgage payments ratcheted up at the same time. Credit debt swaps increased globally by forty-nine percent, to cover $42.5 trillion in debt, in the first half of 2007.

The fifth phase is crash and panic. There was a rapid selling off of assets in a “flight to quality.” Investors wanted liquidity. First two Bear-Stearns hedge funds collapsed in July 2007. They held $10 billion in mortgage backed securities. They lost almost all their value. Banks in Europe and Asia were also exposed to toxic assets. A credit crunch began as banks did not know the extent of their exposure. The commercial paper market was hit, which was the source of funds for the SIVs.

September 2007, Northern Rock Bank failed and was bailed out. There was a run on the bank.

Bond insurers began to fail because they underwrote the credit default swaps on mortgage-backed securities. Financial panic spread. No one could be sure what investments were toxic.

There was a stampede into US Treasury bills. In January 2008, the system had reached the panic stage. The Fed poured money into the system. Consumer spending was hit. The governments in the US and Europe were left to bail the capitalists out.

It was a crisis of the stagnation of capitalism, according to Monthly Review. In the US, capacity utilization was around eighty-five percent in the l960s. It fell to eighty percent between l972 and 2007. Big companies had a “mountain of cash,” at least $600 billion, but investment declined. So the capital went into the financial sector. The FIRE sector included finance, insurance, and real estate. This is the non-productive sector or the economy. The main stimulus to the economy, other than finance, had been military spending.

It was stagnation that led the financialization of the economy. On the other hand, others argued  that it was the other way around. Financialization had led to stagnation by crowding out other investments. However, this theory is rejected by the Monthly Review School. They said there were real opportunities for investment outside the financial sector. It is a structural crisis of capitalism itself which is the real problem.

Recent Trends in International Financial Flows:

US Quantitative Easing by the Fed:  Quantitative Easing is another name for printing money and increasing the money supply in the economy. Some of this money finds its way into emerging economies and boosts economic growth. However, these financial flows can come to a sudden stop and then flow out, leading to a financial crisis.

However, the US Government only gets the money from the Fed by borrowing it, that is, by buying bonds. The Fed, the national bank of the United States, which creates dollars, is not owned by the people but by the private banks. It costs about seven cents to make every US dollar.

Financial Flows in percentage of GDP in Advance Countries: In the 1980s financial flows were five percent of advanced country GDP. This increased to twenty-five percent in 2008. By 2010, financial flows declined to ten percent of advanced country GDP due to the US financial crisis.

Financial flows in Emerging Countries: In the l980s, financial flows were two and a half percent of the GDP of emerging countries. In 2008, financial flows increased to twelve percent, but fell back to seven and a half percent in 2010 due to the US economic crisis.

In emerging market countries, large inflows of foreign capital support large housing markets, big shopping centers, and so on. It tends to make government borrowing easy. Also consumer credit is increased. It also encourages corporate leveraging. These inflows can greatly increase when the Fed and the European Central Bank are engaged in quantitative easing programs such as the period from 2008 up to 2014.

Financial Outflows from Developing Countries: In 2000 financial outflows from developing countries was some 295 billion US dollars. In 2013, this increased to 1800 billion US dollars.

Forex Trading: The volume of Forex trading is about 100 times greater than international trade flows today. This means that the rate of currency exchange in global markets is largely determined by currency flows. Daily Forex Trading in 2014 was 5.3 trillion US dollars per day or 1825 trillion US dollars per year. Trade Flows were 18.3 trillion US dollars per year. These figures were expected to increase.

Forex Trading by Countries in 2013: In the USA, forex trading was 860 Billion US dollars per day. In the UK forex trading was two trillion US dollars per day. In Japan forex trading was 283 Billion US dollars per day. Clearly, London lives up to its reputation as the money-laundering capital of the world.

Global Foreign Direct Investment in 2013: Foreign direct investment was between 1.1 trillion and 1.5 trillion US dollars per year. Some 700 billion US dollars went to developing economies. Some 561 billion US dollars went to developed economies.

Derivatives in the Global Economy: As of June 2007 there were 516 trillion US dollars in derivatives. Much of this value was wiped out, however, by the 2008 US financial crisis.

US Quantitative Easing (printing money): The Fed has been pumping some 85 billion dollars per month into the US economy from September 2012 through 2013. This is 1.02 trillion dollars per year. This followed other quantitative easing periods to get the economy back to health.

European Quantitative Easing (QE): The European Central Bank created some 1.5 trillion dollars in 2013. (LTRO Liquidity Injection Policy)

Regulating the International Financial System:

A number of scholars have stated that the international financial system is the weakest link in the global financial system. Among these are Charles Kindleberger, Susan Strange and James Tobin. Various measures have been proposed to strengthen the system.

The Tobin Tax: James Tobin proposed that a small tax be placed upon international financial flows. This would provide a fund which could be used to bail out economies which experienced financial crises. The tax has never been implemented, however.

George Soros is a financial speculator who made huge profits on speculating on foreign currencies. He wanted a “lender of last resort.” A lender of last resort is a source of loans for a country which experiences a financial crisis. People like George Soros can do a lot to help them along. So someone should come along and pick up the pieces of the economy after George and the other money traders have taken their profits and left the mess behind.

The IMF has traditionally played the role of lender of last resort. However, even the IMF may not be capable of dealing with the need for funds in the contemporary global economy. In the case of the United States economic crises in 2008, it would have been impossible for the IMF to come up with the funds to bail out the US. This had to fall to the US taxpayers, and quantitative easing by the Fed. The US Government bailout at the end of 2008 was more than 800 billion dollars to prop up the banks. The total package was much greater. The US Government bought a lot of essentially worthless paper assets to keep banks and other companies from bankruptcy, which were considered “too big to fail.” But at the same time, several million families lost their homes in foreclosures of their mortgages. They were too small to save.

In the case of countries in the European Union, such as Greece, Spain and Portugal, a combination of funding has come from the IMF and the largest banks of Europe. Sometimes the poor just have to make sacrifices so that the rich can go on having their easy and plush lifestyle. At least in today’s global economy.

A lender of last resort raises the issue of “moral hazard.” The argument is that the existence of a lender of last resort can result in a moral hazard. This is because if a country knows that it can be bailed out in the event of a financial crisis, it will follow risky policies. However, the danger to the global economy of the collapse of a large country or area means that in practice, countries must be bailed out to stabilize the system. There is great fear of financial contagion.

Economists do not agree on what can be done. It reminds one of the old joke: “If one laid all economists end to end, they would all be pointing in different directions.”

Financial Crises and Austerity:

Under the neoliberal policies of today’s global political economy, financial crises are being dealt with by imposing austerity on countries. For neo-Keynesians, like Paul Krugman, this is exactly the wrong medicine and is likely to kill the patient. Krugman has blamed much of the volatility in the global political economy upon these wrong policies in Western countries.

A pattern has emerged in the global economy of swinging from bubbles to depression. Most of the blame is not in emerging market countries like India, Russia, Hungary, South Africa and Turkey. The austerity policies in Europe and America being urged by extreme political conservatives, depresses economic growth in Western countries. There is too much savings and not enough investment to stimulate growth in the world economy. Excess capital flows to emerging economies to take advantage of higher interest rates, but when there is a sudden stop, an economic crisis is triggered.

Summary:

Thorstein Veblen would surely have been amused. Since the l970s, the bankers and money traders have greatly increased their profits in the global financial sector by destabilizing the global financial system. This is exactly what he predicted as the role of businessmen. When they wreck the economy it opens up opportunities to increase their profits.

Following formal rational economic models, economists generally believe that it is just the opposite. That the new system of financial liberalization ensures that capital is used in the most efficient way. When there is an economic crisis, however, the big firms get bailed out while it is the common people who lose their savings, pay higher for everything they need to live, and lose their jobs.

In such a situation, emerging countries owe it to their citizens to take some precautions to curb speculation in the financial sector for profits. Much of these profits are secreted away in Swiss bank accounts or offshore tax havens. All of this goes under the rubric of corporate ethics.

The 1970s were marked by a revolution in the international financial system. Financial flows were liberalized, greatly increasing the volatility in the global political economy. Massive financial flows have come to largely control the exchange rates of big emerging market countries and have contributed to the risk of financial crises in these countries. This development reflects the extension of the financialization of the US economy globally. Recent financial crises include the Mexican Peso Crisis, the Asian Financial Crisis, and the Turkish Economic Crisis. The largest and most serious financial crisis was the 2007-2008 US financial crisis which spread to Europe and still affected the global economy in 2014.

Monetarists believe that the US financial crisis was the result of a liquidity crisis which could have easily been remedied by an appropriate Fed monetary policy. Marxists scholars at the Monthly Review School in New York, on the other hand, argued that the crisis was caused by a structural crisis of capitalism. They argue that it was due to the tendency of mature capitalist economies to fall into economic stagnation.

The Minsky model of an economic crisis is based upon the observation that a speculative bubble can emerge leading to an economic crisis. This is particularly true in the financial sector of the economy. The United States and Europe have dealt with the financial crises through monetarist policies of quantitative easing and austerity, rather than Keynesian job creation programs. This seems to be the wrong way to solve the crisis, in terms of global economic growth. This policy has been criticized by neo-Keynesian economists such as Paul Krugman and Joseph Stiglitz. World economic growth slowed considerably to only 2.1 percent in 2012.

Key Terms:

Financial Liberalization

Capital Flows

Speculative Capital

Home Bias

Casino Economy

Hedge Funds

Hyman Minsky

Minsky Model

Minsky Moment

Financial Instability Theory

East Asian Financial Crises

Mexican Financial Crises

Turkish Financial Crises

Tobin Tax

James Tobin

New International Financial Architecture

Moral Hazard

Lender of Last Resort

Basle Accord (1988)

Volker Shock

Paul Volker

Irrational Exuberance

Mob Psychology

Speculation

Euphoria Stage

Bubble Economy

Herd Mentality

Sudden Stop

Hedge Funds

Mortgage-backed securities

The Federal Reserve

Ben Bernanke (Fed Reserve Chairman)

Henry Paulson (former Treasury Secretary)

“Toxic Assets”

Buyer of last resort

Lender of Last Resort

Liquidity trap

“Propensity to Hoard”

Treasury Bills

“Financial Ice Age”

Fannie Mae

Freddie Mac

deposit insurance

liquidity crises

Solvency crises

Structural crises

Mergers

“debt deflation”

Hyman Minsky

Financial instability hypothesis

Speculative bubbles

Debt overhang

The New Economy

Mean reversion

The Stagnation Problem

Financialization

Financial Keynesianism

Collateralized Debt Obligation (CDO)

Collateralized Mortgage Obligation (CMO)

Subprime Mortgage

Structural Adjustment Vehicle (SIV)

Credit-Default Swaps

Novel Offering

Quantitative Easing

Tapering Policy

Mean Reversion

 

Global Political Economy: Chapter Fifteen-Money, The “God of Commodities”

 

Chapter Fifteen: The God of Commodities:

The International Monetary System

“The best things in life are free,

But you can keep them for the birds and bees,

Now give me money.

That’s what I want.” (The Beatles)

“Thus much of this will make black white, foul fair,

Wrong right, base noble, old young, coward valiant

…This yellow slave

Will knit and break religions, bless the accursed,

Place thieves and give them title…

Shakespeare (The Tragedy of Timons of Athens)

“…Money is the general form of wealth… Money is therefore the god among commodities… It represents the divine existence of commodities, while they represent its earthly form.” Karl Marx, Grundrisse.

The international monetary system which was designed at the end of World War II served to facilitate transactions in the real economy in trade, manufacturing and finance. The global financial system will be considered in chapter sixteen. The Bretton Woods System provided a stable monetary framework for global economic development after World War II. A key architect of the system was John Maynard Keynes. The key feature of the system was the establishment of fixed exchange rates between the major currencies of the world to facilitate economic growth in the real economy. Some forty-four countries joined the Bretton Woods System agreeing to maintain their currencies at a fixed rate with the dollar to within one percent variation. Countries would buy or sell dollars to maintain the fixed exchange rate.

The contradiction between the global monetary system and the global financial system is that a stable monetary system which serves the interests of the real global economy, trade and manufacturing, and global economic development, impedes the making of profits in the financial superstructure by the global business elites. The global big business class is sometimes referred to as the “masters of the universe.” While they are not elected, they have a great deal of political power.

As noted in a previous chapter, the Bretton Woods System, designed in l944, made the dollar the King currency of the world. It possessed seigniorage. The US was given the privilege of printing the global reserve currency. The dollar was linked to gold at the rate of thirty-five dollars per ounce. This was a sort of modified gold system. The major West European currencies and the Japanese Yen were then linked or pegged to the dollar at fixed exchange rates. This system gave great economic and political power to the US dollar and the country which could print dollars, the United States. The dollar became the world’s reserve currency, the foreign exchange in which every country outside the communist orbit had to pay its bills, and settle its accounts in the international system.

The International Monetary Fund (IMF) was set up to keep track of accounts between nations. A current account deficit meant that more dollars had flowed out of the country than had flowed in. A surplus was the opposite. This mechanism had a great impact upon countries, except for the United States, which could simply run the printing presses and print its own dollars.

The Bretton Woods System worked quite nicely for two and a half decades. However, it contained the seeds of its own destruction. As a global power, the United States could resort to paying its own bills by simply printing dollars. Part of the cost of wars could be put off on other countries, as holding dollars was actually a loan to the United States. But the US could devalue the dollar simply by printing large amounts, although the official rate remained the same. Dollar overhang, the amount of dollars overseas, due to US spending for the Vietnam War, finally brought the system crashing down in l971. The world was awash with dollars.

In December l971, President Richard Nixon devalued the dollar by about ten percent with the Smithsonian Agreement. This was simply a late recognition that the real value of the dollar had fallen due to an oversupply. But under the Bretton Woods System, the dollar could not be officially devalued. With the end of the Bretton Woods system, the US would no longer redeem dollars for gold. A new system was to come about with the Jamaica Conference in l976 in which the major industrial powers began to regulate their currencies according to flexible exchange rates. Western European currencies were regulated by a complex European Monetary System (EMS) called “the snake in the tunnel.” Countries were to maintain the value of their currencies within 2.5 percent of a fixed rate. This worked after a fashion, but not very well. The weak currencies, like the Italian Lira would fall through the bottom of the tunnel, while the German Mark kept going through the roof.

In 1969, the Special Drawing Right (SDR) was created. This is a weighted currency basket of the Euro, US dollar, British Sterling and Japanese Yen. It is used as an IMF unit of account and also fluctuates in value. Used mainly for credit, it is some four percent of global foreign reserves.

Global reserves were 9,200 billion US dollars in 2010 (9.2 trillion dollars). Some 65 percent was in US dollars, 25 percent in Euros and the rest in Sterling, Yen, SDRs and gold. The BRICS (Brazil, Russia, India, China and South Africa) had over four trillion dollars global reserves. By March 2013, China alone had 3.44 trillion US dollars in foreign exchange reserves. This indicates that the wealth of the global economy was shifting to the Eastern Hemisphere.

The Post Bretton Woods System:

“Foreigners are out to screw us, and it is our job to screw them first.” (John Connally, US Secretary of the Treasury under President Richard Nixon)

The end of Bretton Woods brought about a financial revolution. Whether one was happy about the collapse of the Bretton Woods System depended partly upon ideology and partly upon one’s location in the global economy.  While the Bretton Woods System collapsed, the Bretton Woods Era continued, as the dollar was still the global reserve currency. Only when the dollar is replaced by other reserve currencies can we say this era has completely ended. Today use of the Euro as a reserve currency has changed things somewhat. But the big emerging market countries, particularly the BRICS, are hoping to replace the US dollar as the global reserve currency.

Many free-market economists argued that it would greatly benefit the global economy and let countries follow their own economic policies with the collapse of fixed exchange rates. A minority of economists argued that this would be deflationary and destabilizing. There would be a lack of trust in governments when their currencies were not linked to gold.

The beginnings of the Eurodollar market in the l960s soon created an international financial market. This was to mushroom with the great rise in the price of oil in the early l970s and the need to recycle massive amounts of dollars from the Organization of Petroleum Exporting States (OPEC) in the Middle East. International financial flows greatly increased. Some of these dollars were recycled through loans to Latin American countries creating more problems as these economies sank into a debt trap. The IMF began to impose harsh austerity measures on them.

One effect of greater financial flows was that countries began to lose the ability to control their macroeconomic autonomy. National economies became more closely linked to each other. Exchange rates of currencies were no longer controlled by trade flows. Now they were controlled by the increasing currency flows which exceeded trade flows by 100 times by 2013.

Destabilizing, it clearly was. The system became highly volatile. If Thorstein Veblen had been around, he would have probably laughed and said, “Well, I told you so. Now the money sharks and businessmen will see their chance to make a killing in the global market. The fat frogs will catch their juicy flies.” And they did. It was difficult to know from day to day what the exchange rate should be and where it would go next, but in this new global casino economy, some would get lucky, and some would simply lose.

The major currencies came to be regulated according to the “reference range system.” This was essentially a system of muddling through. The central banks did whatever they needed to do or could do to keep the international system stable. In Europe the European Monetary System (EMS) was used with an Exchange Rate Mechanism (ERM) known as the Snake in the Tunnel.

Operating the Global Monetary System:

The mechanisms of the global monetary system must provide a method of adjustment (correcting balance of payments problems), provide sufficient international liquidity, and provide a stable reserve currency (or currencies). There are great inequalities in the system, in which some countries gain and some lose. Also inside each country the operation of the monetary system affects workers, small businesses and those companies with large amounts of capital differently. Historically, the monetary system has been run largely by a hegemon, such as Great Britain or the United States.

The current account of a country is the amount of inflows (payments and remittances) minus outflows. In the short term, if a country is in deficit, it may draw down its national reserves. In a surplus, it may use inflows to build up its national reserves.

On the other hand, if the deficit goes on for a long time, or there is a financial crisis, the country may have to devalue the currency. In a surplus, the currency can be allowed to appreciate. Macroeconomic policies may also be used such as raising or lowering interest rates. A deficit country must lower the standard of living for the people for a period for at least part of the population. The cost of imports will rise. If a country must import most of its energy, for example, oil, almost all prices are going to rise. This will hurt all of those who earn fixed incomes. On the other hand, with devaluation exports should increase and this should help correct the imbalance for those who have jobs over a period of time.

When a country is in surplus, the currency will tend to rise. This will hurt the export sector but should help consumers. Countries in deficit could also use an economic stimulus package to provide jobs and pump more money into the economy. On the other hand, stimulus packages risk leading to inflation over a period of time. Countries frequently use such policies to help the chances of the ruling party in winning an election.

If a country refuses to allow its currency to rise, when it has high exports, such as Japan in l985 and China today, then the United States can put pressure on the country to allow their currency to appreciate. This will make their exports more expensive. China allows some appreciation, but has not allowed its currency to float on the international market. India also controls its currency, but on the other hand, the value of the Indian Rupee usually sinks rather than rises.

Liquidity is another crucial aspect of the international monetary system. International liquidity is necessary to meet balance of payments deficits when a country is in crises. Sometimes the problem involves a loan from the IMF, especially in a crisis. Reserves include gold, foreign currencies, and deposits with the IMF.

Some economists believe that the global economy should be based upon a gold standard. The Bretton Woods System was based upon “paper gold,” the US dollar. The problem with a real gold standard is that the supply of gold cannot be increased fast enough to supply adequate liquidity to the international system and so would be recessionary. Profits of major corporations would fall as they could not sell their products. Also the global economy would grow more slowly and create more poverty. The gold standard has been called “The Golden Fetters,” which means that it tends to slow down economic growth. This in itself might be good for the environment, but it is not good for the global capitalist economy. However, it would also eliminate the role of the dollar as the global hegemonic currency, militating against the interests of the United States.

Following the US economic crises in 2008 the Fed engaged in quantitative easing programs to stimulate the economy by putting more money into banks to encourage them to make loans. This was done by buying mortgage backed securities and US securities. The first program by Ben Bernanke, the Fed chief, ran from November 2008 to March 2009 and provided 1.25 trillion dollars. The second program from August 2010 to November 2010 provided another 600 billion dollars. In September 2012, the Fed began the “QE Infinity” program which provided some 85 billion dollars a month in stimulus. Each month, the Fed bought 40 billion dollars’ worth of mortgage backed securities and 45 billion dollars’ worth of US securities. This policy continued until the end of 2013 when Bernanke announced that the Fed would start cutting back the program and probably end it in 2014.  This “quantitative easing” (QE) helped to provide international liquidity, especially for big emerging markets like Brazil and Turkey. But too much liquidity will cause inflation. The European Central Bank was also engaged in quantitative easing for the Eurozone countries.

The country of seigniorage, which provides international liquidity, in this case the US, has the responsibility of maintaining the value of the currency. However, this is theoretical. The value of the dollar naturally shrinks when so many dollars are being printed. On the other hand, the global system needs the money stimulus, like heroin, flowing through its veins to keep going. This is part of the global capitalist system. The opium of the global economy. And since money is debt, the more money the more debt. When the fed slows down the amount of money being printed, this is called “tapering.” Tapering means less dollars flow to big emerging markets like India and Turkey. Tapering by The Fed will cause the currencies in emerging market countries to fall and their economies to slow down.

The Fed began its tapering policy in January 2014 by cutting ten billion dollars a month from its QE program. By September 2014, QE had been reduced to some 25 billion dollars a month and was scheduled to end by the end of 2014. But this would depend upon the economy and the new Fed chief, Janet Yelen.

Whether the Euro will take over the role of the US dollar depends to some extent on the future of US global power. The US tries very hard to ensure that the world’s “black gold,” oil, is marketed in dollars and not in Euros, which would weaken the role of the dollar. Global confidence in the dollar is crucial to the global economy.

Another possibility is that a new reserve currency, sponsored by the BRICS, perhaps the Chinese Yuan, or a new currency unit, will become a global reserve currency. Some countries, especially, Russia, strongly want to see the US dollar replaced as they believe the system allows the US to exploit the world through its monetary policies.

The Irreconcilable Trinity (The Trilemma):

According to the Mundell-Fleming Model from the l960s, there are three goals of monetary management. However, only two of these three can be achieved at any one time. This is called the irreconcilable trinity or the trilemma.

The Three goals of monetary management are:

First: Stable Exchange Rates

Second: National independence in monetary policies to maintain growth

Third: Freedom of capital movement across borders

For example, under the Bretton Woods System, there were stable exchange rates, and a degree of national independence in monetary policies, but little freedom for capital movement. This made it possible for countries to follow full-employment policies. The sector which most desires the free flow of capital is the financial sector as this is how they make much of their profits.

Export businesses, on the other hand, are primarily interested in the exchange rate. Domestic capital interests want national autonomy in macroeconomic policy making. Investors want freedom for capital movement. On the other hand, labor stands to lose by the free flow of capital out of the country. Consequently, there are several contradictions between different sectors of the economy.

Monetary Unions:

A number of monetary unions are in existence in which several countries use the same currency. In a full monetary union, the arrangement for the common use of a currency is formal and there is a common monetary policy. Monetary unions operate in an “optimal currency area.” This is a region of nations or geographical area where use of a common currency can greatly improve economic efficiency. Again, monetary unions are regional.

The following formal monetary unions were in existence in 2014.

The European Union (EU): The most extensive monetary union, of course, is the European Union. The Union came into full force in 2002. There were eighteen states using the Euro as the official currency in 2014. Also Monaco and Andorra use the Euro.

West Africa (CFA Franc): Originally set up by French colonialists in West Africa, the CFA Franc zone in West Africa is one of the oldest monetary unions. Members include Benin, Burkino Faso, Cote d’Ivoire, Guinea-Bissou, Cameroon, Central African Republic, Chad, Republic of the Congo, Equatorial Guinea, and Gabon. In 2014, one US dollar was worth around 480 CFA Francs and the daily rate of fluctuation was high.

The CFP Franc: This is a monetary union in the South Pacific. Included are French Polynesia, New Caledonia, and Wallis and Futuna.

East Caribbean Dollar: This monetary union includes Anguilla, Antigua and Barbados, Dominica, Grenada, Montserrat, Saint Kitts and Nevis, Saint Lucia, Saint Vincent and The Grenadines.

South Africa Rand: This monetary union includes South Africa, Lesotho, Swaziland, and Namibia.

Other planned monetary unions which could be established between 2014 and 2020 include:

The Bolivarian Alternative for the Americas: This planned monetary union would unite several countries in South America, including Venezuela.

The East African Community: The common currency would be the East African Shilling.

The West African Monetary Zone: The currency would be the Eco.

The ASEAN nations plus three more: An Asian Monetary unit would be established.

The Cooperation Council for the Arab States of the Gulf or Gulf Cooperation Council. The monetary union would include the United Arab Emirates and Oman. The proposed currency was to be called the Khaleeji (Gulf).

Clearly, the only one of these monetary unions around the globe which presents any rival to the mighty US dollar as an important global currency is the European Union. The Euro may be used as foreign exchange.

As China becomes a more powerful state, the Yuan might one day come to be used as foreign exchange if the BRICS can increase their power and influence in the global economy, overcome their disagreements and unite with other big emerging economies, such as Mexico, Indonesia, and Turkey.

Hegemony and Money:

The existence of a single global hegemonic currency belonging to and issued by one state in the world reflects the structure of the global political economy since World War II. The post war global economy was structured around the three “great workhouses” of the world, the United States, Western Europe and Japan. These were to be the engines of growth of the global economy. Great Britain as the hegemon which passed the torch to the United States moved off center stage, but still played a large role as a global financial center, where vast sums of money could be traded and laundered. London retained its role as the money-laundering capital of the world. Consequently, the US dollar, the Euro, the Yen and the Pound Sterling are still the premium global currencies reflecting historical political power based upon imperial rule of these centers of power.

Today, the world has moved on. The rising BRICS, Brazil, Russia, India, China and South Africa are gaining position in relation to the old empires, but no one of them has yet become the global hegemon. That might take a global power struggle, or might come more easily as the United States global power declines. Russia is a primary force for change in the system to wean the world away from its global dependency upon the dollar as the global reserve currency. Rather than hold dollars or Euros, Russia wants a new reserve currency. The claim is that this would provide funds for global development. Clearly, Russia wishes to see the United States losing power in the international arena. It would be great for Russia if the ruble could become an international reserve currency.

Political economists wrangle over how to solve the monetary problems of the world. Under a pure gold standard, governments would lose control over monetary policy and could not make corrections in an economic crisis. Some believe that there should be a single global currency. To some extent, this would be the system that already exists, as the dollar is the de facto world reserve currency. Economists generally argue that letting the central banks and the finance ministers run the system is best. But Joseph Stiglitz says that this is a major cause of global poverty in his arguments against the policies of the IMF. In the absence of a consensus, regional arrangements, such as the one proposed by the BRICS and the Bolivarian countries in the South are beginning to emerge.

Arguments for Stable Exchange Rates:

As we saw, Keynes preferred stable exchange rates and this was implemented in the Bretton Woods System. Robert Mundell also argued in favor of more stable exchange rates. However, the global economy is not going to move back to the system of the l950s. So, regardless of the benefits, that is not going to happen. The financialization of the American economy means that most profits are made in the financial sector and this system has been globalized to a considerable extent. The prevailing free-market ideology makes it impossible to go back to a fixed exchange rate system.

First: Flexible exchange rates means that it is difficult for firms, especially small firms, to operate. The market is more volatile. If there is a local currency collapse and companies hold dollar debts, they face bankruptcy. This happens often in Turkey and other emerging market countries.

Second: There is the argument that flexible exchange rates militate against economic development in poor countries and encourage trade protectionism. This is a strong argument among the left in India. However, the left has generally lost the argument in today’s global economy. International pressures are simply too strong and the big Indian multinational corporations are strong enough to operate with flexible exchange rates.

Third: Many, especially on the left, argue that the global system of flexible exchange rates has failed. There is excessive currency and price volatility. A small drop in the value of the Turkish lira means that Turks gets hit hard at the petrol pump and in the cost of natural gas for heat and also electricity. Prices in these basic commodities are dollarized. Price rises in the dollar filter back through the economy to affect prices in general. Incomes do not rise automatically when the cost of basic commodities rise.

International capital flows are great and very destabilizing in emerging economies. Economic policies are inflationary, as prices are essentially dollarized. This increases risk and uncertainty in international trade and investment. On the other hand, as Veblen would have observed, such chaos opens up opportunities for money sharks to make their profits at the expense of others. It allows some countries to move ahead, like China, while others are sunk, when their currencies collapse.

Fourth:  Those who want fixed exchange rates say that they provide international discipline over inflationary policies.

Fifth: Fixed exchange rates reduce uncertainty in trade and investment.

Sixth: Fixed exchange rates facilitate competition based upon comparative advantage and efficient capital flows.

Seventh: If a fixed exchange rate is not feasible, then some compromise should be implemented such as pegged but adjustable rates, managed floating rates, adjustable pegs, or exchange rate target zones.

In fact, this is basically the existing system. Turkey, for example, basically has managed floating rates. However, there is only so much the central bank can do when the currency takes a nose dive downwards.

Arguments in Favor of Flexible Exchange Rates:

With international financial flows running at some one-hundred times that of trade flows there is bound to be great fluctuations in exchange rates. When the Fed announces a tapering program, currencies in developing market economies begin to drop at once. This happened in December of 2013.

First: Those who like flexible exchange rates argue that fixed exchange rates are very costly to maintain. However, it must be asked: “For whom is it costly?” Such a policy does not affect everybody in the same way.

Second: Flexible exchange rates allows currency to flow into the country or out of the country. The government must follow policies friendly to foreign capital. This means that it also serves to ensure policies that accommodate the interests of foreign capital.

Third: It is argued that flexible exchange rates are the least costly way to adjust to economic crises. When there is a balance of payments deficit, it is better to devalue the currency, rather than resort to capital controls. Of course, devaluation hurts all those who hold the local currency and are not able to shift into dollars in time to avoid the devaluation.

Fourth: It is argued that a devaluation best protects jobs and wages, the real variables in the economy. However, this must be an empirical question. It all depends upon when one’s wages might catch up with the inflation. This is not likely to be soon, as one sees in terms of devaluations in many countries.

Fifth: Flexible exchange rates make adjustments easier in a crisis. This is true, but it helps those who hold dollars and hurts those who hold the local currencies.

Sixth: Flexible exchange rates act as a cushion from the shocks from the international economy. This is true, but there is nothing to cushion the shock of losing a large part of one’s income in a devaluation. The common people take the shocks while those with hard money capital get the cushion.

Possibilities:    

First: The only real solution to the above dilemmas, short of the elimination of money altogether, would be complete monetary integration with a single global currency. This is not a possibility. Such a system would be too restrictive on small countries. Even within the Eurozone, there are major problems with using a single currency when two countries are as different economically as Germany and Greece. The monetary policies which fit Germany are not appropriate for a poorer country like Greece or Portugal without an industrial manufacturing base.

Second: An international monetary regime with floating rates against the dollar, the Euro or other global currency. The economies of large populous countries, like India or Indonesia would be too vulnerable without considerable management from the central bank.

Third: A system of regional monetary integration modeled upon the example of the European Union. So far the Euro zone with eighteen countries is the only functioning example. If strong cooperation can be achieved between the five BRICS countries in the BRICS Forum, this could be another example. The currency might be the Chinese Yuan or a currency based upon a basket of currencies. Another possibility is a reserve currency based upon the countries of the Bolivarian revolution in South America.

Fourth: The continuation of the Bretton Woods era will continue as long as the United States is still the most powerful country. If Johan Galtung is right that the American Empire will end around 2025, then it is likely that the US dollar will begin to fade as the global reserve currency. It is not at all clear that the Euro is the answer, however, given the recent financial crises in Europe.

Currently the three largest economic entities in the global economy have roughly equal GDP. These include, in 2013, the United States with some 17.1 trillion dollars GDP, the European Union with some 16.5 trillion dollars GDP and the BRICS with 16 trillion dollars GDP. If the BRICS Forum succeeds and more big emerging markets join the group, the emergence of an alternative global reserve currency seems to be a real possibility. This would simply be a reflection of the declining global power of the United States as its empire weakens.

Summary:

The Bretton Woods Monetary System was designed at the end of World War II to stabilize international money. The US dollar became the global reserve currency linked to gold. International currency flows were restricted between countries with a system of fixed but adjustable exchange rates.

Bretton Woods broke down in l971 due to dollar overhang from the Vietnam War and the over-extension of the US global empire. The global economy was fueled by inflated US dollars. The Bretton Woods Era continued, but was transformed to a system of flexible exchange rates under the guidance of central banks.

In recent years there has been a trend toward the establishment of monetary unions on a regional basis. The paradigm example is the European Union. As the US declines as a global power, ideas have emerged concerning an alternative global reserve currency. A possibility is a currency based upon a basket of the BRICS currencies and perhaps the currencies of other big emerging market countries. A return to the gold standard is not a viable option given the critical dimension of global economic growth in the twenty-first century global economy.

Key Terms:

International Monetary System

Eurodollar Market

Petrodollars

Bretton Woods System

Volatility

Financial Flows

Fixed Exchange Rates

Flexible Exchange Rates

Monetary Reserves

Pegged Currency

Crawling Peg

Adjustable Peg

Managed Float

Smithsonian Agreement

Seigniorage

Dollar Hegemony

Dollar Overhang

Special Drawing Rights

Jamaica Conference (1976)

Deregulation of Financial Markets

Reference Range System

Liquidity

Embedded System

Adjustment

Equilibrium

Plaza Conference (1985)

Gold Standard

Golden Fetters

Trilemma

Irreconcilable Trinity

Mundell-Fleming Model

European Central Bank (ECB)

US Federal Reserve (The Fed)

Bank of Japan

Welfare State

Robust Monetary Policy

Regional Monetary Integration

Fragmentation

Dollarization

The BRICS Forum