The world economy and society are undergoing profound historic changes that promise to lead to a destination that cannot be fully recognised yet. Two politically critical features of the dynamic of change are growing inequality in many advanced developed economies and popular protest that is breaking the mould of established consensual politics. The phenomenon is highlighted in the unprecedented support for the inconsistent populism of Donald Trump’s presidency that provides emotional succour for popular protest. Similarly, Britain is also witnessing the disgruntled determination of a swathe of the British electorate to abandon the European Union (EU) experiment. Neither phenomena appear capable of addressing the problems that prompted the popular revolt that propelled them and may even lead to worse outcomes than the disliked reality provoking the protest.
The economics of the historic change that has led to the contemporary impasse is crucial for understanding why the popular revolt has occurred. The symbolic period of the origins of the current predicament can be traced to the late 1970s when economic stability and the welfare state began to falter. The governments of Margaret Thatcher in Britain and Ronald Reagan in the U.S. then promulgated liberalisation policies that institutionalised the underlying growing financialisation of the global economy. The falling profitability of the real economy and consequent lack of investment opportunities had resulted in the need for an alternative path in financial activity to bolster wealth-making for the holders of liquidity and collateral for credit. This social class, of course, wielded significant political influence too, especially in the U.S., with its ability to influence electoral outcomes and sponsor policy. And, U.S. policy tended to institute a competitive dynamic of imitation.
Multi-layered globalisation, with heightened opening of national borders to the movement of goods and capital, altered the matrix by vastly deepening a process that had roots in the post-war Bretton Woods settlement of 1944. But the specific change that gathered huge momentum to become irresistible was the international mobility of capital during the forty years after the late 1970s. As a consequence, additional volumes of foreign direct investment sought low-cost locations. And it did not incur the penalty of higher cost capital because it was relocated to a venue where labour was cheaper than capital and latter ought, in theory, to be at a premium; capital markets were now global. In addition, financial intermediation itself dwarfed the real economy in value and profitability and became the arena in which wealth was acquired though not necessarily created in any conventional sense. It attracted the greatest interest and professional talent since financial activity could led to rapid and vast enrichment, and production per se, as opposed to profiteering, is never the ultimate motivation of economic agents.
An inexorable process was set in motion of competition between higher cost labour in the developed world, especially at the lower skill end, which was exposed to be a vast reservoir of the cheaper skilled, at a significantly lower price in developing countries. In reality, the phenomenon had already begun with the rise of the so-called newly-industrialising countries (NICs) by the late 1960s, but the entry of China into the global market as a producer of manufactures in the 1980s and beyond opened the flood gates. The particular Chinese model, with strong neo mercantilist impulses, which repressed domestic consumption, created additional pressures by generating imbalances for importers of Chinese goods. In principle, the latter Chinese neo-mercantilist policy instituted an adjustment burden for countries like the U.S. that absorbed a high proportion of Chinese manufactures by reducing the potential for a reverse flow of exports.
One critical issue for the economics of adjustment through prices and the flow of capital is that balance of payments surplus countries export capital and, as a result, the actual exchange value of their currency is unaffected by a surplus in the trade account. Such a surplus should have, in principle, prompted, through price changes, a reverse flow of exports from countries that were experiencing a deficit in their trade account because of imports. Also crucial to the situation was the overturning of the tenets of established international trade theory that excludes the phenomenon of increasing returns to scale, which has grown in importance in secular fashion, as embodied ‘knowledge capital’ has become significant in products. Once the knowledge capital has been created there is no additional cost to its re-location elsewhere to actualise production. Competition, always subject to vagaries of market power and other artificial restraints in the real world, was now fatally undermined by costs diminishing with the volume of production.
The consequences of financialisation, worsened by poor understanding of the inherency of economic instability, though pointed out by a few, lax policy and perverse incentives for financial product innovation, rewarding the immediate profitability of ingenious products, precipitated the inevitable storm. The banking system in the Anglo-Saxon world virtually collapsed in 2008 and governments intervened unrestrainedly to shore it up, effectively nationalising massive private debts. It underlined the existence of an extraordinarily inappropriate open-ended guarantee for egregious banking dynamics and practice. The economics of the government rescue of banks, compounded by global capital mobility and internationalisation of production, significantly in the form of intra-firm trade, deepened the distress being experienced by important segments of semi-skilled labour in developed countries. The situation was intensified even further by rapid technological change that reduced demand for certain types of labour. The stagnant incomes of a significant segment of the US lower middle class and blue-collar workforce and fewer work opportunities for them, also impinged, as a collateral phenomenon, on small and medium-size local businesses dependent on their spending power. Financialisation and the concentration of capital intermediation also subjected these SMEs to a credit squeeze because their specific local needs were more difficult to accommodate by automated due diligence.
The response to the global financial collapse through quantitative easing and nearly-negative interest rates created a surplus of investible funds within the banking system that already well-off owners of assets could borrow. It inflated the price of assets they already owned, which they were able to augment by fresh borrowing to make purchases. The resulting change in the relative price structure of classes of assets and products worsened the comparative position of the majority unable to take advantage of borrowing to benefit from the asset-price boom. And given relatively stagnant GDP growth, greater real wealth for the few could only occur at the expense of everyone else. The unsustainable dynamics of new wealth creation is underlined by unprecedentedly high contemporary price-equity ratios and house prices soaring to historic high multiples of average income.
The growing inequality that the response to the 2008 banking crisis provoked had an additional negative consequence for the majority of the population in developed countries. Governments burdened by a sudden massive increase in budget deficits and sky-high national debt inevitably reined in spending wherever they could. The curtailment of public spending created the impoverishment of many already disadvantaged groups. In addition, low-interest rates resulted in a massive transfer of wealth from the prudent small saver, depositing their monetary assets in banks, to debtors. There has also been a raft of tax rises, often by stealth, that reinforced the iniquitous situation the banking crisis had precipitated. There were grounds for popular discontent stemming from the impact of globalisation on the living standards of a significant proportion of the population in developed countries. It was intensified by its principal attribute of financialisation, which unfolded pitilessly after the 2008 banking collapse. It might also be noted that globalisation benefited developing countries by reducing absolute poverty but inequality within them also rose sharply, as the experience of China and India highlights.
The situation of the European Union illustrates a particular dimension of the problem, with the Euro preventing price adjustments through an exchange rate mechanism that would reflect diverging productivity growth among member states. As a result, Germany, in the main, increased its price advantage over other members of the EU persistently, creating unbalanced growth patterns among members states. In addition, the free movement of labour within the EU placed severe pressure on the demographic stability of some countries exporting it. This also put unwelcome downward pressure on wages of the less and semi-skilled in those countries to which a disproportionate share of labour from poorer EU members migrated. Imprudent borrowing by a number of EU members that markets were prepared to fund, underestimating the political tensions that would accompany EU-wide guarantees for debts incurred by member states, ended in serious crises. There was no EU-wide automatic fiscal provision to ease the stringency of what effectively amounted to a common monetary policy and the social consequences that inevitably arose when restoring financial viability through ruthless budgetary disciple was imposed. The EU experience highlighted in particularly graphic form the dilemma of a globalised world economy. Neither the EU nor the wider world economy possessed mechanisms for truly meaningful economic policy coordination, if not forms of genuine global governance to mitigate the dislocation of change.
Global governance remains politically unthinkable in a competitive parochial world, in which free riding would be the unavoidable norm and elected governments ultimately responsive to national constituencies, indeed powerful lobbies within their own societies. In such circumstances, adjustment mechanisms to cushion change that could be internationally agreed cannot be contemplated and crude bilateral solutions seem to have become more common. Thus, Donald Trump initiated a trade war with China, the EU, and others in an attempt to reverse the advance of globalisation that had impacted negatively on many who voted for him. However, national economies are now so integrated that reversing the outcome through political action is an unlikely prospect. Nor can global governance cooperation be contemplated for national governments to mitigate massive tax avoidance that leverages competition between national jurisdictions. Indeed, there is not even serious prospect of cooperation to reduce the criminal activity of evasion through tax havens. National governments seem averse to curtailing it even within their own country, provided the benefits accrue to itself rather than other countries.
The multi-layered and complex integration of the global economy means that the cost of disentangling and retreating from it would be far too great. No political party initiating it to survive the attempt, within the span of an electoral cycle. This is a reality Britain’s political parties will discover painfully if they truly sever economic ties with the EU. Yet globalisation is an especially difficult problem for a huge swathe of the working population in the developed world facing competition from abroad in the context of the inadequacies of the admittedly difficult task of properly retraining displaced workers and adjustment assistance. At the same time, a huge swathe of the chronically poor in the developing world has been lifted out of poverty through globalisation and access to export markets. In the long run, they too, China most of all, will import on an enhanced scale from the developed world, but the transition promises to be painful and possibly longer. In addition, the vagaries of globalised finance, pre-empting a disproportionate share of corporate profits and tax avoidance or evasion by corporations, are producing sharpening inequality, which has created an intractable socio-political problem. These problems can only be addressed effectively through serious international cooperation to mitigate market disjunctures and reduce tax avoidance and evasion.
Views are personal. The author taught international political economy at the London School of Economics and Political Science for more than two decades.