What's next for global economic policy?

What's next for global economic policy?

Globalisation is built on a collection of ideas that began to evolve as the second world war was ending, and expanded unchallenged until well into this century.

The roots of what we now call globalisation began as an attempt to build alternatives to the classical model of economics that was seen to have failed in the 1930s, as well as an alternative to a central tenet of Marxist theory, just as that ideology was gaining traction in a disaffected and war-ravaged world.

Classical economic theory made running a national economy sound very simple: when worried about the health of the economy, cut interest rates to win a greater share of export markets and boost domestic demand.

Conversely, when policymakers are worried that an economy is overheating and inflation is brewing, the theory has it that they should put rates up to dampen domestic demand.

This formula was very much the orthodoxy among governments until the 1930s, when something happened that had never really occurred before. Almost all of the major economies of the world crashed simultaneously.

In response, governments pursued the traditional policy described above. According to the economist John Maynard Keynes, they failed because one country cutting rates to win a greater share of export markets is not likely to be effective with all countries in recession. As all countries are experiencing a downturn, so economic demand everywhere is weak, and thus there is less demand for any given country’s goods, regardless of rate cuts. 

The plan

Keynes’ initial remedy was to urge governments to focus on domestic demand in times of economic slowdown, via increased public spending. But he had a wider plan to create a globalised financial system, and was one of the architects of the International Monetary Fund and World Bank. His idea was that countries could use these institutions in the way companies use commercial banks, storing their surpluses in times of plenty, while borrowing from those institutions in times of need.

The idea was to enable multiple countries to grow at the same time, rather than compete with one other. The traditional boom-and-bust cycles caused by interest rates in an economy being either too high or too low could be smoothed out by countries with strong economic performance helping fund the World Bank.

The World Bank could then lend the surplus of one country to a nation performing below its economic potential, funding a potential stimulus for that country.

Keynes died before these institutions became fully formed, and those who came after him deviated from his original plans.

One of the more prescient critics of globalisation is Joseph Stiglitz, the Nobel Prize winning economist who, in his 2002 book ‘Globalisation and its discontents’, noted that Keynes’ original vision had been abandoned because the World Bank and IMF attach conditions to the funding they provide to economically underperforming countries.

Mr Stiglitz noted these conditions focus on countries making their exports more competitive relative to rivals, precisely the sort of ‘beggar-thy-neighbour’ growth strategy that Keynes was urging countries to escape from when he created those institutions. The idea of competitiveness in export markets as a primary source of growth has much more in common with the 1930s consensus than the subsequent Keynesian consensus that emerged after the second world war.