Financial crisis tests durability of globalization
By Martin Wolf
Published: October 10 2008 03:00 | Last updated: October 10 2008 03:00
The first world war damaged, but did not destroy, the globalisation of late 19th and early 20th century. The world economy recovered its vitality in the 1920s. Then came the US stock market crash of 1929 and the financial melt-down of the 1930s. During the great depression, the world chose autarky. By the late 1930s, the integrated global economy of half a century before was little more than a memory. Will todays prove more robust The good news is that it has already survived terrorism, war and a series of devastating financial crises. As Carmen Reinhart of the University of Maryland and Kenneth Rogoff of Harvard have shown in a seminal paper, the epoch of globalisation has been an epoch of banking crises (see chart).* While most of these crises occurred in emerging economies, they also brought Japan and the Scandinavian economies low in the early 1990s. In the case of Japan, the financial crisis afflicted the economy for more than a decade.
Attentive readers will notice that the incidence of crises, measured by the proportion of countries affected, reached its apogee in the late 1990s, whereupon it collapsed. This looked encouraging: Maybe, some hoped, the era of crises was coming to an end, as people learned how open financial systems should work.
The bad news is that this view now seems extremely naive. The current financial crisis affects the US and Europe, which account for more than half of world output (measured at market exchange rates). Judged by the share of the world economy affected, this is the most significant financial crisis since the 1930s. This crisis also affects the worlds most advanced economies and financial systems. This is no crisis of backwardness, but one of sophistication.
What then might such a crisis do to globalisation, which depends on the continuation of broadly liberal economic policies across the globe While technology – particularly the reduction in the costs of information and communications – has played a big part, it does not drive globalisation on its own. Also important have been decisions to move towards open financial systems, accept inward direct investment and liberalise trade.
Trade seems to be the engine of globalisation. In each successive business cycle, trade has grown faster than world output.
Between 2001 and 2006, for example, world exports of manufactures grew at a trend rate of 7.7 per cent a year, in real terms, while output of manufactures grew at 4 per cent. As the growth of trade accelerated, it seems to have pulled the world economy into faster growth, as well.
The financial crisis of today threatens globalisation in three ways.
First, it will reduce willingness to liberalise financial markets. If even the US and Europe cannot manage liberalised financial markets, can emerging economies hope to do so Second, it will undermine the credibility of free-market capitalism. This will affect not just finance, but, quite possibly, trade and direct investment as well. The more intrusive governments become in the high-income countries, the more unwilling the rest of the world will be to listen to their lectures on the virtues of free markets.
Finally, it will worsen the performance of the world economy. If, as now seems plausible, the US and Europe go into a significant recession, a rise in economic nationalism is to be expected – and feared.
The failure of the Doha round of multilateral trade negotiations must increase this danger. The 2000s have seen extraordinarily dynamic growth in emerging economies, driven by China and India. While these countries should continue to grow fast even in difficult times, their pace would probably slow.
This then is, potentially, a turning point not just for the financial sector, but for financial globalisation and even globalisation as a whole. Much depends on how swiftly and effectively this crisis is dealt with.
Much depends, too, on how long the associated recession lasts.
Much depends, not least, on how far the world turns away from liberalisation.
With luck the excesses of the financial sector will not taint the market economy too much. But, at this moment, when the crisis is at its peak, this is but a hope. It is up to policy makers to ensure that it turns out to be a fact.
Lessons must indeed be learned. But among those lessons is not a need for self-sufficiency. That would add economic disaster to financial calamity.
“This Time is Different: A Panoramic View of Eight Centuries of Financial Crises”, Working Paper 13882, www.nber.org. Copyright The Financial Times Limited 2009.