World Trade: Two Steps Forward, One Step Back

Asian crisis or no, globalization is on the rise--promising both greater opportunities and higher risks

Since the devaluation of the Thai baht in July, 1997, the fast-growing open economies of Asia have been roiled by a series of currency, stock market, and banking crises. No country on the Pacific Rim has been spared--even Japan, whose global industrial might has been undermined by the government's reluctance to jettison its failed policy. And with the Asian locomotive running in reverse, all the open economies of the emerging nations--from Latin America to Eastern Europe--have been hit hard. Even the developed, commodity-producing countries, such as Canada and Australia, have been hurt.

These shocks will not end globalization but are stark evidence of its double-edged nature. Short of war or an epidemic of market-closing, inward-turning policies, most countries in the 21st century are likely to keep pursuing globalization despite the minuses. Goods, labor, and capital will criss-cross the globe as never before. Why? The benefits are just too good to pass up. History shows that access to larger markets spurs innovation, while competition prods businesses to do things better and cheaper. Freer trade also promotes the movement of people and ideas across borders, providing the yeast of creativity and invention.

If current trends continue, world exports of goods and services will reach $11.4 trillion by 2005, or 28% of world gross domestic product, according to forecasts by Standard & Poor's DRI, nearly double this year's projected $6.5 trillion, or 24.3% of world GDP. World trade's share of GDP 20 years ago was a mere 9.3%.

But the benefits of growing trade, innovation, and growth go hand in hand with greater vulnerability to the vicissitudes of the global financial marketplace. Financial capital surges back and forth across borders on waves of optimism and pessimism far faster and in volumes several times greater than two decades ago. Inflows of foreign monies finance growth, but sudden withdrawals can trigger downturns.

The many successes of Asia's economies--and their continuing troubles today--offer an early demonstration of how globalization may play out. Despite the troubles in Asia, living standards in developing nations are higher than they were 20 years ago--and, after some very tough times, growth is expected to rebound. But right now, for millions of people in Indonesia, Thailand, and Korea who are feeling the pain of poverty and unemployment, globalization hardly seems worth the effort. After boasting annual GDP growth of nearly 7% in the 1992-97 period, the economies of Asia's middle-income countries are shrinking dramatically.

NEW CONSENSUS. An understandable backlash against the free flow of goods and capital is developing in some quarters. Foreign money managers and the International Monetary Fund have been demonized by some in Asia, and protectionist tendencies have been fanned even in the world's richest country because U.S. exports are losing buyers and the trade deficit is widening. To ensure that markets remain open and that globalization fulfills its promise, a new consensus will have to develop for managing the process--steering vulnerable economies past the most dangerous shoals and coping better with shipwrecks when they occur. U.S. monetary officials have spoken about the need for a "new global financial architecture," and over the next few years, it should begin to take shape. At the least, this should involve buttressing IMF finances and introducing new IMF procedures for assessing country risk. At its most ambitious, a new architecture will involve the private sector and nongovernmental institutions more actively in economic decision-making.

Whatever the nature of such a consensus, several critical factors--from information and transportation technology to existing trade and market-opening agreements--will continue to boost trade and investment. "There's a lot of oomph left for globalization, and [the Asia crisis] won't put an end to it," says Rudi Dornbusch, an economist at Massachusetts Institute of Technology.

Even with Asia in recession, cross-border investments are likely to grow for years to come. Countries need one another, and they can't just will that dependence away. "There's only one thing worse for Asia than foreigners buying up assets on the cheap--and that's foreigners not buying up assets on the cheap," observes C. Fred Bergsten, director of the Institute for International Economics. Asia needs foreign capital--private as well as official--to rebuild.

Similarly, every currency crisis in Latin America stirs up talk about erecting barriers to foreign capital or reversing privatizations. In the end, though, "populists also want money," says MIT's Dornbusch. Some countries, such as Chile, have put restrictions on capital inflows to insulate the economy from sudden withdrawals, but even Chile lately moved in the opposite direction: Deciding the country wasn't getting enough capital, officials slashed the central bank's reserve requirement on short-term foreign inflows from 30% to 10%.

Most important for promoting continued globalization, even if there are no further market-opening trade agreements, will be ever-improving technologies for transport and communications, says Douglas A. Irwin, an economist at Dartmouth College. Trade volumes will likely soon revert, after a one- or two-year slowdown, to the recent historical 7%-8% annual growth rate, says Gail Fosler, chief economist at the Conference Board.

Even as trade grows, however, financial crises are likely to keep erupting. That's because global investors are naturally jittery, and they can act on their emotions in a trice. What needs to happen to ameliorate the financial perils of globalization? For one thing, developing nations should not hesitate to participate more fully in financial markets. This may sound like jumping from the frying pan into the fire, but it isn't. Barry Eichengreen, an economist at the University of California at Berkeley, argues that a big problem in Asia was that many countries persisted in pegging their exchange rates, and local and foreign businesses alike put credence in avowals of exchange-rate stability. If more countries allow their currencies to float, businesses won't expect governments to guarantee a certain exchange rate, and they'll be forced to hedge by buying currency futures to protect themselves.

Then, too, in coming years, banks and other lenders and investors should be forced to swallow some losses when trouble hits. A huge problem in recent financial crises has been the obscure issue of "moral hazard"--when private lenders throw good money after bad on the assumption that they will be bailed out by an international lender of last resort--that is, the IMF. One solution: get the private sector to take a bigger role, and thereby reduce moral hazard. Catherine L. Mann, a senior fellow at the Institute for International Economics, suggests new forms of credit insurance and rollover insurance that will better match risk and return in emerging countries and sort out or tier different borrowers according to their creditworthiness.

It's critical to involve the private sector more because the resources of international institutions have been strained to the breaking point by recent crises. The IMF had to dip into a little-used fund to help finance its part of the latest $22 billion aid package to Russia, and members of Congress have been tying approval of future U.S. funding of the IMF to issues ranging from environmental to abortion policies. Hence the call for a new global financial architecture.

Economists, financial experts, and former officials have offered up a grab bag of IMF reforms: The IMF should upgrade its staff to do more rigorous risk analysis. The IMF should be more "transparent" in its deliberations, announcing, through an "early warning system," when countries are in trouble and detailing aspects of negotiations with government officials.

DIFFERENT GRADES. A new Bretton Woods parley should review the global economy and put corruption-fighting at the top of its agenda, says Edward Yardeni, chief economist at Deutsche Bank Securities Inc. in New York. The IMF should have different grades of membership, suggests David D. Hale, an economist with the Zurich Group in Chicago. Environmental and labor issues should be addressed in trade negotiations, says Dani Rodrik, an economist at Harvard University's John F. Kennedy School of Government.

Eichengreen, who was an adviser at the IMF last year, believes some changes would create a good deal more harm than good. Publicizing problems in individual countries, for instance, could bring on the very crisis that the IMF would hope to avert. Environmental and human-rights issues, says Jagdish Bhagwati, a professor of economics at Columbia University, are best left off the table at trade negotiations, though they may well merit consideration in other forums.

But clearly, something needs to be done. Asian nations have threatened to set up their own regional IMF, which would restrict financial flows and make trade more regionalized. Right now, Asia is too weak to pull off such a move. But if the IMF fails to get the necessary funding and doesn't adapt its policies in coming years, a revived Asia could well decide to pull away. Economic leaders attending the 1944 Bretton Woods meetings surely never imagined that the IMF would evolve into the world's chief financial firefighter--but they did expect it to help ward off global factionalism.

The insular response to globalization may have some political appeal, but fortunately, it is not holding sway. Even today, Asian nations are moving to open up their financial sectors and restructure their banks. That's important, but it won't be enough. Today, everything from intracompany trade to E-commerce challenges the jurisdiction of the nation-state, argues Wolfgang H. Reinicke, an economist at the World Bank. Eventually, private actors and nongovernmental institutions will have to assume some public functions and work with governments to set internationally accepted standards of behavior. A form of "mixed regulation" will develop, meaning that governments, multilateral organizations, and private companies will all monitor risk.

There are precedents. The bank-capital standards set forth in the Basle Accord of 1988 and its later amendments, concluded by central banks, shifted some regulatory burden to commercial banks. Banks take on the risk assessment of their portfolios, with central bank supervisors looking over their shoulders. The accord set globally accepted standards of capital adequacy which, while not met by all banks in all countries, nonetheless provide a benchmark for regulators and investors. In other arenas, from accounting standards to privacy on the Internet, public policy will take on a global aspect. "We have to establish a public policy framework that's equivalent to this dynamism," says Reinicke. Otherwise, people and companies won't be able to fully exploit the benefits that globalization should bring to more and more nations in the 21st century.

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