Needless to say, time has left me a lot wiser: We need to design economies so that they can operate without disaster even when deregulatory clowns like those of the George W. Bush or the Donald J. Trump administrations are in control of the levers of policy at key moments. How to do that is not so clear. What is clear is that only a fool today would think that our political economy would support a clever technocracy so that we might have our cake and eat it too. Indeed, the most likely scenario seems to be that we will be unable to eat our cake, and then the kleptocrats will steal it out from under our noses so that we will not have it either. In short: I should have listened harder to Jagdish 20 years ago...
Hoisted from the Archives: Reply to Bhagwati: "I open my May/June  issue of Foreign Affairs to discover myself pilloried in an article by Jagdish Bhagwati between Paul Krugman and Roger C. Altman (excellent company to be in, by the way: much better than I am used to) as a banner-waving proponent of international capital mobility, guilty of "assum[ing] that free capital mobility is enormously beneficial while simultaneously failing to evaluate its crisis-prone downside."
I rub my eyes in surprise. I had not thought of myself as a banner-waving proponent of international capital mobility.
I wish that Jagdish Bhagwati's research assistants had shown him the sentence from my January 28 Los Angeles Times op-ed after the two he quotes (it reads: "But the free flow of financial capital is also giving us one major international financial crisis every two years"); or shown him my evaluation of the causes of the crisis a paragraph but one above where he quotes (it reads: "the sudden change in [market] opinion [toward East Asia] reflects not a cool judgment of changing fundamentals [of East Asian growth] but instead a sudden psychological victory of fear over greed").
If I am the the point man waving the banner, all I can say is that the ranks of the army of international capital mobility must be thin indeed.
But since I have apparently been elected, let me pick up the banner and wave it around a few times, for on this issue I am what Jagdish Bhagwati calls a "[neo-]liberal"—someone who believes that we should neither encourage governments to choke off international flows of saving and investment (as Bhagwati thinks), nor look with schadenfreude on and discourse on the long-run salutary effects of the great depressions caused by international financial panics, but instead try to have our cake and eat it too: to reap the benefits of international capital mobility, and to minimize the human costs of recurrent crises through appropriate and well-funded international central banking institutions and practices.
We should try to have our cake because the benefits of international capital mobility truly are mammoth. Between 1994 and 1996 some $200 billion of international capital flowed into Malaysia, the Philippines, South Korea, and Thailand. In all of these countries the private return on investment is high—higher than in the industrial core. In all of these countries the social return on investment is higher still: if the economic history of the past two centuries teaches us anything, it teaches us that investments in modern machine technologies are a very good if not the best way to upgrade the skills of the labor force and gain the organizational expertise necessary for high total factor productivity.
This inflow of capital to these four countries was worth at least $15 billion a year and perhaps as much as $40 billion a year in higher GDP to the receiving countries even after taking account of the interest, dividends, and capital gains owed to investors from abroad. Just as the flow of finance from the British core to the periphery in the late nineteenth century played an important role in producing the Australian and North American economies that have had the world's highest standard of living in the twentieth century, so the flow of finance from today's industrial core to the NIC periphery has every prospect of cutting a generation or so off of the time needed for East Asian workers and consumers to achieve industrial core levels of productivity and economic welfare.
Calculations of the effect of international capital mobility on economic welfare are considerably more complicated and uncertain than calculations of the effect on growth, but they carry the same message: the ability to attract international capital to boost development or cushion the costs of macroeconomic policy mistakes can be very, very valuable.
We should try to eat our cake too because the costs of unmanaged international financial crises are horrific. Because of the Latin American debt crisis of 1982 the decade of the 1980s was lost to Latin American development—leaving the typical Latin American country between five and ten percent poorer at the beginning of the 1990s than it would have been in a counterfactual world in which borrowing from abroad had not financed oil imports and elite consumption in the late 1970s. The financial crisis of 1873 saw the share of the U.S. non-agricultural labor force employed in building railroads fall from perhaps eight to perhaps two percent. And international financial crises turned the global recession of 1929-1931 into the Great Depression, generating not only a decade of relative poverty but the rise of the Nazi regime and the fifty million dead from World War II in Europe.
If there were no reasonable prospect of successfully managing international financial crises, then I would agree with Professor Bhagwati: the risks of an 1873 or a 1982 or—worst of all—a 1933 would then significantly outweigh the benefits of capital mobility. But there is every reasonable prospect of successfully managing international financial crises. The much-larger-than-anyone-anticipated Mexican crisis of 1994-1995—successfully handled—saw Mexican economic growth resume after a single year of recession. The East Asian crisis of 1997 may not even generate an absolute recession: as of this writing it looks as though East Asian GDPs will not decline, but instead that growth will pause in 1998 and resume in 1999.
But successful handling of international financial crises requires political and economic skill. It requires rejecting the arguments of the Wall Street Journal's editorial page that East Asia "needs" a deep, prolonged recession with mass unemployment to punish entrepreneurs and banks in NICs who overborrowed. It requires rejecting the arguments of Ralph Nader that East Asia "needs" a deep, prolonged recession with mass unemployment to punish New York financiers who overlent. And it requires rejecting the arguments of Jagdish Bhagwati that international capital mobility—good enough to finance the industrialization of the NICs of Australia, Canada, and the U.S. a century ago—is too risky for the NICs of today...
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