point is. Moreover, that late-1950s experience with consumer debt burdens
has made me reluctant to underestimate the ability of most households and
companies to manage their financial affairs.
I
I
t is tempting to conclude that the U.S. current account deficit is essentially
a by-product of long-term forces, and is thus largely benign. After
all, we do seem to have been able to finance it with relative ease in recent
years. But do the apparent continued increases in the deficits of U.S. individual
households and nonfinancial businesses themselves reflect growing
economic strain? And does it matter whether those deficits are being financed
from domestic or foreign sources? If economic decisions were made
without regard to currency or cross-border risks, then one could argue that
current account imbalances would be of no particular economic significance,
and the accumulation of debt to foreigners would have few implications
beyond the solvency of the debtors themselves. Whether the debt of U.S.
entities was owed to domestic or foreign lenders would be of little import.
But national borders do matter, at least to some extent. Debt service
payments on foreign loans ultimately must be funded from exports of
tradable goods and services, or from capital inflows, whereas domestic debt
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CURRENT ACCOUNTS AND DEBT
has a broader base from which it can be serviced. For a business, cross-border
transactions can be complicated by a volatile exchange rate, but generally
this is a normal business risk. It is true that the market adjustment
process seems to be less effective or transparent across borders than within
national borders. Prices of identical goods at nearby locations, but across
borders, for example, have been shown to differ significantly even when
denominated in the same currency* Thus, cross-border current account
imbalances may impart a degree of economic stress that is likely greater
than that stemming from domestic imbalances only. Cross-border legal and
currency risks are important additions to normal domestic risks. But how
significant are the differences?
Globalization is changing many of our economic guideposts. It is probably
reasonable to assume that the worldwide dispersion of the financial
balances of unconsolidated economic entities as a ratio to world nominal
GDP noted earlier will continue to rise as increasing specialization and the
division of labor spread globally. Whether the dispersion of world current
account balances continues to increase as well is more of an open question.
Such an increase would imply a further decline in home bias. But in a
world of nation-states, home bias can decline only so far. It must eventually
stabilize, as indeed it may already have.+ In that event the U.S. current account
deficit would likely move toward balance.
In the interim, whatever the significance and possible negative implications
of the current account deficit, maintaining economic flexibility, as
I have stressed, may be the most effective way to counter such risks. The
piling up of dollar claims against U.S. residents is already leading to concerns
about "concentration risk"—the too-many-eggs-in-one-basket worry
that could prompt foreign holders to exchange dollars for other currencies,
even when the dollar investments yield more. Although foreign investors
*The persistent divergence subsequent to the creation of the euro of many prices of identical
goods among member countries of the euro area is analyzed in John H. Rogers (2002). For the
case of U.S. and Canadian prices, see Charles Engel and John H. Rogers (1996).
tThe correlation coefficient measures of home bias have flattened out since 2000. So have the
measures of dispersion. This is consistent with the United States' accounting for a rising share
of deficits.
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THE AGE OF TURBULENCE
have not yet significantly slowed their financing of U.S. capital investments,
since early 2002 the value of the dollar relative to other currencies
has declined, as has the share of dollar assets in some measures of global
cross-border portfolios.*
If the current disturbing drift toward protectionism is contained and
markets remain sufficiently flexible, changing terms of trade, interest rates,
asset prices, and exchange rates should cause U.S. saving to rise relative to
domestic investment. This would reduce the need for foreign financing and
reverse the trend of the past decade toward increasing reliance on funds
from abroad. If, however, the pernicious drift toward fiscal irresponsibility
in the United States and elsewhere is not arrested and is compounded by a
protectionist reversal of globalization, the process of adjusting the current
account deficit could be quite painful for the United States and our trading
partners.
*Of the more than $40 trillion equivalent of cross-border banking and international bond
claims reported by the private sector to the Bank for International Settlements for the end of
the third quarter of 2006, 43 percent were in dollars and 39 percent were in euros. Monetary
authorities have been somewhat more inclined to hold dollar obligations: at the end of the
third quarter of 2006, of the $4.7 trillion equivalent held as foreign-exchange reserves, approximately
two-thirds were held in dollars and approximately one-quarter in euros.
362
NINETEEN
GLOBALIZATION
AND REGULATION
B
B
y all contemporaneous accounts, the world prior to 1914 seemed to
be moving irreversibly toward higher levels of civility and civilization;
human society seemed perfectible. The nineteenth century
had brought an end to the wretched slave trade. Dehumanizing violence
seemed on the decline. Aside from America's Civil War in the 1860s and
the brief Franco-Prussian War of 1870-71, there had been no war engaging
large parts of the "civilized" world since the Napoleonic era. The pace of
global invention had advanced throughout the nineteenth century bringing
railroads, the telephone, the electric light, cinema, the motor car, and household
conveniences too numerous to mention. Medical science, improved
nutrition, and the mass distribution of potable water had elevated life expectancy
in what we call the developed world from thirty-six years in 1820
to more than fifty by 1914. The sense of the irreversibility of such progress
was universal.
World War I was more devastating to civility and civilization than the
physically far more destructive World War II: the earlier conflict destroyed
an idea. I cannot erase the thought of those pre-World War I years, when
THE AGE OF TURBULENCE
the future of mankind appeared unencumbered and without limit.* Today
our outlook is starkly different from a century ago but perhaps a bit more
consonant with reality Will terror, global warming, or resurgent populism
do to the current era of life-advancing globalization what World War I did to
the previous one? No one can be confident of the answer. But in approaching
the issue, it is worth probing the roots and institutions of post-World
War II economics that have raised the standards of living of virtually all the
inhabitants of this globe and helped restore some of humanity's hopes.
Individual economies grow and prosper as their inhabitants learn to
specialize and engage in the division of labor. So it is on a global scale.
Globalization—the deepening of specialization and the extension of the
division of labor beyond national borders—is patently a key to understanding
much of our recent economic history. A growing capacity to conduct
transactions and take risks throughout the world is creating a truly global
economy. Production has become more and more international. Much of
what is assembled in final salable form in one country increasingly consists
of components from many continents. Being able to seek out the most
competitive sources of labor and material inputs worldwide rather than
just nationwide not only reduces costs and price inflation but also raises the
ratio of the value of outputs to inputs—the broadest measure of productivity
and a useful proxy for standards of living. On average, standards of living
have risen markedly. Hundreds of millions of people in developing countries
have been elevated from subsistence poverty. Other hundreds of millions
are now experiencing a level of affluence that people born in developed
nations have experienced all their lives.
On the other hand, increased concentrations of income that have
*I still have a book from my student days, Economics and the Public Welfare, in which retired
economist Benjamin Anderson evoked the idealism and optimism of that lost era in a way I've
never forgotten: "Those who have an adult's recollection and an adult's understanding of
the world which preceded the first World War look back upon it with a great nostalgia. There
was a sense of security then which has never since existed. Progress was generally taken for
granted.... Decade after decade had seen increasing political freedom, the progressive spread
of democratic institutions, the steady lifting of the standard of life for the masses of men.... In
financial matters the good faith of governments and central banks was taken for granted. Governments
and central banks were not always able to keep their promises, but when this happened
they were ashamed, and they took measures to make the promises good as far as they
could."
364
GLOBALIZATION AND REGULATION
emerged under globalization have rekindled the battle between the cultures
of the welfare state and of capitalism—a battle some thought had
ended once and for all with the disgrace of central planning. Hovering over
us as well is the prospect of terrorism that would threaten the rule of law
and hence prosperity. A worldwide debate is under way on the future of
globalization and capitalism, and its resolution will define the world marketplace
and the way we live for decades to come.
History warns us that globalization is reversible. We can lose many of
the historic gains of the past quarter century. The barriers to trade and
commerce that came down following World War II can be resurrected, but
surely not without consequences similar to those that followed the stockmarket
crash of 1929.
I have two grave concerns about our ability to preserve the momentum
of the world's recent material progress. First is the emergence of increasing
concentrations of income, which is a threat to the comity and stability of
democratic societies. Such inequality may, I fear, spark a politically expedient
but economically destructive backlash. The second is the impact of the
inevitable slowdown in the process of globalization itself. This could reduce
world growth and diminish the broad sanction for capitalism that evolved
out of the demise of the Soviet Union. People quickly adjust to higher
standards of living, and if progress slows, they feel deprived and seek new
explanations or new leadership. Ironically, capitalism now seems to be held
in greater favor in the many parts of the developing world where growth is
rapid—China, part of India, and much of Eastern Europe—than where it
originated, in slower-growing Western Europe.
A "fully globalized" world is one in which unfettered production, trade,
and finance are driven by profit seeking and risk taking that are wholly indifferent
to distance and national borders. That state will never be achieved.
People's inherent aversion to risk, and the home bias that is a manifestation
of that aversion, mean that globalization has limits. Trade liberalization in
recent decades has brought about a major lowering of barriers to movement
in goods, services, and capital flows. But further progress will come
with increasing difficulty, as the stalemate in the Doha round of trade negotiations
demonstrated.
Because so much of our recent experience has little precedent, it is dif
365
THE AGE OF TURBULENCE
ficult to determine how long today's globalization dynamic will take to
play out. And even then we have to be careful not to fall into the trap of
equating the leveling-off of globalization with the exhaustion of opportunities
for new investment. The closing of the American frontier at the end
of the nineteenth century, for example, did not signal, as many feared, the
onset of economic stagnation.
P
P
ost-World War II economic recovery was fostered initially by the widespread
recognition of economists and political leaders that the surge of
protectionism following World War I had been a primary contributor to the
depth of the Great Depression. As a consequence, policymakers began
systematically taking down trade barriers and, much later, barriers to financial
flows. Before the fall of the Soviet Union, globalization was spurred
further when the inflation-ridden 1970s provoked a rethinking of the
heavy-handed economic policies and regulations that grew out of the Depression
years.
Because of deregulation, increased innovation,* and lower barriers to
trade and investment, cross-border trade in recent decades has been expanding
at a pace far faster than GDP, implying a comparable rise, on average,
in the ratio of imports to GDP worldwide. As a consequence, most
economies are being increasingly exposed to the rigors and stress of international
competition, which, while little different from the stress of domestic
competition, appear less subject to control. The job insecurity
engendered in developed economies by burgeoning imports is taking its
toll on wage increases—fear of job loss has significantly muted employees'
demands. Thus, imports, which of necessity are competitively priced, have
been restraining inflationary pressures.
There were outsized gains in the volume of international trade in the
first decades after World War II, but each country's exports and imports
largely grew in lockstep. Significant and persistent trade imbalances were
