Economic Globalization Sociology 2, Class 6 Copyright © 2011 by Evan Schofer Do not copy or distribute without permission

Announcements A watch was left in the classroom on Tuesday Agenda Today: Economic Globalization (continued)

Readings Stiglitz: Making Globalization Work, Ch 1: “Another World Is Possible” Discusses the “promise” of globalization, and areas where results have fallen short –The promise of globalization: Greater economic prosperity for both rich and poor countries –Criticisms of globalization, often raised by those from poor countries 1. The rules of the game benefit rich countries –Ex: trade agreements 2. Globalization tends to focus on material issues (money) and less on the environment & social issues

Readings Stiglitz: Making Globalization Work, Ch 1: “Another World Is Possible” –Criticisms of globalization (continued) 3. Globalization sometimes undermines democracy –Similar to the argument in “Supercapitalism” 4. Claims that “everybody wins” are wrong –There are losers in both rich and poor countries 5. Pro-market / pro-globalization policies have sometimes been forced on poor countries… which is unfair –A point also echoed in Elwood reading (Week 2).

Upcoming Readings Next week: Trade –Krugman, Paul R “What Do Undergrads Need to Know About Trade?” The American Economic Review, Vol. 83, No. 2, Papers and Proceedings of the Hundred and Fifth Annual Meeting of the American Economic Association. (May, 1993), pp Explains common misunderstandings about trade Critical of “pop-internationalists” (e.g. Thomas Friedman) –Stiglitz, Joseph E “Making Trade Fair.” Chapter 3 in Making Globalization Work. Reviews claims about benefits & problems of international trade Reviews the history of trade agreements Suggests ways to improve the international trading system –Ex: Addresses agricultural subsidies… –Krugman, Paul R “The Trouble With Trade.” The New York Times, Dec 28, Talks about how expanded trade in manufactured goods is affecting jobs in wealthy countries

Review: Economic Globalization Economic globalization: Simple definition: When economic activity that was formally local or national scale becomes organized on a global scale –Spanning countries, rather than contained within them Examples: Globalization of… Trade / exchange – international flow of goods/services Production – creation of goods spans borders Corporations – increasingly multinational Labor – some movement of workers; not too much Direct Investment – buying a factory in another country Capital – buying intangible goods in another country

Review: What is most globalized? Some things are more globalized than others… How Global? ExtremelyCapital flows VeryTrade ModeratelyCorporations, FDI, Production Not so muchLabor (workers)

Video: Commanding Heights Episode 3, chapters 3-6 Time: 3:30 (or 6:15) to 28:00 Basic issues regarding trade, capital flows Global link: h_menu_03.html h_menu_03.html Local link: Video\PBS.Commanding.Heights.Ep3.The.New.Rules.o f.the.Game.DivX6.avi Video\PBS.Commanding.Heights.Ep3.The.New.Rules.o f.the.Game.DivX6.avi

Economic Globalization: Origins Question: What are some basic things that are absolutely required in order to have a global economy? –1. Inexpensive transportation & communication –2. International financial (money) system –3. Countries that are willing to participate Absence of legal or regulatory “barriers” –For a related discussion, see Greico and Ikenberry “Economic Globalization and Political Backlash.” pp Emphasizes role of technology, as well as political changes that permitted globalization.

Transportation Historically, people only traded lightweight, valuable items… spices, silk, ivory, etc… Things that could be easily carried long distances Global economic activity requires cost- effective transportation systems Otherwise most business activity remains localized Most changes are pretty obvious: increase in cars, trucks, planes, trains, ships… But, one change matters more than others: containerized shipping

Transportation Containerized shipping = a huge revolution in global transportation Started in the 1970’s Shipping containers: a standard 40ft long box Easy to load and unload onto ships, trains, trucks Drastically reduced cost of shipping Huge ships can hold thousands of containers!

Containerized Shipping: Pics Ships can hold hundreds of containers!

Containerized Shipping: Pics Containers allow mechanical loading Pics: from Maersk Sealand Website

Containerized Shipping: Pics Containers can be transferred to trains, trucks

Containerized Shipping Question: Guess how much it costs to send a 40 foot shipping container with 10,000 pounds of cargo from Shanghai, China to the port at Long Beach? Answer: Less than $3,500 Taxes, tariffs, etc. make it cost a bit more… Question: How many pairs of Nike shoes fit in a container? Answer: over 10,000!

Containerized Shipping Consequence: Containerized shipping resulted in a dramatic increase in global trade Example: Container holds 10,000 pairs of shoes Container costs $3,500 to ship (including taxes) Total cost of shipping per pair: 35 cents! If cost of making a shoe in China is 36 cents less than in US, then there is an incentive to ship… Higher costs might come from: more expensive labor, costs of adhering to environmental laws, etc.

Containerized Shipping Containerized shipping has indirect consequences for the environment… –Some examples: –Companies can dump garbage in other countries Anything that is costly to dispose of in the US Hazardous waste; Old computers –Mass shipping leads to spread of “invasive” non- native species Examples: Asian Tiger mosquito, Zebra mussel arrived in cargo ships.

International Financial System Another barrier to the global economy: Money Suppose I build and sell computers… –What if someone from Europe wants to buy one? They only have European money: Euros –Problems: 1. I don’t want Euros – they are useless to me 2. How much is my computer worth in Euros money? –Even if I would accept the money, I don’t know the value…

International Financial System In order to conduct trade, there must be an international system to handle currencies Example: The Gold Standard –For every dollar the government prints, they hold a corresponding amount of gold in the bank Value of all currencies = tied to a common “standard” Example: US$1 = 1/35 ounce of gold Other currencies might have a different value: Example: Euro = 1/20 ounce.

The Gold Standard The gold standard is one solution to trade in a world of multiple currencies To sell a computer to someone in Europe, I can directly convert price US$ 1,000 computer = 35 ounces of gold = 700 Euros European gives 700 Euros to his bank… converts to gold Gold is given to US central bank; US$ 1,000 given to me Result: International trade is possible!

The Gold Standard Issue: If trade is one sided, gold drains from one country to another A “trade imbalance”, or a “current accounts deficit” Consequence –European banks have less gold, issue fewer Euros Money supply shrinks –European economy slows down, imports reduce… Result: System prevents asymmetric trade; system stays in equilibrium.

The Gold Standard The gold standard fell apart in the depression Governments wanted to boost their economies… Question: What are some ways the government can boost their economy? –Governments increased spending (e.g., hired people to build roads) to increase consumption This required printing more money… even though gold supply didn’t expand Currencies were no longer tied to gold… Trade became difficult.

Bretton Woods Plan B: The Bretton Woods agreement helped to re-establish an international financial system New plan: U.S. Dollars would serve as the currency for international transactions US dollars would have a fixed value vs. gold Other currencies would have a fixed exchange rate versus the dollar Everybody was happy again… for a while…

Bretton Woods The Bretton Woods system also fell apart Basic Problem: The fixed exchange rates works only if trade and capital flows are small … compared to the size of the US economy Eventually, when global trade flows harmed the US economy, the US changed the system… –The process is described by Herman Schwartz: “International Money, Capital Flows, and Domestic Politics.”

Floating Exchange Rates Plan C: The system of floating exchange rates Value of currencies is determined by market Like the price of commodities: oil, wheat, etc. Selling a computer to someone in Europe: –European goes to the currency market (bank) to buy US dollars – to pay me for the computer Current exchange rate:.75 –European pays.75 Euros to get each US$ Therefore, a US$ 1,000 computer costs 750 Euros…

Currency Value Examples CountryCurrencyNumber per US$ EuropeEuro0.748 CanadaDollar.987 ChinaYuan/RMB6.60 IndiaRupee45.04 JapanYen82.71 MexicoPeso12.09 South KoreaWon ThailandBaht30.38 United KingdomPound.63 As of Jan 12, 2011

Trade & Exchange Rates Currency values affect trade: Example: Suppose the Euro becomes more valuable relative to the dollar: Value of dollar drops from.70 Euros to.10 Euros –Euro worth 1.44 US$, goes up to 10 US$ How much would a US$ 1,000 computer cost to a European? Answer: Only 100 Euros! When a currency goes up relative to others, it is cheap to import If currency value drops, imports become expensive.

Trade & Exchange Rates Who benefits if Euro goes up relative to the US$? 1. European consumers – they can buy American products cheaply 2. American exporters – they can sell lots more to Europe Who Loses? 1. American consumers – European imports costs more 2. European companies – can’t compete with cheap US imports

Floating Exchange Rates Why do currency values “float” (change)? What forces affect supply and demand? 1. Asymmetric trade If a country imports more than it exports, its currency drops Ex: US has a current accounts deficit with Japan (imports more than it exports) To purchase Japanese goods, Americans must sell dollars, buy Japanese Yen –Demand drives up value of Yen relative to the dollar.

Floating Exchange Rates Example: The effects of asymmetric trade on currency values Suppose I sell 10,000,000 computers Europeans will sell 7.5 billion Euros to banks in order to purchase 10 billion US$… –If banks (currency markets) are flooded with Euros, supply increases, value drops… Currency markets don’t want more Euros Banks will give fewer US$ in exchange

Floating Exchange Rates What forces affect currency values? 2. Asymmetric capital flows If capital moves into a country, its currency goes up –Ex: In early 1990s, global investors moved money into Thailand, Mexico… raising the value of currency If capital moves out of a country, its currency goes down –Investors feared problems in Mexico, Thailand… pulled money out –Thai Baht and Mexican Peso dropped in value

Floating Exchange Rates What causes asymmetric capital flows? 2. a. Interest rates If a country raises interest rates, its currency goes up –Reason: Foreign investors prefer high rates –The “electronic herd” is attracted to high rates… If a country cuts interest rates, its currency drops –Investors would prefer moving money into countries where banks pay higher interest… –Important issue: Globalization limits the ability of governments to control their own monetary policy Sometimes countries want to lower interest rates to boost the economy… –But can’t because it would hurt their currency

Floating Exchange Rates What causes asymmetric capital flows? 2. b. Anything else that “scares” investors Government instability Concern that an economy isn’t going to do well –Ex: Fears that Thailand was going “bust” Policy changes that investors don’t like –Ex: big increase in taxes –Shift away from free-market policies (“golden straightjacket”) All of these things can cause investors to pull their money out of a country quickly, harming currency values.

Floating Exchange Rates What forces affect currency values? 3. Countries can intervene strategically to alter their currency values Governments can sell their currency to lower its value –They buy other currencies on global markets Governments can buy their own currency to raise its value –They spend “reserves” of gold or other currencies on global markets This requires lots of money, so rich countries can do it more.

Trade & Exchange Rates Recent news article: WASHINGTON (AP) -- America's beleaguered manufacturing companies, chafing over the loss of 2.7 million jobs over the last three years, vowed Wednesday to press ahead harder to get China to stop manipulating its currency to gain trade advantages. (Associated Press) Issue: China keeps value of currency low Aids exporters, at expense of US companies

Trade & Exchange Rates Issue: Countries can strategically alter their currency values to gain an advantage in trade –Asymmetric trade with China should cause Chinese Yuan to rise relative to the US$ The US imports much more than it exports –But: China floods market with Yuan, buys US$ Yuan value stays low compared to US$ Result: Chinese exports remain cheap for Americans Result: American manufacturing companies = Angry! –Note: Only big/wealthy countries can do this US did a similar thing in the 1970s Thailand tried, but ran out of money… it’s currency suddenly plummeted.

Financial Flows & Exchange Rates Issue: Trade & financial flows have same impact on currencies Asymmetrical flows cause currency values to change –But remember: Investment flows are larger than trade flows, and they can happen much faster Elwood: “pinball capital” Result: global investors can cause currency values to change rapidly Called: market volatility (rapid change in value) If a currency value falls too low, serious economic problems arise.

Exchange Rates & Volatility Capital flows and resulting currency volatility can produce severe crises Example: Mexico in 1994 Global investors bought lots of stock, investments in Mexico over several years… –This caused a slow rise in the peso. Not a problem. A minor political crisis led to panic selling in 1994 –The stock market began to plummet Global investors rushed to sell stocks, converted pesos to dollars Result: Selling of pesos made the value of pesos plummet!

Video Commanding Heights, Ep 3, chapter 7 Time: 27:50 – 32:45.

Exchange Rates & Volatility Why was it bad for the value of pesos to drop severely, rapidly? –1. Suddenly, imports were very expensive Price of gas shot up Businesses dependent on imports couldn’t afford costs; potential for bankruptcies –2. Many Mexican companies had borrowed money from US banks US banks must paid in $, not pesos If pesos are worth little, suddenly can’t afford to pay loans Result: More bankruptcies, economic recession.

Exchange Rates & Volatility In the case of the 1994 peso crisis, the US government stepped in Provided emergency loans, etc., to prevent massive bankruptcy But, that was just a small crisis… It is clear that crises could occur that are too large to stop so easily.

Asian Financial Crisis Commanding Heights Video: In the 1990s, foreign investors moved capital into Asia And, foreign banks lent money to Asian companies at very low interest rates –Consequence: Rapid economic growth Economies “heated up” But, capitalism is prone to boom-bust cycles… Companies built more factories and housing than needed –The “boom” ended But – global dynamics made the “bust” much worse!

Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? –1. Investors pulled out quickly – affecting currencies Asian currency valued dropped… Imports became expensive Companies could no longer pay off loans to foreign banks –Bankruptcies, unemployment…

Asian Financial Crisis How did globalization prompt a crisis for Asian economies in the 1990s? –2. Contagion Worries about Thailand spread to other Asian countries –Self-fulfilling prophecy: fear of problems caused investors to pull out, creating real problems Also, many US companies were invested in Asia (or had made loans)… Now they were losing money –Lesson: Integrated economies mean that crises tend to spread… Example: US financial crisis caused economic disruption around the globe.

More Video: Commanding Heights Topic: Asian financial crisis, spillover to other regions… –Video: 40:48 to 48:10 Asian economic miracle –Video: 48:10-1:14:30 Asian financial crisis and contagion

Capital Flows & the United States Krugman article: “Don’t Cry for Me America” Explains how investors are starting to pull out of the US Results won’t be as dire for us… –Isn’t happening too quickly –American companies have loans payable in US$ (if it were Euros, we’d be in bigger trouble) But, still… a serious issue for the US econoomy.

In the News: Article from 2007 LONDON (AFP) - The dollar plunged to a record low Tuesday against the euro, which broke through the 1.60-dollar barrier, as the unit was hit by dismal US housing news and fresh fears over the health of the US economy. Also weighing on the dollar was … the interest rate differential between the United States and the eurozone. The European Central Bank's benchmark rate, 4.00 percent, is already substantially higher than that of the US Federal Reserve, which stands at 2.25 percent. Higher interest rates in the eurozone makes the euro a more attractive investment than the dollar. While the Fed is scrambling to galvanize economic momentum and head off recession by lowering rates, the ECB is focused on curbing inflation -- currently at 3.6 percent in the eurozone -- and has shown no inclination to make credit cheaper. Issue: Fed can’t lower interest rates without hurting the dollar!