1. Economic Globalization Sociology 2, Class 7 Copyright © 2013 by Evan Schofer Do not copy or distribute without permission

2. Announcements Midterm is approaching… 2 weeks I’ll provide details and a review sheet soon Agenda –Today: More on economic globalization Capital flows and currency crises Trade and trade agreements

3. 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 – good & services Production – making things Corporations – “multi-national corporations” Labor – immigration “Direct” Investment – building factories Capital – Moving money to buy “intangible” assets

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

5. Global Capital Flows: Recent Data FYI: Recent data on global capital flows 2011 Global GDP: $70 Trillion 2010 Global Trade $18 Trillion 2008 Global capital flows: $604 Trillion Hard to get good data…

6. Video: Commanding Heights Episode 3, chapters 3-6 Time: 3:30 (or 6:15 or 10:00 if time is short) to 28:00 Basic issues regarding trade, capital flows Global link: http://www.pbs.org/wgbh/commandingheights/lo/story/c h_menu_03.html http://www.pbs.org/wgbh/commandingheights/lo/story/c 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

7. 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. 220-223. Emphasizes role of technology, as well as political changes that permitted globalization.

8. 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

9. 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!

10. Containerized Shipping: Pics Ships can hold hundreds of containers!

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

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

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

14. 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 people will ship them… Higher costs might come from: more expensive labor, costs of adhering to environmental laws, etc. Shipping containers are so cheap that people ship garbage & scrap metal… Or even dump hazardous waste in other countries.

15. 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…

16. 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.

17. 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!

18. 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.

19. The Gold Standard The gold standard fell apart in the depression Governments wanted to boost their economies… 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.

20. 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…

21. 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.”

22. 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…

23. Currency Value Examples CountryCurrencyNumber per US$ EuropeEuro0.748 CanadaDollar.987 ChinaYuan/RMB6.60 IndiaRupee45.04 JapanYen82.71 MexicoPeso12.09 South KoreaWon1112.06 ThailandBaht30.38 United KingdomPound.63 As of Jan 12, 2011

24. 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.

25. 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

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

27. 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 –Changing currency values often result in a trade equilibrium Drop in currency limits subsequent imports But, we’ll discuss exceptions… (ex: China & US)

28. Floating Exchange Rates What forces affect currency values? 2. Asymmetric capital flows –If capital moves into a country, 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.

29. 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 doing so might cause adverse effects on currency…

30. Floating Exchange Rates What causes asymmetric capital flows? 2. b. Anything else that “scares” investors –Concern that an economy may have problems 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”) –Government instability –All of these things can cause investors to pull their money out of a country quickly, harming currency values.

31. Floating Exchange Rates What forces affect currency values? 4. Countries can intervene strategically to alter their currency values –Sometimes keeping it at a “fixed” value with the dollar or other major currency 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 –Of course, this requires lots of money Mainly, big / wealthy countries do this (ex: China) Small countries sometimes fail (ex: Thailand).

32. Financial Flows & Exchange Rates Issue: Trade & financial flows have a similar 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).

33. 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!

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

35. 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. Mexican companies had borrowed money from US banks US banks must paid in $, not pesos If pesos are worth less, suddenly you can’t afford to pay loans Result: More bankruptcies, economic recession.

36. 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.

37. 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!

38. 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…

39. 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.

40. More Video: Commanding Heights Topic: Asian financial crisis, spillover to other regions… Video: 40:48 to 48:10 (8 minutes) –Asian economic miracle Video: 48:10-1:14:30 (36 minutes) –Asian financial crisis and contagion