The Limits of Global Reaganomics and the Need for Global Pro-Third World Economic Institutions.
In our 1984 book “World Economy/Big Prediction” we predicted that barring some really revolutionary new technology of physical production (a la “cold fusion”), the future long-term engine of growth for the world economy would have to be modernization of the less developed countries. In making this prediction we used our observations on technology and the Solow economic growth model. The problem is that, despite the impressive growth in some Third World countries, the global institutions to facilitate this growth have not developed.
(For Cambridge Forecast Group book “World Economy/Big Prediction” from 1984 as mentioned above)
Basically, the current problems with the world economy, trade tensions, bubbles, cash crises, debt crises, etc. are caused by two global failures, (1) the failure to create a pro-Third World global fiscality that can stimulate Third World economies directly, (2) the failure of global urban and rural land reform in the developing world and the subsequent failure to expand the South’s internal market enough forcing them to rely on exports to the West.
To flesh out this point, let’s look at an updated history of the last 40 years. (the cfg book was written in 1992/1993) In the 1970’s, after the ’73 oil price rise by OPEC the patterns of world growth were as follows: OPEC‘s enormous petrodollar surpluses were deposited in the money-center banks and the loaned out short-term to Third World countries on the theory that sovereign governments wouldn‘t default. This together with the commodity price boom kept Third World markets opened. The developed countries had recovered from the recession of the early 70’s and America’s budget deficit was small compared with what it was later to become. The problem was dollar inflation which had cooled down considerably rose dramatically after the second oil price rise.
US policy now faced a dilemma. If it slammed on the monetary breaks it would make Third World debt unpayable and endanger the money-center banks. If it let the dollar inflation soar into double digit levels it would endanger the world economy. At the IMF meeting in Belgrade in the autumn of 1979, a solution was proposed. OPEC would use its petrodollar surpluses to convert short term Third World debt into long-term (lower payment) debt. This would sop up excess petrodollars and keep inflation down and also would keep Third World markets for Western products open. The hangup was the Saudi insistence that the PLO be given observer status at the IMF and that the US recognize the PLO. This was too politically controversial, so then Sec’y of the Treasury Paul Volcker flew back from Belgrade and slammed on the monetary breaks causing the Third World debt crisis to worsen.
Discussion of Western/OPEC cooperation continued until finally the Israeli invasion of Lebanon put the kibosh on it. The Reagan administration adopted a policy of drastic tax cuts, vastly increased military spending , running a huge budget deficit and trade deficit. In other words, the US became the borrower, consumer and importer of last resort (in the words of David Hale of Kemper Financial Securities) hopefully giving the Third World countries, which undergoing austerity, someplace to export to. By the mid-eighties this policy ran into the roadblock of rising protectionist sentiment in the US.
It was at this point that the “Reagan revolution” came up with the concept that was to dominate global development strategy. In order to explain this concept, it is important to observe that the “Reagan revolution” was not so much a revolution as it was a continuation and intensification of long-standing U.S. policy towards global economic growth. Since 1945, the US had historically run budget and trade deficits in order to act as “an engine of growth” for the rest of the world economy. The Reagan debt-led model of growth simply put this strategy into “full throttle” by an “order of magnitude” increase in the U.S. budget and trade deficits, and, in order to ward off inflation, financed the deficits by debt creation rather than by monetary creation.
The Reagan debt-led model of global growth, however unpalatable it might have seemed from a bookkeeping point of view, was in fact a bold and decisive strategy. For several years, it put the U.S. squarely back in charge of the world economy. and allowed the U.S. to break the international OPEC/West/LDC “gridlock” on global economic strategy. The world’s most important commodity was now, not oil, but the U.S. dollar. Commodity prices plunged. Large parts of the global economy were turned into a “global distress sale” and U.S. growth was financed from the “proceeds”. A significant portion of the Third World’s consumer markets were shut down and replaced by the U.S. consumer market. The world’s financial power and “market” power which had been dispersed between the U.S., Europe, Japan and OPEC was now pulled firmly back into the hands of the U.S. In short, Reagan’s response in 1982 to ten years of Western, OPEC and Third World bickering was: “You’ll do it my way. Even if I’m not quite sure what my way is yet.”
In other words, the U.S. was now able to set the agenda for discussions of global development strategy for the next decade.
The strategy towards North/South development that ultimately emerged from this U.S. dominance was the so-called neoliberal strategy. It’s most important feature was the initiation, in 1986, of a new round of global trade negotiations, the Uruguay Round, of the General Agreement on Trade and Tariffs (GATT). To give some background, the origins of the General Agreement on Tariffs and Trade (and of its stillborn predecessor, the International Trade Organization (ITO)) go back to American-British wartime discussions concerning the shape of the post-war world economy. Despite vigorous efforts by developing countries (in the Havana negotiations of 1947) the draft ITO Charter only “paid lip service to development concerns”. The GATT, a separate temporary agreement negotiated by 23 countries (which became permanent when ITO was never ratified), was even less receptive to the needs of the developing countries. Tariffs on trade in manufactures between developed countries were reduced substantially under the auspices of GATT, but products in which the developing world had a comparative advantage (such as textiles or agricultural products) received much less favorable treatment. In addition, when the developing countries diversified into industrial exports, they faced a proliferation of new discriminatory non-tariff trade restrictions directed specifically at them (such as the Multifibre Agreement which discriminated against Third World textile exports).
The basic thrust of the Uruguay Round was as follows: It had been estimated that the above restrictions on LDC exports to the West cost the Third World 500 billion dollars each year. The West would agree to abolish those restrictions, thus providing 500 billion dollars worth of economic benefit to the Third World. In return, the Third World would agree to:
- open up their service economies to imports;
- give wide autonomy to outside investment;
- agree to strengthen their patent protection of Western technologies, (thus, according to some critics, “locking in” Western advantage in these technologies).
According to the neoliberal strategy, such an agreement, and even the promise of such an agreement, would bring about a massive North/South capital transfer. This capital would be lured by the promise of access to Western markets, by cheap labor, and by a favorable climate for Western investment brought about by deregulation in the LDC’s. This flood of capital investment would, in turn, “jump start” the Third World economies, lead to a rising standard of living and open up markets for Western exports. The Third World would follow the path of the dynamic Asian LDC’s and would simultaneously break the cycle of slow growth, trade imbalances and fiscal deficits in the West. In the meantime, the West’s increased access to LDC service sector and high-tech markets, brought about by the GATT agreement, would reduce protectionist sentiment in the West.
“Cheap labor is drawing investment and production away from the industrial countries. Plentiful goods and materials are crowding the world markets, and annual exports from developing to industrialized nations have risen by $100 billion since 1989. A new economic order is being born. Eventually, the entire world should share the bounty of this new order. As nations develop, their need for imported goods rises, and worldwide demand grows. Multinationals expect the developing countries to become vast new markets by the end of the decade (for Western high tech, capital equipment and services, a la GATT) as productivity and incomes climb worldwide. History is on the side of the optimists.” (Editorial from Business Week, 8/2/93.)
To look at another aspect of this, the economist Robert Lucas maintains that the reason why underdeveloped countries are underdeveloped is that they have a small amount of “human capital” (individual and social labor productivity). And the economist Helpman says that a developing country can increase its human capital by exporting to the markets of the developed countries. Going up against first world competition increases the developing countries “learning by doing” (increases human capital) However, Lucas counters by saying that the Third World as a whole cannot do this, because “there is a zero sum aspect, with inevitable mercantilist overtones, to productivity growth fueled by ‘learning by doing’’. What this means is that the vast majority of the human race cannot grow economically indefinitely simply by exporting to a small minority of the human race. In other words, (following Samir Amin) the internal market of the developing countries has to be expanded directly by urban and rural land reform and by a pro-Third World global fiscality that funds sustainable development projects in the Third World.
(Although Lucas underestimated the growth potential of the Third World and the willingness of the developed countries to absorb imports from the developing countries).
To continue with our history, the nativist backlash to the proposed GATT agreement was the Perot candidacy. When Perot turned out to be a nutcase, it was Clinton that benefited from this sentiment.
And it was Clinton that passed the GATT legislation and the smaller but similar NAFTA (North American Free Trade Agreement). The problems began immediately. After the NAFTA agreement Mexico, under pressure from the Clinton administration, kept the Peso artificially high so that the US could have a trade surplus with Mexico in order to generate support for the GATT agreement. After the GATT agreement passed in 1994, Mexican debt built up attempting to keep its currency up but became unpayable and Mexico had to be bailed out by a special US fund, the Exchange Stabilization Fund.
After the passage of GATT, Clinton, to avoid wage nativism (fear of trade with low wage countries), talked up the Asian economies, saying that they were the “wave of the future”. In addition, the Southeast Asian countries pegged their currencies to the dollar which was weakening against the yen. Money surged into the Southeast Asian countries. As one investor put it “investing in Asia became a religion”
Meanwhile the Japanese yen was rising dangerously against the dollar endangering Japan’s exports to the US. In 1995, Japan took action to lift the dollar up (by buying US bonds) As the dollar rose, the Southeast Asian countries became less and less competitive and their economies collapsed in a wave of currency devaluations and their debt became unpayable. The IMF raised hundreds of billions of dollars to bail them out. Money flowed out of the Southeast Asian economies into the US, causing the internet bubble, and causing (a temporary) surge of US growth which (together with a tax rise) wiped out the deficit.
Under the Bush junior and Obama administrations, the US ran huge budget and trade deficits and printed an enormous amount of dollars. This kept US interest rates low and money flowed into the stock markets of the developing countries which had a higher rate of return. As a result, in the early 21st century, the developing countries were growing rapidly even as the developed countries stagnated. (And 500 million people were lifted out of poverty in the developing world).
However, in the spring of 2013, Fed Chief Bernanke said that the US was reconsidering its monetary policy and would stop its bond buying program (for fear of another real estate bubble like the one under Bush junior). The surge of money into Third World markets stopped on a dime. In fact, in June of 2013, the amount of money going into Third World markets dropped by over 90% from the month earlier. It remains to be seen whether the concerns about the health of the developing countries’ economies will cause the Fed to back off.
Lawrence Feiner and Richard Melson July 2013 Cambridge Forecast Group
CFG Comment on this Update, July 12, 2013:
“It looks like the Fed has backed off of its proposed monetary tightening, as we predicted (sort of) in the Blog update. In other words it has to overstimulate the American economy (and real estate market) in order to safeguard Third World solvency. By overstimulating U.S. asset prices–stocks and houses–the American consumer starts to spend as his 401k looks better and America absorbs more imports worldwide….going back to the American consumer as locomotive, absent a new locomotive. Also lower interest rates sends money to emerging markets.”
The Reagan Revolution and the Developing Countries (1980-1990):
A Seminal Decade for Predicting the World Economic Future
by Lawrence Feiner and Richard Melson:
“Both former principals of the Cambridge Forecast Group, the authors have written a sharp challenge to prevailing economic thought, arguing that despite the chaos that seems to have enveloped the world economy since the end of the Cold War, the direction and development of world economic history is, in fact, quite predictable. Professors of economics and professional economists will find this book both appealing and important.” Read review.
by lawrence feiner, richard melson
CAMBRIDGE FORECAST GROUP
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