Globalization’s Wrong Turn

And How It Hurt America

By Dani Rodrik June 11, 2019

Trading up? Shipping containers in Shanghai, China, May 2012

ALY SONG / REUTERS

G lobalization is in trouble. A populist backlash, personified by U.S.

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President Donald Trump, is in full swing. A simmering trade war
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between China and the United States could easily boil over.
globalization’s biggest boosters now concede that it has produced lopsided
benefits and that something will have to change.

Today’s woes have their roots in the 1990s, when policymakers set the
world on its current, hyperglobalist path, requiring domestic economies to
be put in the service of the world economy instead of the other way
around. In trade, the transformation was signaled by the creation of the
World Trade Organization, in 1995. The WTO not only made it harder
for countries to shield themselves from international competition but also
reached into policy areas that international trade rules had not previously
touched: agriculture, services, intellectual property, industrial policy, and
health and sanitary regulations. Even more ambitious regional trade deals,
such as the North American Free Trade Agreement, took off around the
same time.

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In finance, the change was marked by a fundamental shift in governments’

attitudes away from managing capital flows and toward liberalization.
Pushed by the United States and global organizations such as the
International Monetary Fund and the Organization for Economic
Cooperation and Development, countries freed up vast quantities of
short-term finance to slosh across borders in search of higher returns.
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At the time, these changes seemed to be based on sound economics.
Openness to trade would lead economies to allocate their resources to
where they would be the most productive. Capital would flow from the
countries where it was plentiful to the countries where it was needed.
More trade and freer finance would unleash private investment and fuel
global economic growth. But these new arrangements came with risks that
the hyperglobalists did not foresee, although economic theory could have
predicted the downside to globalization just as well as it did the upside.

Increased trade with China and other low-wage countries accelerated the
decline in manufacturing employment in the developed world, leaving
many distressed communities behind. The financialization of the global
economy produced the worst financial crisis since the Great Depression.
And after the crash, international institutions promoted policies of
austerity that made the damage even worse. More and more of what
happened to ordinary people seemed the result of anonymous market
forces or caused by distant decision-makers in foreign countries.

Politicians and policymakers downplayed these problems, denying that the

new terms of the global economy entailed sacrificing sovereignty. Yet they
seemed immobilized by these same forces. The center-right and the
center-left disagreed not over the rules of the new world economy but
over how they should accommodate their national economies to them. The
right wanted to cut taxes and slash regulations; the left asked for more
spending on education and public infrastructure. Both sides agreed that
economies needed
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competitiveness. Globalization, exclaimed U.S. President Bill Clinton, “is
the economic equivalent of a force of nature, like wind or water.” British
Prime Minister Tony Blair mocked those who wanted to “debate
globalization,” saying, “you might as well debate whether autumn should
follow summer.”

Yet there was nothing inevitable about the path the world followed
beginning in the 1990s. International institutions played their part, but
hyperglobalization was more a state of mind than a genuine, immutable
constraint on domestic policy. Before it came along, countries had
experimented with two very different models of globalization: the gold
standard and the Bretton Woods system. The new hyperglobalization was
closer in spirit to the historically more distant and more intrusive gold
standard. That is the source of many of today’s problems. It is to the more
flexible principles of Bretton Woods that today’s policymakers should look
if they are to craft a fairer and more sustainable global economy.

THE GOLDEN STRAITJACKET

For roughly 50 years before World War I, plus a brief revival during the
interwar period, the gold standard set the rules of economic management.
A government on the gold standard had to fix the value of its national
currency to the price of gold, maintain open borders to finance, and repay
its external debts under all circumstances. If those rules meant the
government had to impose what economists would today call austerity, so
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be it, however great the damage toCONTINUE
domestic incomes and employment.
That willingness to impose economic pain meant it was no coincidence
that the first self-consciously populist movement arose under the gold
standard. At the tail end of the nineteenth century, the People’s Party gave
voice to distressed American farmers, who were suffering from high
interest rates on their debt and declining prices for their crops. The
solution was clear: easier credit, enabled by making the currency
redeemable in silver as well as gold. If the government allowed anyone
with silver bullion to convert it into currency at a set rate, the supply of
money would increase, driving up prices and easing the burden of the
farmers’ debts. But the northeastern establishment and its backing for the
gold standard stood in the way. Frustrations grew, and at the 1896
Democratic National Convention, William Jennings Bryan, a candidate
for the presidential nomination, famously declared, “You shall not crucify
mankind upon a cross of gold.”

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William Jennings Bryan campaigning in 1896

Library of Congress

The gold standard survived the populist assault in the United States
thanks in part to fortuitous discoveries of gold ore that eased credit
conditions after the 1890s. Nearly four decades later, the gold standard
would be brought down for good, this time by the United Kingdom,
under the pressure of similar grievances. After effectively suspending the
gold standard
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1925 at its pre-war rate. But the British economy was only a shadow of its
pre-war self, and four years later, the crash of 1929 pushed the country
over the edge. Business and labor demanded lower interest rates, which,
under the gold standard, would have sent capital fleeing abroad. This time,
however, the British government chose the domestic economy over the
global rules and abandoned the gold standard in 1931. Two years later,
Franklin Roosevelt, the newly elected U.S. president, wisely followed suit.
As economists now know, the sooner a country left the gold standard, the
sooner it came out of the Great Depression.

The experience of the gold standard taught the architects of the postwar
international economic system, chief among them the economist John
Maynard Keynes, that keeping domestic economies on a tight leash to
promote international trade and investment made the system more, not
less, fragile. Accordingly, the international regime that the Allied countries
crafted at the Bretton Woods conference, in 1944, gave governments
plenty of room to set monetary and fiscal policy. Central to this system
were the controls it put on international capital mobility. As Keynes
emphasized, capital controls were not merely a temporary expedient until
financial markets stabilized after the war; they were a “permanent
arrangement.” Each government fixed the value of its currency, but it
could adjust that value when the economy ran up against the constraint of
international finance. The Bretton Woods system was predicated on the
belief that the best way to encourage international trade and long-term
investment was to enable national governments to manage their
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economies.
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 It is to the more flexible principles of Bretton
Woods that today’s policymakers should look if
they are to craft a fairer and more sustainable
global economy.

Bretton Woods covered only international monetary and financial

arrangements. Rules for trade developed in a more ad hoc manner, under
the auspices of the General Agreement on Tariffs and Trade (GATT). But
the same philosophy applied. Countries were to open up their economies
only to the extent that this did not upset domestic social and political
bargains. Trade liberalization remained limited to lowering border
restrictions—-import quotas and tariffs—on manufactured goods and
applied only to developed countries. Developing countries were essentially
free to do what they wanted. And even developed countries had plenty of
flexibility to protect sensitive sectors. When, in the early 1970s, a rapid
rise in garment imports from developing countries threatened
employment in the developed world, developed and developing nations
negotiated a special regime that allowed the former to reimpose import
quotas.

Compared with both the gold standard and the subsequent hyper-
globalization, the Bretton Woods and GATT rules gave countries great
freedom to choose the terms on which they would participate in the world
economy. Advanced economies used that freedom to regulate and tax their
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economies as they wished and to build generous welfare states, unhindered
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by worries of global competitiveness or capital flight. Developing nations
diversified their economies through trade restrictions and industrial
policies.

Domestic autonomy from global economic pressures might sound like a

recipe for less globalization. But during the Bretton Woods era, the global
economy was on a tear. Developed and developing economies alike grew
at unprecedented rates. Trade and foreign direct investment expanded
even faster, outpacing the growth of world GDP. The share of exports in
global output more than tripled, from less than five percent in 1945 to 16
percent in 1981. This success was a remarkable validation of Keynes’ idea
that the global economy functions best when each government takes care
of its own economy and society.

BACK TO THE SPIRIT OF THE GOLD STANDARD

Ironically, the hyperglobalists used the very success of the Bretton Woods
system to legitimize their own project to displace it. If the shallow Bretton
Woods arrangements had done so much to lift world trade, investment,
and living standards, they argued, imagine what deeper integration could
achieve.

But in the process of constructing the new regime, the central lesson of
the old one was forgotten. Globalization became the end, national
economies the means. Economists and policymakers came to view every
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conceivable feature of domestic economies through the lens of global
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markets. Domestic regulations were either hidden trade barriers, to be
negotiated away through trade agreements, or potential sources of trade
competitiveness. The confidence of financial markets became the
paramount measure of the success or failure of monetary and fiscal policy.

The premise of the Bretton Woods regime had been that the GATT and
other international agreements would act as a counterweight to powerful
protectionists at home—labor unions and firms serving mainly the
domestic market. By the 1990s, however, the balance of political power in
rich countries had swung away from the protectionists toward exporter
and investor lobbies.

The trade deals that emerged in the 1990s reflected the strength of those
lobbies. The clearest illustration of that power came when international
trade agreements incorporated domestic protections for intellectual
property rights, the result of aggressive lobbying by pharmaceutical firms
eager to capture profits by extending their monopoly power to foreign
markets. To this day, Big Pharma is the single largest lobby behind trade
deals. International investors also won special privileges in trade
agreements, allowing them (and only them) to directly sue governments in
international tribunals for alleged violations of their property rights. Big
banks, with the power of the U.S. Treasury behind them, pushed countries
to open up to international finance.

Those who lost out from hyper-globalization received little support. Many
manufacturing-dependent communities in the United States saw their
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jobs shipped off to China and Mexico and suffered serious economic and
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social consequences, ranging from joblessness to epidemics of drug
addiction. In principle, workers hurt by trade should have been
compensated through the federal Trade Adjustment Assistance program,
but politicians had no incentives to fund it adequately or to make sure it
was working well.

Economists were brimming with confidence in the 1990s about

globalization as an engine of growth. The game was to encourage exports
and attract foreign investment. Do that, and the gains would prove so
large that everyone would eventually win. This technocratic consensus
served to legitimize and further reinforce the power of globalizing
corporate and financial special interests.

An important element of hyper-globalist triumphalism was the belief that

countries with different economic and social models would ultimately
converge, if not on identical models, at least on sufficiently similar market
economy models. China’s admission to the WTO, in particular, was
predicated on the expectation in the West that the state would give up
directing economic activity. The Chinese government, however, had
different ideas. It saw little reason to move away from the kind of
managed economy that had produced such miraculous results over the
previous 40 years. Western investors’ complaints that China was violating
its WTO commitments and engaging in unfair economic practices fell on
deaf ears. Regardless of the legal merits of each side’s case, the deeper
problem lay elsewhere: the new trade regime could not accommodate the
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A SANER GLOBALIZATION

Policymakers can no longer resuscitate the Bretton Woods system in all its
details; the world can’t (and shouldn’t) go back to fixed exchange rates,
pervasive capital controls, and high levels of trade protection. But
policymakers can draw on its lessons to craft a new, healthier
globalization.

Trump’s in-your-face unilateralism is the wrong way forward. Politicians

should work to revive the multilateral trade regime’s legitimacy rather
than squelching it. The way to achieve that, however, is not to further open
markets and tighten global rules on trade and investment. Barriers to trade
in goods and many services are already quite low. The task is to ensure
greater popular support for a world economy that is open in essential
respects, even if it falls short of the hyperglobalist ideal.

If China and the United States are to resolve their

trade conflict, they need to acknowledge that the
differences between their economies are not going
away.

Building that support will require new international norms that expand
the space for governments to pursue domestic objectives. For rich
countries, this will mean a system that allows them to reconstitute their
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domestic social contracts. The set of rules that permit countries to
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temporarily protect sensitive sectors from competition badly needs reform.
For example, the WTO allows countries to impose temporary tariffs,
known as antidumping duties, on imports being sold by a foreign
company below cost that threaten to harm a domestic industry. The WTO
should also let governments respond to so-called social dumping, the
practice of countries violating workers’ rights in order to keep wages low
and attract production. An anti-social-dumping regime would permit
countries to protect not merely industry profits but labor standards, too.
For developing countries, the international rules should accommodate
governments’ need to restructure their economies to accelerate growth.
The WTO should also loosen the rules on subsidies, investment, and
intellectual property rights that constrain developing countries’ ability to
boost particular industries.

If China and the United States are to resolve their trade conflict, they
need to acknowledge that the differences between their economies are not
going away. The Chinese economic miracle was built on industrial and
financial policies that violated key tenets of the new hyperglobalist regime:
subsidies for preferred industries, requirements that foreign companies
transfer technology to domestic firms if they wanted to operate in China,
pervasive state ownership, and currency controls. The Chinese government
is not going to abandon such policies now. What U.S. companies see as
the theft of intellectual property is a time-honored practice, in which a
young United States itself engaged back when it was playing catch-up
with industrializing England in the nineteenth century. For its part, China
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must realize that the United States and European countries have
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legitimate reasons to protect their social contracts and homegrown
technologies from Chinese practices. Taking a page from the U.S.-Soviet
relationship during the Cold War, China and the United States should
aim for peaceful coexistence rather than convergence.

In international finance, countries should reinstate the norm that domestic

governments get to control the cross-border mobility of capital, especially
of the short-term kind. The rules should prioritize the integrity of
domestic macroeconomic policies, tax systems, and financial regulations
over free capital flows. The International Monetary Fund has already
reversed its categorical opposition to capital controls, but governments
and international institutions should do more to legitimize their use. For
example, governments can make their domestic economies more stable by
using “countercyclical capital regulation,” that is, restricting capital inflows
when the economy is running hot and taxing outflows during a downturn.
Governments should also crack down on tax evasion by the wealthy by
establishing a global financial registry that would record the residence and
nationality of shareholders and the actual owners of financial assets.

Left to its own devices, globalization always creates winners and losers. A
key principle for a new globalization should be that changes in its rules
must produce benefits for all rather than the few. Economic theory
contributes an important idea here. It suggests that the scope for
compensating the losers is much greater when the barrier being reduced is
high to begin with. From this perspective, whittling away at the
remaining, mostly
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does not make much sense. Countries should focus instead on freeing up
cross-border labor mobility, where the barriers are far greater. Indeed,
labor markets are the area that offers the strongest economic case for
deepening globalization. Expanding temporary work visa programs,
especially for low-skilled workers, in advanced economies would be one
way to go.

Proposing greater globalization of labor markets might seem to fly in the

face of the usual concern that increased competition from foreign workers
will harm low-skilled workers in advanced economies. And it may well be
a political nonstarter in the United States and western Europe right now.
If governments aren’t proposing to compensate those who lose out, they
should take this concern seriously. But the potential economic gains are
huge: even a small increase in cross-border labor mobility would produce
global economic gains that would dwarf those from the completion of the
entire current, long-stalled round of multilateral trade negotiations. That
means there’s plenty of scope for compensating the losers—for example,
by taxing increased cross-border labor flows and spending the proceeds
directly on labor-market assistance programs.

In general, global governance should be light and flexible, allowing

governments to choose their own methods of regulation. Countries trade
not to confer benefits on others but because trade creates gains at home.
When those gains are distributed fairly throughout the domestic economy,
countries don’t need external rules to enforce openness; they’ll choose it of
their own
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A lighter touch may even help globalization. After all, trade expanded
faster relative to global output during the three and a half decades of the
Bretton Woods regime than it has since 1990, even excluding the
slowdown following the 2008 global financial crisis. Countries should
pursue international agreements to constrain domestic policy only when
they’re needed to tackle genuine beggar-thy-neighbor problems, such as
corporate tax havens, economic cartels, and policies that keep one’s
currency artificially cheap.

The current system of international rules tries to rein in many economic

policies that don’t represent true beggar-thy-neighbor problems. Consider
bans on genetically modified organisms, agricultural subsidies, industrial
policies, and overly lax financial regulation. Each of these policies could
well harm other countries, but the domestic economy in question will pay
the bulk of the economic cost. Governments adopt such policies
presumably because they think the social and political benefits are worth
the price tag. In any individual case, a government might well be wrong.
But international institutions aren’t likely to be better judges of the
tradeoffs—and even when they’re right, their decisions will lack
democratic legitimacy.

The push into hyperglobalization since the 1990s has led to much greater
levels of international economic integration. At the same time, it has
produced domestic disintegration. As professional, corporate, and financial
elites have connected with their peers all over the globe, they have grown
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more distant from their compatriots at home. Today’s populist backlash is
a symptom of that fragmentation.

The bulk of the work needed to mend domestic economic and political
systems has to be done at home. Closing the economic and social gaps
widened by hyperglobalization will require restoring primacy to the
domestic sphere in the policy hierarchy and demoting the international.
The greatest contribution the world economy can make to this project is
to enable, rather than encumber, that correction.

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