Achieving sustainable prosperity: reforming the global economy for the common good

In the third and final part of this series on state economic intervention, I explore some calls for reform of the institutions and policies which govern the global economy, in the spirit of Keynes and some of his followers. A ‘new Bretton Woods’ may seem a little utopian today, but it is nonetheless necessary if capitalism is to deliver sustainable prosperity and social justice for the broad mass of the world’s population.

Bretton Woods and economic performance

As I have frequently argued on this blog, the twenty years or so which followed World War Two saw the best performance in the history of capitalist development. The capitalist world economy as a whole grew faster than ever before, or since. From the late 1940s to the early 1970s, there was full employment in many countries, and a relatively equitable distribution of income and wealth. Productivity and wages also rose rapidly. This was no accident. The institutions and policies established at Bretton Woods (BW) in 1944 played an important role in supporting these outcomes. Fixed but adjustable exchange rates, controls on global capital flows, and the genesis of the IMF and the International Bank for Reconstruction and Development (IBRD, what was to later become the World Bank), were intended to create a framework which avoided the huge disruption which had resulted from two world wars and the Great Depression in between. The perceived success of state collective action in wartime, and the theoretical and practical development of macroeconomics by Keynes and others, legitimised a greater level of state economic intervention, at both national and international levels.

What has been referred to as the ‘Golden Age of Capitalism’ did however prove unsustainable and broke down towards the end of the 1960s, ushering in a more ad hoc international monetary system, and a global economic environment which has generally proved to be more unstable, more prone to crises, and weaker in terms of overall growth and prosperity. While some countries have performed well in recent decades, particularly in East Asia, unemployment has been higher globally and inequality within many countries has risen significantly.

The need for reform

Although the original BW agreement and the structure and functioning of the international monetary system (IMS) achieved much, its breakdown and the largely ad hoc (non) system which has evolved since the early 1970s show that reform and a new system are needed in the spirit of the original. This is so if we are to achieve greater global financial and economic stability which supports high levels of employment and successful development in a way which is more sustainable than at present.

Some authors have proposed that a new BW is needed as part of a global Green New Deal which drives a green transition together with the faster development of poorer nations by supporting a big investment push, and more sustainable and equitable growth. In The Case for a New Bretton Woods, Kevin Gallagher and Richard Kozul-Wright (GKW) argue that, since the beginning of what they call the ‘market fundamentalism’ phase of capitalism which began in the 1980s, inequality has risen dramatically in many economies and, particularly since the early 2000s, the global labour share of income has fallen while the profits of multinational corporations (MNCs) have risen even while global investment has weakened. The deregulation and growth of global finance has seen increased rents and rent-seeking, greater instability, slower global growth, rising debt and weaker aggregate demand. For them, markets should be a means rather than the ends of economic development, and laissez-faire, doctrines of austerity and the dominance of financial interests should all be abandoned.

GKW also argue that recent global trade deals have barely increased global GDP at all, but have instead tended to increase market concentration and the power of MNCs to force governments to loosen regulations on labour, social and environmental protections as a cost-cutting strategy. These have increased monopoly profits, reduced wages and allowed increased dividend payments to shareholders and share buybacks out of profits, while reducing governments’ tax revenue, weakening global demand and employment, and contributing to climate change. For them, trade agreements should be about trade, rather than undermining governments and engaging in monopolistic practices and corporate rent-seeking.

For José Antonio Ocampo, currently the Columbian finance minister but also a noted economist, in his book Resetting the International Monetary (Non) System, we currently have what he calls a fiduciary dollar standard, with the dominant reserve currency as the dollar. This has evolved from the gold-dollar standard which underpinned the original BW system, which saw the dollar at a fixed parity to the price of gold, and other currencies fixed to the dollar.

There have been many calls for reform of the IMS, not least in the 1970s in the wake of two oil price shocks, and following emerging market crises in the late 1990s and early 2000s, as well as amid what Ocampo calls the ‘North Atlantic Financial Crisis’ (NAFC) of the late 2000s. For Ocampo there is a real need for an improved global governance structure which supports a reformed international monetary architecture, including reform of:

1. The global reserve system (how international liquidity is provided).
2. Macroeconomic management of linkages between different economies (macroeconomic policy, exchange rates between currencies, cross-border payments and capital flows).
3. Balance of payments crisis management (emergency BoP financing and debt workout mechanisms).

Other left-Keynesian authors, such as John Eatwell and Lance Taylor (ET), have for many years made the case for increased global regulation of financial markets. Since liberalised financial markets are international and individual institutions can generate ‘systemic risk’, or risk at the level of the system as a whole (ie. the world economy), regulation to manage and reduce this should occupy the same domain as the market, in the same way that national systemic risk gave rise to the need for national regulation of finance. In economic terms, systemic risk and the potential for instability and crises are an ‘externality’, meaning that the costs of excessive risk-taking by individual banks and other financial institutions can end up being born by the system as a whole: risk-taking is therefore underpriced by private sector institutions, which is economically inefficient. There is a need for it to be correctly priced to increase market efficiency, and this in turn means that there is a need for international regulation.

The collapse of BW and the financial deregulation that followed was in a way ‘required’ by the end of the fixed but adjustable exchange rate regime. ET argue that this meant the privatisation of risk, which had previously been born by the public sector under BW. There was a progressively greater need for the development of new and growing trading of financial assets to deal with fluctuating exchange rates in the new and evolving IMS.

GKW set out the need for any reformed IMS and a new BW to support seven global public goods:

1. Financial stability
2. Relative global equality
3. Counter-cyclical and long run finance
4. A lender of last resort and debt authority
5. Balanced trade
6. A stable global climate
7. International cooperation

These in turn must support the following national goals:

1. Full and decent employment
2. Green structural transformation
3. Stable growth
4. Equality and justice
5. Decarbonisation
6. Resilience
7. Policy autonomy

Policies and institutions

Ocampo outlines the most comprehensive blueprint for a modern reform of the IMS, with a particular emphasis on the needs of developing countries. He divides it into the three themes mentioned above, repeated here for convenience, plus a fourth:

1. The global reserve system.
2. Macroeconomic cooperation.
3. Balance of payments crisis management.
4. The governance of the system.

The global reserve system

The current global reserve system, which determines how global liquidity is provided, is deficient in three ways:

1. The asymmetric adjustment problem. Countries running large current account deficits face pressure to reduce them via domestic deflation, while those running surpluses face no such pressure. This imparts a recessionary bias to the global economy as a whole, leading to slower growth and higher unemployment.
2. The use of a national currency (the dollar) as the major international currency. This requires the US to run a current account deficit to supply the world with sufficient dollars to underwrite the growth of international trade. This may reduce confidence in the dollar. It has meant that the US’s net investment position has deteriorated since the 1970s. Due to the unstable value of the dollar and US monetary policy, the world economy is hostage to the resulting fluctuations. Thus global stability is reduced and has become inconsistent with US domestic economic objectives.
3. The inequity bias. Emerging and developing countries are incentivised to ‘self insure’ against financial crises by running current account surpluses and accumulating foreign exchange reserves. They then lend these to rich countries at low interest rates, generally investing them in safe financial assets. This leads to persistently greater current account imbalances around the world, increasing systemic instability.

At BW, Keynes’ original idea to resolve these problems was for the creation of an international currency unit (ICU) or a global reserve bank, but this was perhaps unrealistic politically, given the global dominance of the US at the time. Instead, Ocampo proposes an evolving series of reforms, possibly mixing a multi-currency system with an increased use of the IMF’s Special Drawing Rights (SDRs). SDRs are a supplementary foreign exchange reserve asset originally created in 1969 by the IMF while the BW fixed exchange rate system was still in operation. Their value is based on a weighted basket of key international currencies, of which the dollar is the greatest. They are allocated to IMF member countries, and their creation and use has increased sporadically during recent crises. Ocampo suggests that increasing SDR use is the most important aspect of his proposed reforms. Their allocation could be counter-cyclical, so that liquidity provision increases during recessions and falls during booms. They should also meet the demands for reserves globally. This would reduce the cost of economies building self insurance by running persistent current account surpluses and reduce the recessionary bias of the global economy. If SDRs were used to finance IMF lending to countries in crisis, they would in fact act as the creation of global money, akin to domestic central banks. SDR allocations could also penalise excessive current account surpluses in order to help correct the asymmetric adjustment problem.

Macroeconomic cooperation

1. Cooperation is needed to correct global payment imbalances, which are currently dominated by the G20 group of nations. There is a need for greater surveillance and policy dialogue between countries. This has improved since the NAFC, but needs to go further.
2. Exchange rates. A new fixed rate system is unrealistic, so Ocampo suggests a system of ‘managed floating’, in order to improve adjustment to international trade and global payments imbalances. Adjustments should ideally take in to account output and employment gaps, and inflationary and deflationary pressures.
3. Capital account regulations. Capital flows between countries play a central role in the determination of exchange rates today. They tend to be highly volatile and pro-cyclical, and can lead to damaging instability. Industrial country financial flows to smaller or less developed emerging economies’ financial markets can overwhelm the latter. Regulations should be a normal part of the macro policy toolkit. They should be used pragmatically and modified dynamically to reduce opportunities for evasion.

Crisis resolution

1. Balance of payments financing. The IMF should continue its recent trend towards reducing or eliminating the conditionality of its lending to countries in crisis. Conditionality itself has tended to reduce the demand for lending and increased reserve accumulation via current account surpluses, contributing to the problems mentioned already. There is a need to design automatic credit facilities with no conditionality and available to an increased range of countries. Increased counter-cyclical lending can act as a ‘global financial safety net’. Multilateral development banks should play a greater role in such lending.
2. Sovereign debt workout mechanisms are needed to manage debt overhangs, in order to reduce excessively contractionary adjustment policies during crises. Support should deal with illiquidity and insolvency and reduce the prospect of one leading to the other. Ocampo argues for a mix of voluntary and statutory solutions; for an international debt registry; for effective mechanisms for creditor coordination for individual renegotiations; and a multi-stakeholder sovereign debt forum under the UN Financing for Development programme, including governments, international institutions, the private sector and civil society.

Governance

The G20 should be more representative of the global economy in order to increase its legitimacy. This requires an increase in the representation of emerging and developing countries. It needs to evolve more effectively as the global economic share or weight of countries changes over time. This would mean reducing the influence (the quota and voting power) of European countries.

Overall, there is a need for a dense, multi-layered architecture relying more broadly on regional institutions and networks of global, regional and national institutions. Regional arrangements can vary and take various forms, such as payments agreements, swap lines, reserve pools, and common central banks, with varying degrees of multilateralisation. De-linking these arrangements from the IMF, while remaining flexible, may also prove inevitable.

Political economy

Ocampo is comprehensive in his proposals, while also remaining fairly realistic. GKW, in their own call to arms and for a new BW, argue that it is unlikely to happen without a degree of global solidarity which allows space for national development and green strategies underpinned by permanent global institutions and cooperation. The new institutions should be accountable to their full membership, open to a diversity of viewpoints, cognisant of new voices and have balanced dispute resolution systems. The rich countries need to echo the postwar US in its enlightened self-interest which gave rise to the Marshall Plan for Western Europe. A new Plan is needed for the 21st century, with aid similarly taking the form of grants rather than loans, monitored by the donors but at the same time ‘owned’ by the recipients. Given that it could potentially increase growth and development, it could offer wide-ranging benefits to the global economy in the long run.

All these kinds of reforms and their sustainability require the mobilisation of support from multiple stakeholders, locally, nationally and globally. GKW stress the need for a new social contract around developmental states, the provision of a countervailing power to the dominant financial and market fundamentalist interests, and wide-ranging engagement in a global conversation to enable and legitimise a new BW and to build and sustain it.

The lack of a clear global hegemonic power today likely hampers efforts at reform. This is perhaps ironic, as it was US dominance over the UK which prevented Keynes’ full range of ideas about successful and sustainable global monetary reform from attaining their full fruition at the original BW. But perhaps we have to accept that cooperation requires hegemonic leadership.

Despite many good intentions, there are difficulties with global cooperation between states, not least in political terms. Politicians themselves often have limited political capital, and in the absence of obvious, immediate crises, of whatever form, tend to focus on narrower domestic concerns. There is therefore a need for them to make the argument to their constituents and citizens that in certain areas global cooperation can bring domestic and national benefits.

There will always be problems of conflict over the means and outcomes of particular policies due to the creation of winners and losers and over the distribution of costs and benefits. At the global level, some policies might benefit all nations, others only some, alongside the creation of losers. But the case can still be made for the kinds of public goods listed above, for a global commons, and for the avoidance of beggar-thy-neighbour policy outcomes resulting from narrow and at times ill-considered domestic concerns. The march of technology and the resulting human connectivity have the potential to unite billions across the globe, while unfortunately the threats of climate change and financial and economic instability have yet to truly galvanise a sufficiently ambitious response at all levels of society. Global conflict and other sources of tensions within and between nations also catalyse division. We need our politicians to lead, but also mobilisation from below to enable some kind of push in the right direction.