Last week, on the 16th of October, European Central Bank chief Christine Lagarde gave a speech for her former organization, the International Monetary Fund. The topic was the future of globalization. Lagarde stated that between 1999 and 2019, trade as a share of GDP rose from 31% to 54% in the euro area. A momentous change which is underpinned by two key reasons. The first reason is the classical concept of comparative advantage, a theory proposed by David Ricardo. In comparing the England and Portugal of 1817 Ricardo explained that while Portugal could produce both wine and cloth more cheaply, it would still be better off trading with England to meet its needs for cloth. As the production of cloth in England entails less opportunity costs, both countries could become more wealthy through free trade. At the time this theory of comparative advantage was a key argument against mercantilism: the practice of protecting the home economy through trade barriers.
Flash forward to the current day and England has all sorts of laws in place to guarantee a living wage, healthcare and unemployment benefits. Moreover the production of wine and cloth has to conform to regulations as not to harm public health or the environment. Bangladesh has none of this rules and therefore cloth is produced over there, without any natural advantage. This is an effect that I call reverse mercantilism: free trade as a process that both negates all the labor and environmental regulation, while simultaneously impairing the home economy.
The second reason for globalization according to Lagarde is the diversification of demand. If there is a downturn in domestic demand this can be compensated by exporting abroad, thus keeping production, and the associated jobs, going even during domestic demand shocks.
This second point makes more sense to me, on the other hand, we cannot ignore that our “demand destinations” are trying the same thing. Every international actor will strive for a positive balance of payments and will only be able to do so if it is allowed to do so within the international balance of power. When Germany and Japan reached a highly positive balance of trade versus the United States, Richard Nixon responded by abolishing the gold standard in 1971, unilaterally exchanging the hard currency holdings of the Japanese and Germans with volatile fiat currency. This was only allowed because of the military and political power of the US as leader of the free world: trade policy cannot be seen as separate from power. Make no mistake: the Chinese are also looking to “exploit diverse sources of demand as a means of diversifying risk in the face of domestic shocks”.
Although Lagarde pays lip-service to globalization as a global force for good she begrudgingly admits that some re-shoring and near-shoring will be “inevitable”. As Dani Rodrik writes in his excellent book The Globalization Paradox the redistributive effect of free trade is far larger than the net total gain. For each dollar of aggregate gain an amount of 50 dollar is redistributed, mostly from employees to employers. Re-shoring may help to restore some balance.
The other main challenge of a reduction in globalization is therefore to strengthen internal demand and growth. Although I agree with Lagarde on the goal I do not think her solutions are correct. First of all the incessant printing of more euros is supposed to make the consumer spend more. As saving becomes more expensive and borrowing becomes cheaper why not take your cash out of the bank to buy a new car and take out consumer loans to live a lifestyle that you really cannot afford? In reality the destruction of pension funds, savings and the prospects of home ownership are only making people more insecure, thus dampening spending rather than promoting it.
Lagarde’s second solution is even more scary. According to Lagarde the green and digital sectors have far higher rates of return than other industries. Therefore the ECB needs to direct investment to these sectors. She goes as far as saying “Europe already has the ideal tool in place to kickstart this process, in the form of the €750 billion Next Generation EU (NGEU) fund set up in response to the pandemic.” Although it would seem this fund is a response to the lethal pandemic we all suffer from, Lagarde bluntly states the fund is there to shift the economy in the direction she desires.
To anyone with a basic knowledge of finance and investments the idea that any bureaucrat is able to outperform the market is absurd. Especially her mention of the digital sector should raise some red flags if one remembers the Dot-com bubble that burst in 2000. For her green expectations I would like to remind the reader of a cautionary tale from the twentieth century. Ever since the invention of the airplane investors have predicted the increase of passenger and freight flights. This prediction has definitely been borne out. However, this does not mean that airline or airplane stocks have been a wise investment. The market has grown tremendously but at the same time there has always been murderous competition, leading to notoriously low margins in the whole sector. A 1950 investor would have been better off investing in “boring” stocks such as food processing, banking or mining.
To be sure, Lagarde is addressing some serious topics, there are however some key issues with her solutions. First of all I think there is a serious issue with her motivations. Lagarde previously stated that she does not feel French or European but part of the world community. Because in her current role she is one of my most powerful leaders, that scares me. On the other hand it does explain a lot of her decisions. The ECB policy has been great in shoring up the prices of assets such as stocks, real estate and government bonds. The one dollar gain is more valuable to Lagarde than the 50 dollar redistribution, even if this makes footloose multinational corporations more powerful at the expense of European citizens. The second problem that I have with her is the immense power concentrated in one organization. The 750 billion is larger than the yearly government budget of Germany or France. And the third problem I have is that she wields this power without democratic control. You are right to be concerned.