The Global Economy during International Relations

The Global Economy during International Relations

The Global Economy

The growth of the world economy

The global economy is considered as the international exchange of goods and services that is expressed in monetary units of account.
The Global Economy

The distinction between war and trade was only loosely drawn. However, the mere existence of the exchange of goods does not create an economy, much less a world economy. Immanuel Wallerstein made some distinctions in his monumental study of the origins of the modern world system.

Wallerstein begins by defining a ‘world’ in social rather than geographical terms. A world consists of those who are in regular contact with each other and in some extended sense form a social system. The maximum size of a world being determined by the effectiveness of the technology of transportation currently available. It is only in the twentieth century that the social and the geographical world are effectively the same. Such microsystems still exist in places such as New Guinea and the Amazon basin. These are fascinating for social anthropologists, but they are of little interest in this context.

Wallerstein’s Suggestion

Our interest is in worlds where the long-distance movement of essential, bulk, goods takes place. Wallerstein suggests there are two kinds of worlds in which this happens. On the one hand there are empires, on the other, world-systems. In empires, exchanges take place within the same political structure, characteristically in the form of tribute. Thus Rome conquered Sicily and then Egypt in order to extract from those territories the grain it needed to feed the enormous population of the imperial city. The grain so transferred was tribute paid by the conquered to their conquerors. Within a world economy, exchanges takes place between territories under different political control, and thus tribute cannot be extracted. It exchanges take place on an economic basis as trade.

Wallerstein suggests that such world economies occur quite often but are usually short-lived, filling spaces between empires. This system has spread and now dominates the world as a geographical and not just a social whole.

Structure of the world economy

Wallerstein presents an account of the structure of this world economy as necessarily divided into cores, peripheries and semi-peripheries. His account of this system makes good sense and can be divorced from other aspects of his model. Initially two sets of transactions were under way. The large-scale movement of sugar and spices, mostly in the form of tribute, within the Spanish Empire, and the trading of craft products and early manufactures from the ‘advanced’ areas of Europe (the Low Countries, England and Northern France) for grain from Eastern Europe, and sugar from the Spanish Empire. This basic set of exchanges was initially based on very small differences of productivity between north-west Europe and the rest.

The strength of this description is that it makes the point that from the beginning the world economy and the world political system were closely intertwined. It also reflects the importance of communication and transport technologies in determining the power of states relative to their size. Contemporaries in the sixteenth centuries were deeply impressed by the scale and scope of Spanish/Habsburg power.

Agricultural Revolution

Over the next two centuries this economy expanded. The ‘agricultural revolution’ increased productivity markedly, and the spread of empire generated important new commodities, in particular tea and slaves. Ever greater areas of the world were integrated into a single economy, still with the states of north-west Europe occupying the core positions. The United Kingdom – increasingly becoming the ‘core of the core’.

The ‘Golden Triangle’ brought together basic manufactures from Britain, slaves from West Africa and sugar from the Caribbean. Somewhat later, in the early nineteenth century, in the East the demand for tea from China, the lack of a product desired by the Chinese and the inability (at that time) to directly coerce the Chinese Empire led to the development of another triangle, this time involving British cotton goods, Indian opium and Chinese tea.

However, it remained the case that at the end of the eighteenth century virtually all states were still, in large measure and self-sufficient. Although foreign trade was important to some, in particular the Netherlands and Britain, this importance was still largely marginal.

Problems and perspectives

How is this different from production and consumption taking place in the same country? 

The first issue concerns money. The producer wishes to be paid in the currency of A, while the consumer wishes to pay in currency B. As far as large-scale trading was concerned, bills of exchange issued by the great merchant banking houses. There were widely accepted throughout Europe and in the rest of the world.

A gold-based system was readily comprehensible, and required no special mechanism to operate. There was one feature of the system that potentially posed political problems. If one country had firms that were more successful at selling abroad than another, or consumers keener to buy foreign goods, this might lead to a flow of gold in or out of the country.

In the eighteenth century David Hume, in a splendidly concise essay, demonstrated that negative and positive flows would be self-correcting. Inward flows would raise price levels and make exports more expensive, imports cheaper, and thus reverse the flow. On the other hand, outward flows of gold – although his argument begs the question whether governments would allow this mechanism to work.

Problems

In any event, since 1914 a different problem has emerged. Since that date, most currencies most of the time have not been directly convertible into gold, and thus domestic price levels are not directly affected by the flow of precious metals, but this simply allows balance of payments crises to emerge and persist more readily.

Assuming this problem can be solved, an international economy based on a large-scale division of labour can emerge. In a system of uncontrolled exchange, patterns of specialization will develop, with some countries producing one range of goods. Some countries may become specialists in agricultural products, others in industrial goods. Trade policy joins balance of payments policy and exchange rate policy as areas where, like it or not, states must have a position.

Economic Nationalism

Still, if economic nationalism came first in history and is still in certain respects politically dominant. Economic liberalism has been the intellectually dominant position for most of the last two centuries. The basic liberal proposition is that although in some areas a degree of regulation may be a necessary evil. In general free market solutions to economic problems maximize welfare in the system taken as a whole, and should be adopted.

There were three essential steps along the way to this conclusion:

  • The first was Hume’s demolition of the mercantilist love affair with gold, noted above.
  • The second was Adam Smith’s demonstration of the gains to be had from an extended division of labour in The Wealth of Nations, gains which are a function of the size of the market and therefore can, in principle, be increased by foreign trade.
  • The third and crucial step was David Ricardo’s ‘theory of comparative advantage’ which, although published in 1817. It remains in an amended form the basis of liberal trade theory and the liberal international economic order.

Ricardo’s Achievement

Ricardo’s achievement was to provide a logically sound, answer to one of the fundamental problems posed by international trade. It is intuitively easy to see why trade takes place when two countries have different kinds of resources. Europe could produce bananas under glass, and the Windward Islands could set up small-scale craft audio-visual and ‘white goods’ workshops. This does not happen and the Windward Islands grow bananas and import televisions and refrigerators from the industrial world.

It is easy to see why two similar countries that are efficient in the production of different products would trade. Ricardo provides the answer, which is that although one country may be more efficient at producing everything. It will almost always be the case that the comparative costs of producing different products will be different.

Ricardo’s Demonstration

Ricardo’s demonstration of this proposition assumed a two-country, two commodity economy that the costs of production are measured in labour-time. Nowadays, this is, of course, much too simple and the modern demonstration of Ricardo’s principle takes a chapter or more in the average economics textbook.

What Ricardo demonstrated was that under virtually all circumstances trade would be beneficial to both parties.  After Ricardo, economic liberals were able to argue that the removal of restrictions on trade would be to the benefit of all, because the general welfare would be maximized by the lowering of barriers between regions and countries. Each country, by specializing in the products has a comparative advantage and engaging in trade. It is contributing to the general good as well as to its own welfare. This belief is still at the heart of the ‘embedded liberalism’ of the modern trade system.

Ricardo provided liberals with a powerful argument, but he did not silence all opponents. The key issue for opponents was the pattern of specialization established by free trade. One issue is the term of trade at which products are exchanged, and whether or not there is a trend moving against primary products.

Structuralism

The notion that there is a ‘South’ or ‘Third World’ is, today, quite hotly contested by those who point out that the states which make up the putative South are many and various, with very little in common – thus, say, Brazil and India are both large industrializing countries, but differ in every other respect; the Maldives and Brunei are both small, but one is oil-rich and Muslim while the other is not, and the other 130 or so states which might be thought of as Southern are equally ill-matched. All these states have in common is not being members of the OECD, the rich-states club. Some OECD members  were once thought of as Southern.

Although the term itself has many meanings in social theory, in International Relations structuralism is a convenient term to refer to this distinctive approach, a cluster of theories which emerged in the 1950s, 1960s and 1970s whose aim was to give an account of the political and economic subordination of the South to the North.

Structuralism is a general theory of international relations in the sense that it purports to explain how the world as a whole works. It is also a ‘Southern’ theory in two senses; uniquely among modern theories of International Relations it actually originated in the South, and it is explicitly oriented towards the problems and interests of the South, designed to solve those problems and serve those interests.

The Argentinian economist: Raúl Prebisch

A key figure in the development of structuralist ideas was the Argentinian economist Raúl Prebisch, a guiding light of the UN’s Economic Commission for Latin America (ECLA) in the 1950s, even though his own position was rather less radical than that of later structuralists. Prebisch was influenced by Marxist–Leninist ideas on political economy, but rejected the assumption, common to Marx, Lenin and orthodox communist parties in Latin America, that the effects of imperialism would be to produce capitalist industrialization in the South; in this he was influenced by the revisionist Marxist political economist Paul Baran, who argued, in The Political Economy of Growth, that monopoly capitalism in the mid-twentieth century was no longer performing a progressive role – instead, the industrialization of the rest of the world was being held back in the interest of maintaining monopoly profits in the centres of capitalism.

Prebisch’s innovation was to identify the mechanism by which the capitalist centres held back the periphery. On his account, it was via the pattern of specialization that so-called ‘free trade’ established in the world economy. This pattern involved the South in the production of primary products are exchanged for the manufactured goods of the North. Because, Prebisch argues, there is a long-term, secular trend for the terms of trade to move against primary products – to put the point non technically, over time, a given ‘basket’ of a typical primary product will buy fewer and fewer baskets of manufactured products.

Economic Thinking

This is a fundamental challenge to liberal economic thinking, which, assumes that all economies have a comparative advantage in the production of some product(s). Prebisch’s point is that in order to continue to import the same value of manufactured goods the Windward Islands will have to continually increase the value of banana exports, which will be difficult because of competition from other banana-producing countries, and because the demand for bananas is limited in a way that the demand for manufactured goods is not.

In manufacturing, new products are being developed all the time, new ‘needs’ are being produced via technological innovation and the power of marketing. In agriculture, productivity gains are likely to be less dramatic, while there is a limit to the market for even so desirable a product as a banana. Countries that specialize in agricultural products will be continually running on the spot in order to preserve existing living standards.

The simple answer is that this is still hotly contested. Liberal economists on the whole deny that there is a trend of the sort that Prebisch identifies. Prices of commodities rise and fall in response to general and particular factors, and there is no clear trend. Keynesian and (some) Marxian economists tend to be more sympathetic to the general thesis.

The new global economy

The theories of international political economy presented above – with the exception of some variants of Marxism – mostly share certain core assumptions; that the state encompasses a national economy, that international economic activity took place between such national economies, that international trade took place between national firms, and that the primary function of international financial transactions was to facilitate trade. Each of these assumptions is now under threat.

The most important of these changes is the rise in significance of the international business enterprise, or MNC. MNCs are regarded by many as the root of all international evil. It is important to keep a sense of proportion when examining their influence. The first step is to make it clear that there are many different kinds of business enterprise that are multinational. Their common defining feature is that they all operate across national boundaries and are based on direct foreign investment – the ownership and control of assets located abroad – as opposed to indirect or portfolio investment in which assets are purchased for the financial return, rather than the control, they bring, and as opposed to simply trading across frontiers.

Few Steps Accepted by All.

While there are sharply contrasting views of the significance of these corporations, there are a few points that are accepted by all.

 

  1. First, there are a great many more MNCs operating in the world today than there were in the 1960s and 1970s. Many of these new corporations are engaged in ‘cutting edge’ economic activities, in the production of high-technology manufactures.

 

  1. Second, and largely because of the nature of these activities, these newer corporations carry out most of their activities in the advanced industrial world and the ‘Newly Industrializing Countries’ (NICs) rather than in the less developed countries generally or the least developed countries in particular.

 

  1. Third, whereas up to the 1960s nearly all large MNCs were based on American capital held abroad, the situation today is rather different. The United States is still the country with the largest individual stock of overseas capital. To reiterate, the point about the emergence of the MNC is that many of the assumptions that have guided past thinking now have to be abandoned. Today, a high proportion of international trade is ‘intrafirm’ trade, that is between different branches of the same corporation. It is probably between a quarter and a third by value of the trade of the advanced industrial countries.

Transfer Pricing to MNCs

Transfer pricing is an activity open only to MNCs, In practice, more easily controlled by tax authorities than this summary would suggest. Effectively all large corporations today are behaviourally ‘multinational’. The distinction between multinationals and others relied on a national compartmentalization of economic activity to which MNCs were an exception.

The new technologies upon which production today is based work against any such compartmentalization. The same point can be made with respect to a change in some ways more radical in its implications than the rise of MNCs – the emergence of global financial markets. One of the reasons for the collapse of the IMF’s exchange-rate regime in the 1960s and 1970s was the existence of the ‘Eurodollar’ market. Once it was determined at Bretton Woods that private movements of capital would be allowed.

Eurodollars

‘Eurodollars’ were foreign currencies held in banks beyond the regulatory reach of the country that issued them. The generic title derives from the fact that these were originally US dollars held in European banks. A market in Eurodollars existed alongside domestic capital markets. Originally on quite a small scale initially established for political reasons. It grew very quickly, largely because various features of US banking regulations encouraged US MNCs to keep working balances abroad. The Eurodollar market still exists, but under different conditions.

National capital markets and national stock exchanges are simply local manifestations of a world-wide market. The creation of credit is beyond the control of national authorities. Trading takes place on a 24-hour basis, following the sun from Tokyo to Hong Kong to Frankfurt and London to New York and back to Tokyo. Some transactions in this market are clearly ‘international’ – foreign currency loans, the purchase of Eurobonds whereas others are ‘local’.

Distinction between multinational and national

The distinction between multinational and national corporations is no longer of great interest. So the distinction between international and national capital markets is now somewhat unreal. In the aftermath of the rush to create new financial instruments in the 1980s, virtually any economic or financial activity can be ‘securitized’ and traded internationally. Foreign bankers can exchange dollar debts for shares in Brazilian soccer teams.

The end of the South?

The story of the South, structuralism and the NIEO will be brought to a kind of conclusion. A few basic points will make clear the impact of these changes. In classic Southern/structuralist thinking from Prebisch onwards, the South is seen as a source of primary products for the world economy. However, over the past 20 years the South have become major centres for manufacturing production. It easily reaching the NIEO targets in this respect without much assistance from the Northern states.

Significance

The significance of this can be underlined by examining classic writings of structuralists on industrialization in the South. Some have attempted to undermine the significance of these moves by, for example, describing Southern industrialization as dependent development. Again, 20 years ago the MNC was regarded as an enemy of Southern development, exploiting local raw materials or cheap labour and expatriating profits. Mexico borrowed from the banks to finance this development – forgetting that banks have to be paid whether the investments they finance are profitable or not. MNCs actually share the risks associated with new ventures of this kind.

MNCs continue to exploit their strengths, advanced production techniques have limited the amounts of raw materials used in production processes. Nowadays, manufacturing MNCs are concerned to find political stability, trained workers and access to global markets before they will invest or franchise, and profits that are not invested in R & D will be wasted.

Triangular Diplomacy

Today, Southern countries have to engage in the same kind of triangular diplomacy between national and international capital and the state that is characteristic of Northern countries – albeit with slightly, but not greatly, different bargaining power. Some Southern countries have done very well out of this; others have been altogether ignored by the giant corporations. Clearly, one of the features of the last 20 years has been stratification within the South.

Some countries have done very well, such as the NICs of the Pacific Rim, and, to a lesser extent, Latin America. Others have done very badly, particularly in sub-Saharan Africa. Still others have experienced some success, but from a very low base. It mixed with the continuation of extremes of poverty, as is the case in India and the Philippines.

China is rapidly becoming one of the world’s leading industrial powers, while Singapore is richer than many Northern industrial countries. Meanwhile, living standards are actually falling in Bangladesh and Pakistan.

Increment in the South

It should be apparent that what is being suggested here is not that all is well in the South and that oppression and injustice are coming to an end. This is obviously not the case; poverty, malnutrition and hunger remain real problems. Perhaps of increasing significance, and, even in those areas where industrialization is taking off, exploitation is rife. High-pollution industries abound and in many cases these industries have been deliberately exported from the North. The point is that exploitation is rather different in kind from the exploitation described and anticipated by the structuralists.

Then the assumption was that the South would be pushed down as a concomitant to the North continuing to rise. The world economy is a zero-sum game in which the ‘winnings’ of the North matched the ‘losses’ of the South. Now, things look rather different. Certainly the North has continued to grow and develop new products and industries. The South has also experienced (equally uneven) growth. Contrary to expectations capital has moved to (some) Southern countries.

 

How is this stratification to be understood?

On this account, there is a natural tendency for the capitalist mode of production to spread throughout the world and the basic obstacle to this spread is to be found local policies. Capitalists wish to ‘exploit’ the world via industrialization and development – although they do not express their intentions in such a manner. If they are allowed to, and they will do so unless prevented by local circumstances. The key point is that policy matters.

Getting the policy right in this context does not mean simply adopting free market. Some more simplistic commentators have suggested, and as the neo liberal proponents of the ‘Washington Consensus’ for some time in the 1980s and early 1990s made part of the conditions for assistance laid down by the IMF and the World Bank. It has usually involved quite extensive state intervention in free markets in order to shape development in the right direction. Plus, it has often involved overtly protectionist, nationalist, policies. In short, the new global economy continues to be open to nationalist interpretations. The particular variant of nationalism that was the ‘structuralist’ model is no longer as relevant. It remains politically very important.

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