July 3, 2014

The road to global prosperity by Michael Mandelbaum

The road to global prosperity by Michael Mandelbaum

The rise of the international economy as the major influence on the future on nations and government. and the daily lives of people everywhere has four main causes.

1. Sharp decline in the importance of large-scale war
2. Conquest of territory and the defense of borders have ceased to be the chief concern of government almost everywhere and have been replaced by the promotion of economic growth
3. Prosperity is widely understood as requiring a free-market economy.
4. Advance in technology

Growth is the chief goal of almost all national economies and therefore of the international economy as a whole. One major source of growth is adding more resources and the other is making more effective use of existing resources: that is increasing productivity.

The new aversion to war has three sources. One is economic. People and their government discovered that they could do far better economically by trading and investing with their neighbors than by attempting to conquer them. At the same time, because economic growth has made people richer, they have more to lose through war than did their forebears.

Germany a century ago, China in the second decade of the 21st century has achieved rapid economic growth, has used some of its new wealth to build up its armed forces, and harbors ambitions for greater power and influence - certainly in its home region and ultimately, perhaps, beyond East Asia. Several issues have the potential to entangle China in hostilities with its neighbors and with United States. China claims sovereignty over waters off its coast that conflict with the claims of Japan, Korea, Vietnam, Thailand, Brunei, Malaysia and the Philippines. The parts of the seas and oceans over which sovereign states assert control are called their ‘territorial waters’.

China has good reason to develop a wider-ranging “blue-water’ navy for patrolling the world’s oceans because it depends heavily on seaborne commerce. Ships carry the petroleum that China needs, and the products it makes and sells over great distance and far beyond the Pacific Ocean. An interruption of that commerce world stifles the Chinese economy; yet lacking the requisite naval force, China has no way of preventing this. To protect its commerce lifelines, China depends on the world’s leading naval power, the United States.

Either the United States controls the world’s sea-lines or China does; sharing control is not feasible. The German decision to build high-seas fleet to challenge that of Great Britain contributed to the political tension that led to WW1

The world runs on oil. Most land, sea, and air transport uses it. The concentration of much of the world’s accessible oil in the Persian Gulf creates two vulnerabilities for the global economy: it must be shipped over long distances to the places where it is used, including through narrow passages such as the Strait of Hormuz in the Gulf and the Strait of Malacca in the western Pacific; and its region of origin is a politically volatile place. United State is acting as a global policeman by giving protection to sea route for trading. A weaker, poorer, less internationally active America could have an indirect effect on cross-border economic activity by making the world a politically and militarily more turbulent place. Such a development would also affect global commerce more directly.

Markets need protection in order to function properly, and government supplies that protection. The government acted as the watchman standing guard at the factory gate to prevent theft or sabotage after the workers had gone home. For international markets, United States acting as the Policeman/watchman, giving security and protection for the trade to happen peacefully.

Joseph Schumpeter who was one of the 20th century’s most influential economic thinkers, talks about creative destruction. In his 1942 book, ‘Capitalism, Socialism and Democracy, Schumpeter wrote that market capitalism, “ is by nature a form or method of economic change and not only never is but never can be stationary,,,,, The fundamental impulse that sets and keeps the capitalist engine in motion comes from the new consumers’ goods, the new methods of production or transportation, the new markets, the new forms of industrial organization that capitalist enterprise creates”. Market activity “incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one. This process of Creative Destruction is the essential fact about capitalism.

The principle of comparative advantage, first formulated by the English economist, David Ricardo in 1819, states that two countries that trade with each other will benefit even if one has an advantage over the other in producing everything that they exchange. Comparative advantage, so stated, is a law of economics in the same way that the law of gravity is a law of physics: it is always and everywhere true.

In 2004, as journalist James Kynge reports in his book, ‘China Shakes the World’, manholes covers began disappearing in large numbers from cities all over the world. It turned out that thieves were stealing them and shipping them to China. As the world’s largest manufacture, the country had developed an enormous need for scrap metal.

All economic activity is divided into three parts: agriculture, industry and services. The jobs in these three sectors are performed by, respectively, farmers in the fields, workers in factories, and employees in offices. Human beings are, among many other things, what economists’ call ‘factors of production’ - part of what goes go into the making of goods or services. Indeed, humans are more important than the other two factors - land and capital - because without human economic activity cannot take place. Like capital, unlike land, humans are mobile.

In 2011, 215 million people lived outside their countries of birth, an increase of 50% over two decades. A sense of national identity lies at the heart of nationalism and opponents of immigration often feel that the influx of foreigners is eroding their identity, depriving the society of something precious and essential, in almost the way that invading armies seek to do. Someone moving from Massachusetts to Texas can deprive a Texan of his job but does not threaten his culture, as a Mexican moving to Texas can appear to do.

The flow of money for investment across sovereign borders takes three distinct forms: debt, including bank loans, bonds, and other financial instruments; portfolio investment - shares in companies and foreign direct investment, which give a foreigner or foreign entity to physical assets such as factories and mines. Of these, the first has the potential to do the most economic damage.

The sovereign wealth fund, a large pool of government-owned or government controlled money invested outside the home country, The assets of these funds were expected to total as much as %12 trillion by 2015. In 2010, seven countries had funds with assets exceeding $100 billion: UAE, Norway, Singapore, Russia, Kuwait, Hong Kong & China. Britain had invested $454 billion in the United States compared with only $2.3 billion by China. But China was growing far more than Britain, the British investment came from private firms, not state-owned enterprises, and in any event, it had been all over a century since Americans had regarded Britain as a potentially hostile power.

The perception of foreign investment as a vehicle for illicit political control gained wide currency in the 20th century because it was integral to one of that era’s most influential ideologies, Marxism-Leninism. Contrary to Lenin’s’ expectation, capitalist countries proved capable of prospering without e=imperial possessions and of co-existing peacefully, but imperial expansion, when it occurred, did bring foreign investment in its wake and did sometimes enrich the investors at the expense of the local people.

Global movements of capital changed direction. In the 19th century it had flowed downhill, from wealthy to less wealthy places: UK, the major overseas investor was the world’s richest country. After 1945 it circulated horizontally: the trilateral countries invested in each other. In the era that began around 1990, however, capital began to flow uphill; from poorer to richer places, esp. from China, a country with hundreds of millions of very poor people, to the United States. On several occasions their proposed investments triggered a hostile political reaction, because the investing countries were neither democratic nor unambiguously friendly and because the investments came not from private interests but from governments.

On the basis of 150 year history of globalization it is possible to identify the four major fault lines in the global economy and the domestic politics that underlie them.

The first of them is the framework, consisting of the services known as ‘global public goods’ that any economy needs to function smoothly. The public good of security will be provided to the world by the United States or it will not be provided at all.

A conflict of interests also lies beneath the global economy’s second fault-line - the ongoing, inevitable clash between the winners and the losers from the cross-border movement of money, people and goods. As for the movement of people - immigration - it has the potential to administer the largest positive shock to the global economy.

The third cross-border flow, of products and service, should be the least controversial. Trade, because of the principle of comparative advantage, always brings net benefits to all countries engaging in it. Yet trade has never been entirely free. The global economy’s third fault line runs through the domestic politics of the major economic powers and the members of Europe’s common currency.

The fourth and final one cuts across the domestic affairs of a different group of countries. The BRIC - Brazil, Russia, India & China - are the most important of the emerging market countries, the ones with greatest potential for economic growth in the decades to come. All have made the basic choice to organize their national economies along free-market lines and to take part in cross-border trade and investment, The magnitude of their respective contributions to the global economy in the future now depends on whether and to what extent they adopt policies conducive to rapid growth. To put in the language of computing, all have installed the basic operating system for globalization: what remains for them to do is to make use of the most appropriate programs.

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