The World: A Brief Introduction

by Richard Haass

  Global trade pacts have not been as effective at reducing barriers to trade in agricultural goods or in services, which includes such fields as construction, finance, accounting, health care, and transportation. Nor have global trade agreements done much to reduce trade distorting practices such as government subsidies, currency manipulation, and theft of intellectual property.

  One consequence of the difficulty in achieving a new global trade accord has been the proliferation of regional and other “narrower” trade pacts between or among two or several countries. The number of regional trade agreements reported to the WTO has increased fifteen-fold over the past thirty years, from just over twenty in 1990 to around three hundred in early 2019. The European Union can be understood in part as a regional free trade accord for its members. The United States, Canada, and Mexico entered into the North American Free Trade Agreement in 1994, which reduced tariffs, facilitated investment flows, and protected intellectual property rights. The result was a major expansion in regional trade and investment to the overall benefit of all three countries. Mexico’s economy grew at a much faster pace, increasing the number of jobs available at home and reducing the flow of would-be immigrants to the United States. NAFTA was partly renegotiated in 2018, resulting in a new pact rebranded the United States-Mexico-Canada Agreement by the U.S. government and signed into law in early 2020.

  Eleven countries in the Americas and Asia created the Comprehensive and Progressive Agreement for Trans-Pacific Partnership (CPTPP, once known as the Trans-Pacific Partnership) in 2018 to expand their trade and raise labor and environmental standards in their respective regions. The impact of CPTPP was weakened by the decision in 2017 by the United States (which had negotiated and signed the agreement under the Obama administration, although it had not yet been brought before Congress for approval) not to join the new trade group, one that among other things reduces tariff and select nontariff barriers, provides greater protection to intellectual property, and creates new mechanisms to resolve disputes over trade and investment. In so doing, the United States lost an opportunity to create a common front that could pressure China to modify its trade practices and raise its standards or risk being excluded from important markets. Increasingly, agreements such as CPTPP have become the laboratories for developing new trade arrangements that cover an expanding range of practices.

  Trade can be good for importing countries because it increases choice and lowers costs. But even if trade is good for a society overall, it may jeopardize specific companies and the jobs of those who work for them if imports become so popular that domestic workers are laid off and factories are closed. One potential response is protectionism and the use of tariffs, but as already noted, this can be costly to the society because it raises prices for imports, be they finished goods or raw materials that end up in (and raise the cost of) other products. Tariffs can also trigger a trade war in which other governments retaliate for the imposition of tariffs on their goods by placing tariffs on the other country’s exports. In such scenarios, there are rarely winners.

  One alternative to protectionism when firms close and workers lose their jobs is government and private-sector programs that provide temporary financial support to laid-off workers along with opportunities to train workers for new jobs. Such programs, known as trade adjustment assistance, are increasingly necessary when companies must close and jobs disappear not because of foreign competition and cheap imports but because of new technologies that increase productivity and require fewer workers to achieve the same—or even higher—outputs. The arrival of artificial intelligence, robotics, autonomous vehicles, and other new technologies suggests that it will be more important than ever for governments and firms to train employees so that they are ready to transition to newly created jobs as their previous jobs are eliminated. It will also be necessary to make sure funds for health care and retirement are portable so that workers can retain them when they switch jobs.

  INVESTMENT

  Cross-border investment, like trade, has increased sharply over the decades, with international flows of capital (money) increasing substantially in the decades prior to the Global Financial Crisis before stagnating in the decade since. Foreign direct investment flows increased more than one hundred times from 1970 to 2018. Foreign investment can take the form of building a manufacturing plant in another country or purchasing foreign companies. Investment can prove beneficial for both sides, although, in practice, investment can be a complicated source of friction. For the country being invested in, foreign investment can be a welcome source of capital that helps businesses to grow. Depending on the terms of the investment, it can also be a means for foreign investors to gain access to desired technologies. Those making the investment can then produce goods more efficiently that can be exported anywhere, allowing access to a desired foreign market. There is no equivalent of the WTO to regulate foreign investment. There are, however, various bilateral and multilateral compacts that set terms meant to encourage investment, mostly by protecting the rights and interests of investors.

  What might matter most are local conditions: investors are understandably wary of investing in situations where they cannot be confident of physical security, political stability, and legal protections. My former boss at the State Department, Secretary of State Colin Powell, was fond of saying that capital is a coward. Potential investors are often scared off by widespread corruption, the absence of an independent central bank, high taxes, requirements that they share or transfer important technologies, and restrictions on their ability to repatriate (send home) profits. The educational level of the workforce and physical infrastructure also matter.

  Countries wanting to attract investment need to compete in these areas. At the same time, governments have the right to restrict investment in their countries for reasons of national security, to avoid foreign ownership of critical companies and industries to ensure their independence, and to protect their intellectual and technological properties. Some have also put into place controls that limit the ability of outsiders to move in and out of markets at short notice in a manner that could contribute to financial turmoil.

  LOOKING AHEAD

  Trade and investment have been areas of great progress for some seventy years now. The volume of both has grown steadily and markedly, at once both a contributor to global growth and a reflection of it. The problem ahead is that the barriers to further progress are complex and addressing them will prove more difficult. New agreements will need to be negotiated and enforced. Another problem is a familiar one: how to help those workers who lose out because of foreign competition or, as increasingly will be the case, because of new, more productive technologies that eliminate existing jobs. The answer lies in educating and training workers (and in making it possible for them to navigate the inevitable transitions) so they can step into new jobs. Identifying the answer is the easy part; putting it into practice so that people can continue to work will be the challenge.

  Currency and Monetary Policy

  Money is basic to the functioning of any economy. It allows goods and services (including work) of every kind to be paid for and sold in an efficient manner. All the alternatives, such as barter or exchanging one good or service for another, would be extremely inefficient given that there may not be a match either in what is sought or in value. This is true for trade between and within countries alike. Money is also essential for investment, for providing credit for business and personal uses or mortgages to buy homes. Money allows for savings.

  A question arises, though, as to what money is to be used. The United States uses dollars, Japan yen, much of Europe euros, Russia rubles, China yuan, Mexico pesos, and so on. There is no global currency, because there is no global central bank or printing press. Most governments want to have maximum control over their own economies, something that argues for having their own currencies. In this way they can decide how much of it to put in circulation so that they can achieve maximum l
evels of economic growth and employment without causing severe inflation that would undermine the value of the currency. The effect of severe inflation is to wipe out savings and make normal business activity all but impossible, in the process undermining political stability. This was what happened in Germany in the 1920s, when hyperinflation caused the price level to increase billions (yes, billions) of times in a span of two years, paving the way for Hitler to come to power. It is what happened in Zimbabwe beginning in 2007 and Venezuela more recently. Governments also want to keep control over their monetary policies in order to avoid the opposite danger, that of deflation, which would cause their economies to shrink, leading to a rise in unemployment and a reduced standard of living.

  Central banks are tasked with managing the money supply, which in turn should affect their currency’s value and inflation. To expand the money supply, most advanced countries buy their own bonds and give the seller currency, and to reduce the money supply, they sell their bonds and pull currency out of circulation. Interest rates can also be adjusted in order to influence inflation and other economic targets. All of this is known as monetary policy. The lower interest rates are, the more people and businesses tend to borrow, invest, and spend, all of which increases the pace of economic activity and growth. The risk, though, is that an overheated economy will lead to inflation, in which people and businesses begin to lose confidence in the value of the currency, especially if the larger supply of money is not backed by increased economic activity. Such a loss of confidence gets in the way of trade and investment. Higher rates can be necessary to limit inflation, but they also have the effect of reducing borrowing and slowing economic activity. Fewer jobs will be created, and fewer homes will be built. Getting the balance right is easier said than done; this is one reason why central banks should be independent, seeking to do what is best for the long-term health of the economy rather than promoting short-term political goals. Making the task even harder is that other factors such as government spending and tax policy (together known as fiscal policy) as well as trade policy can and do affect the pace of economic activity but are outside the purview of central banks and are determined by executives and legislatures.

  The World Bank (more formally, the International Bank for Reconstruction and Development) is not the world’s central bank, as its name suggests, but rather a global organization devoted to promoting economic development in poorer countries. The International Monetary Fund (IMF), one of the institutions created at the 1944 Bretton Woods Conference that was convened to plan for the post–World War II global economy, operates in the domain of currencies and monetary policy but with a limited mandate. One of its roles is to assess and advise governments on their financial health. Another is to assist countries that find themselves overextended financially and in need of loans, in which case the IMF gives the government a loan and in return gets the recipient to commit to change its fiscal and monetary policies and undertake broader reforms. Its prescriptions generally include decreasing public spending and increasing taxation. The IMF has little leverage and hence little influence over countries that run sustained trade and payments surpluses, however, even if those surpluses are the result of fiscal, monetary, and currency policies that encourage exports and discourage imports and domestic consumption. This was the case with Japan decades ago and applies today to countries such as Germany and China.

  While there is no worldwide central bank, national currencies can be exchanged for one another. For most countries, the exchange rate—how many pesos or euros for how many dollars, for example—is largely determined by markets, by realities of supply and demand. Some countries do peg their currencies to another one—promising to hold its value stable. But governments’ efforts to determine the rates of their currencies tend to fail over time because sooner or later currencies will come to reflect underlying economic conditions. In practice, the choice for most countries is not really between a completely market-driven exchange rate and a hard peg, because countries can and do intervene in the market to try to influence the market value of their currency. There are, however, differences in emphasis and degree.

  THE ERA OF THE DOLLAR

  The dollar remains the currency of choice for conducting international trade and the closest thing to an international currency. What this means in practice is that the price of Chinese goods is generally quoted in dollars, and even if a Brazilian company is importing those goods, it will usually pay the Chinese company in dollars. Once the Chinese company receives the dollars, it will exchange them at a bank for the local currency or sell them to private investors who want to invest in the United States due to an attractive return on U.S. assets or a perceived measure of safety in investing in the United States. Those countries that sell more goods and services internationally than they buy also end up accumulating large amounts of dollars; this is the case with Japan and China. This is not a problem as long as they come about it honestly (and not through unfair trade or currency practices) and are content to do so, whether because of their confidence in the dollar or the lack of any real alternatives. If there was no widely accepted reserve currency, the world could not have the same level of international trade and investment that it currently does, and the world would be a poorer place.

  The dollar’s role reflects the reality of American political stability along with the sheer size of the American economy and its relative openness. It also reflects people’s confidence that the value of a dollar won’t dramatically change and that the U.S. Treasury won’t default on its debts. Central banks around the world want to hold the U.S. dollar, to ensure their ability to purchase imports, to enable them to pay their debts to foreigners, and to act as an insurance policy for when financial crises strike. According to the IMF, as of early 2019 the U.S. dollar constituted more than 60 percent of the official foreign exchange reserves held by the world’s central banks, while the euro, the second most widely held reserve currency, accounted for just 20 percent.

  THE U.S. DOLLAR IS THE MOST WIDELY HELD RESERVE CURRENCY

  Share of allocated global reserves, Q1 2019

  Source: International Monetary Fund.

  After World War II, all currencies in the world were fixed to the dollar, which in turn was backed by gold. In principle, anyone holding dollars could exchange them for gold. This didn’t last given the chronic, large trade surpluses run in the 1960s by export-dependent countries such as Japan, then the emerging world power in trade much as China is today. In 1971, the U.S. government “closed the gold window” and ceased offering to convert dollars for gold because it simply did not have enough of the mineral to cover the world’s dollar holdings.

  The bottom line is that the world moved to a situation in which the dollar was valuable not because of the gold it could be exchanged for but because people were prepared to accept dollars in exchange for goods and services they sold to Americans and others. This situation is one described by economists as “fiat currencies,” in that the currency is worth what markets say it is worth.

  For a brief time, the world’s major economies tried to keep their exchange rates fixed even without the link to gold. Every currency was set or locked in compared with the dollar and as a result with one another. This system was adopted because it provided greater predictability to governments and businesses than “floating” (constantly adjusting) rates; one could enter a deal knowing in advance just what it would cost in the local currency months or years later.

  Fixed currencies did not prove to be steadier and more predictable in practice, because markets had their own views about the relative worth of currencies. When markets lost confidence in a currency, governments that wanted to maintain the fixed exchange rate were forced to spend their currency reserves (usually dollars) to purchase their own currency. At some point, however, the government would run out of reserves, the difference would become unsustainable, and the government would be forced to “devalue” its currency, essentially a
cknowledging the lower value set by markets. Such moves proved to be economically disruptive and politically damaging to the governments in question. And on the other side of the ledger, the United States grew frustrated that some countries with chronic surpluses didn’t want to “revalue”—change the value of their currencies up—a move that would have made their exports more expensive and imports cheaper, outcomes that would have reduced their trade surplus, helped producers and exporters elsewhere, and limited their dollar holdings.

  After the end of a global system of fixed exchange rates based on the dollar, countries were left free to pick their own currency and monetary system. Most countries have come to forgo fixed rates and accept the market price. Letting the market set the value of your currency also frees a country’s central bank to set monetary policy as it sees fit. But not everyone has chosen to let the market set the value of their currency. The countries of Europe, for example, moved toward a system where their currencies were anchored first to the German mark and then to the euro, when they entered into the monetary and currency union that created it. And even governments that mostly let the market set the value of their currency do not, however, necessarily adopt a completely “hands-off” posture; they sometimes intervene in currency markets to buy or sell their own currency in an effort to moderate fluctuations. Such a situation is often described as a “managed float” as opposed to a purely floating rate.

  The United States continues to run a trade deficit, importing considerably more than it exports in the way of goods and services. Again, the rest of the world is content with this so long as it is confident that the value of the dollar will remain relatively steady and the U.S. economy will remain healthy and able to buy their exports. The net outflow of dollars associated with the trade deficit is a source of useful liquidity (funds) to the world, enabling it to grow faster than it otherwise would. But it could become a source of instability if excessive trade deficits cause a loss of confidence in the health of the dollar and reduce the willingness of others to accept it as the de facto global currency. If that were to happen, the U.S. central bank (the Federal Reserve) could find itself having to raise interest rates even as unemployment was rising. The need to stabilize the dollar would take precedence over economic growth.