For now and for the foreseeable future, the dollar is both the national currency of the United States and the de facto international currency of the world. This is mostly good for the United States, because it leaves it with control over its own economic fate and means that when it must borrow, it does so in its own currency and does not have to worry that the amount it owes increases because of shifts in relative currency values. Because demand for the dollar pushes down interest rates, the U.S. government, companies, and households can also borrow at cheaper rates. France’s minister of finance in the 1960s Valéry Giscard d’Estaing famously called this an “exorbitant privilege.”
Some see a dollar-dominated world as a mixed blessing. The rest of the world is affected by U.S. monetary policy but has little influence over it. The Federal Reserve, or the Fed, is responsible for setting U.S. monetary policy in response to conditions in the United States, not in response to the needs of the global economy. But the adjustment of interest rates by the Federal Reserve for the purpose of managing inflation or maximizing employment in the United States affects other economies as well, especially those that still fix their exchange rate to the dollar or have accumulated debt in dollars.
At least in principle, the dollar could be replaced by another currency, a number of them (a basket), a new international currency, a cryptocurrency, or some combination. It is remarkable that even during the global financial crisis of 2008–2009, which started in the United States, the dollar rallied and remained the favored currency for investors. There is no other country with an economy of sufficient size and with a currency that can be traded freely anywhere in the world that enjoys the requisite amount of confidence. Japan is too small; the future of the euro is too uncertain. China, the world’s second-largest economy, is not prepared to allow its currency to float, preferring the greater predictability of a managed exchange rate, and it continues to want to control the flow of money into—and out of—the country. A basket of currencies requires a degree of coordination that doesn’t exist, although it could emerge if enough governments lost confidence in the United States. There is no independent world central bank, so an international currency is not a serious option, although the IMF issues a limited amount of special drawing rights that are used to bolster the financial reserves of member countries and some argue could one day evolve into an international currency. The world is a long way away from such a point, however. The dollar is not perfect, but in the land of the blind the one-eyed man is king, and for now the dollar is the proverbial one-eyed man.
What could change things? As other economies grow and become more open, they may be both willing and able to take on the role of a reserve currency. China obviously comes to mind here. Change could also come about if the world comes to have concerns over the health or management of the U.S. economy. The large and growing pool of U.S. debt, now above $22 trillion and increasing at around $1 trillion a year, could dilute confidence in the dollar. And there is the increasing U.S. propensity to “weaponize” international financial transactions to sanction select governments and individuals, a practice that could well hasten a move to dollar alternatives. For instance, after the United States withdrew from the Iran nuclear agreement, European countries tried, so far unsuccessfully, to build a parallel international financial system that would have allowed them to process financial transactions with Iran while avoiding U.S. sanctions.
There are additional arrangements that contribute to the smooth functioning of the global economy. There is a large degree of interconnectedness to the world, and there are several groups (the Basel Committee on Banking Supervision, the Financial Stability Board, and others) that set standards for banking practices to reduce the chances that a crisis within an individual country will spread across borders. The 2008 global financial crisis was primarily triggered by economic mismanagement in the United States, but it affected every other country in the world given the centrality of the American economy.
All of which brings us back to where this chapter began: there is a global economy, a degree of global coordination, and a de facto global currency, but there is no global central bank or common understanding on monetary arrangements. This reality has mostly worked well; economic growth, investment and trade flows, gains in development—all are a testament to a “system” that has been, for the most part, effective. At the same time, the system remains vulnerable not just to the effects of national policies in the United States but, because of interconnectedness (globalization) and the potential for what is known as contagion, to the knock-on effects of a financial crisis in any country of scale. This situation is best understood as a condition to be managed rather than a problem to be solved because governments will not be willing to give up control of their own economies to some international authority.
Development
Development is a widely used term that reflects more than economic growth. It also captures the degree to which a country’s wealth has kept up with or, better yet, surpassed population increases, how well any increased wealth is distributed throughout the population, and measures reflecting the quality of life. Development is most often associated with the economic condition of relatively poor countries (variously described as “underdeveloped,” “least developed,” or “developing”).
There is no clear line separating developing countries from developed ones. The World Bank has rejected the distinction as overly simplistic and separates countries according to per capita income (a measure of the value of what a country produces in a single year divided by the number of people living there), a good approximation of an average citizen’s standard of living. Countries are then determined to be either low income, lower middle income, upper middle income, or high income. GDP per capita ranges from above $160,000 in Monaco and $80,000 in Switzerland to under $500 in Burundi, South Sudan, Malawi, Niger, Madagascar, Mozambique, and Somalia. Although the American economy is not quite twice the size of China’s, GDP per capita in the United States ($60,000) is six times that of China because the American population is but one-fourth that of China’s.
There is now agreement that any assessment of development must reflect a range of social factors, with the favored measure being the Human Development Index (HDI), which ranks countries according to an overall assessment of per capita wealth, educational attainment, and life expectancy. According to the latest HDI rankings, Norway enjoys the highest human development, while the United States comes in at number 13, China at 86, and Niger last. Human development has improved all over the world: between 1990 and 2015, the number of countries classified as having low human development fell from sixty-two to forty-one, while those classified as having very high human development rose from eleven to fifty-one. At the same time, progress has slowed since 2010.
The term “development” first gained currency after World War II, initially in regard to European countries that had been ravaged by the war and faced the challenge of getting back on their feet. Indeed, the formal name of the World Bank (created in 1944, before the war had even come to an end) is the International Bank for Reconstruction and Development. Over time, the notion of development became less associated with European countries, because many of them recovered fairly quickly thanks to the massive economic assistance that was provided by the United States under the Marshall Plan, their own efforts, and the emergence of what began as the European Coal and Steel Community and would later evolve into the European Community and eventually the European Union. Development came to be associated much more with poor countries in Africa, Asia, the Middle East, and Latin America. Many of these countries found themselves newly independent following the demise of the colonial era, and they were unprepared for the demands that independence brought with it.
Why did development become such an important issue, and why does it remain so today? Humanitarian concerns are a substantial factor; the quality of the lives of billions of men, women, and children are at stake. There is also an economic in
terest, in that billions of people in developing countries are potential consumers and producers. National security is a factor as well, in that a lack of development can create venues where terrorists or criminals or pirates can put down roots, where radicalism can flourish, and where infectious disease can spring up and spread. A lack of development can also produce conditions that generate refugees, who in turn can overwhelm the capacity of neighbors, in the process creating additional weak states.
HUMAN DEVELOPMENT INDEX, 2017
1. Democratic Republic of the Congo
2. Central African Republic
Source: United Nations Development Programme.
National security issues caused development to get caught up in the Cold War competition between the United States and the Soviet Union. The United States saw development as essential in order to prevent disaffected populations from turning to local Communists who would in turn look to the Soviet Union for assistance. Showing that market-oriented approaches to development were superior to central, government-dominated planning was part of the competitive struggle between systems that was central to the Cold War. The Soviet Union did much the same, although it emphasized centrally planned economies much like its own. Both superpowers dispatched a good deal of foreign aid to countries to either keep them in their camp or woo them to their side.
Considerable development took place in the decades after World War II and, more recently, following the end of the Cold War. The proportion of people living in extreme poverty (defined as those living on less than $1.90 per day) is down from 40–50 percent of the world’s population fifty years ago and more than one-third of the population as recently as 1990 to under 10 percent today. Nearly 1.1 billion people have moved out of extreme poverty since 1990. China’s economic boom has driven much of this improvement, because its extreme poverty rate plummeted from 66 percent in 1990 to less than 1 percent in 2015.
Two centuries ago, less than 20 percent of the world’s people were literate, but now more than 85 percent of the world’s people can read and write, with adult male literacy rates a few points higher than that and adult female rates a few points lower. The percentage of those who are undernourished worldwide is also down, while life expectancy has improved by some twenty-five years on average compared with seventy years ago. As a result, the gap between the expected duration of the average life in developed countries and the average life in the developing ones has narrowed markedly. The average number of years of education that people receive in the developing world more than tripled between 1950 and 2010. Access to improved sanitation and clean drinking water is up, while child and maternal mortality is down.
New technologies have the potential to foster development. By the end of 2018, there were more than 7.5 billion mobile cellular subscriptions, averaging just over one for every person on the planet. The number of internet users reached 1 billion in 2005 and is now estimated to stand at 3.9 billion, or just over half the people on the planet. Such technologies can provide access to education and health care, connect farmers and small manufacturers with useful market data, and enable banking. Eighty percent of those in developed countries use the internet, as do 45 percent of those in developing countries. This latter number is growing fast: in 2005, only 15 million Africans had access to the internet, but by 2016 this number had climbed to nearly 200 million.
At the same time, much remains to be done before development is a reality for many. Approximately ten percent of the world’s population still lives in extreme poverty, is undernourished, is illiterate, and lacks access to electricity. Almost everyone in the wealthier developed countries can read and write, but two in five African adults cannot, which nevertheless represents gains in literacy there. Nearly 900 million people still practice open defecation. Many girls and women still face discrimination and a host of barriers to realizing their full potential. Projected rapid increases in population in South Asia and sub-Saharan Africa could dilute any progress that comes to pass. For instance, while the proportion of Africans living in extreme poverty has declined, due to rapid population growth the number of Africans living in extreme poverty has increased by over 100 million over the past quarter century. Climate change will be an added burden. The bottom line is that nearly one billion people still live in a situation assessed to be one of low human development.
In addition, inequality has increased both between and within many countries given differences in how both economies and populations have grown. In the world as a whole, the top 10 percent holds 85 percent of global wealth. Further, overall gains in living standards do not mean that everyone has achieved the basics.
Despite considerable progress, development remains a pressing issue. Many debates surround the policies designed to promote development. The most basic is the question of the appropriate role of the state and whether it is better to embrace a directed, top-down approach to development or to take a bottom-up approach in which the state takes a backseat to market forces and private interests. This debate has survived the end of the Cold War and continues to this day, between those taking a more market-oriented and democratic path (for example, India) and those favoring a large government role, which can bring with it more economic progress but less personal freedom. China is most often held out as the exemplar of this latter approach.
In truth, the choices are less stark than they may appear because most countries combine elements of both approaches. Still, there are clear differences of degree. Those countries favoring a large role for the government do so for economic and political reasons alike. The government can name priorities and choose where investment goes, rewarding constituents or allies. Economic control tends to translate into political control. Some (but not all) of the uncertainties associated with markets can be reduced.
There are many paths available to countries regardless of their level of development. In some cases, the government may choose to close off selected areas of its market to imports in order to nurture homegrown industries not ready to compete successfully with foreign producers, something known as “import substitution” or the “infant industry argument.” Such protectionist policies can provide time and space for domestic industries and agriculture to gain strength so that they can compete successfully with imports and hold their own as exporters. The danger is that because local producers are shielded from foreign competition, they can be costly, generate products of lesser quality, and be prone to corruption. There is also the reality that this approach may not be sustainable, because others are likely to tire of one-sided trading relationships in which their exports do not enjoy the same sort of access to the market of the developing country—especially if the developing country turns into a manufacturing and exporting superpower as has China.
Another way governments can foster development is by providing subsidies to select industries and agriculture, something that can give them huge advantages when it comes to competing with those who must pay for capital, raw materials, or labor at market prices. The beneficiaries of subsidies are often state-owned enterprises that enjoy actual or near-monopoly power. Governments can also help domestic producers by limiting foreign investment (again to shield locals from competition). And governments can require foreign companies that do invest to transfer their technology to local firms in ways that will eventually make the host country more competitive.
An alternative approach to economic development emphasizes reduced government subsidies, the privatization of state-owned enterprises, provision of incentives to foreign investors, a sound currency to promote investment and savings, reasonable tax policies that provide a mix of incentives for individuals and businesses, safeguards against corruption and out-of-control public spending often associated with government subsidy, and defined property rights so land and buildings can attract investment and be collateral for loans.
Again, trade can be an engine of development, but in a way that involves less government protection, be i
t through tariffs, other barriers, or limits on foreign investment. Openness to trade can both generate high-quality jobs tied to exports and provide consumers access to the best products produced elsewhere, a value both in and of itself and as a stimulus to modernize and improve. Trade is also less prone to corruption and misallocation than assistance. Poorer countries often have a built-in advantage of lower labor costs, something that makes their products less expensive and hence more competitive. To be viable, however, trade requires access to foreign markets (and sometimes favored access, for example, by increasing quotas or reducing tariffs), something that often cannot be achieved unless it is explicitly negotiated.
There is no right or wrong approach to development. China has done remarkably well thus far, but at the cost of political freedom, environmental damage, creating a society (through enforced limits on family size) in which there will be insufficient working-age men and women to support the elderly, large inefficiencies that have wasted great sums of money, and widespread corruption. Other countries such as South Korea have done well by following a more market-oriented path. They have been willing to live with greater uncertainty and the ups and downs of economic cycles in order to achieve high growth rates, limit the political reach of the government, and reduce both the chance of massive corruption and the inefficiencies stemming from misguided central planning.
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