A quarterly magazine of the IMF

March 2002, Volume 39, Number 1

The End of Globalization
Lessons from the Great Depression

Harvard University Press, Cambridge, Massachusetts/London, England, 2001, vi + 260 pp., $39.95/£27.50 (cloth).

Harold James presents a fascinating treatment of the implosion of the world economy in the years between the two world wars. The Great Depression, he argues, was a consequence of the flaws of the first era of globalization in the four decades before World War I and, thus, a cautionary tale for the current era.

The book's main thesis is that globalization in the nineteenth century contained the seeds of its own destruction: the free movement of goods, capital, and labor had negative effects on powerful groups in the world's leading economies, and, more important, globalization was generally perceived as harmful. James treats the backlash against free trade in the 1880s and 1890s by European landowners harmed by cheap American grain and rapidly declining transportation costs, the backlash against free migration by New World labor threatened by competition from Old World immigrants, and the rise of central banks and domestic monetary policies to protect domestic economies from the vicissitudes of capital mobility. While his treatment complements the work of Kevin O'Rourke and Jeffrey Williamson (Globalization and History: The Evolution of a Nineteenth Century Atlantic Economy, MIT Press, 1999) and Barry Eichengreen (Globalizing Capital: A History of the Industrial Monetary System, Princeton University Press, 1996), what is new is the political dimension linking fears of globalization to the rise of nationalism across the world.

The elements in the global crisis that the author stresses—political upheaval, weak financial systems, price instability, poor public finances, loss of credibility, destabilizing capital flows, and adherence to gold pegs—have resonance, according to James, in the recent East Asian crisis. However, the fact that the 1930s crisis was a core-country phenomenon centered on the international gold standard, and the 1990s crisis a peripheral event involving diverse exchange rate arrangements, suggests that this analogy is a trifle overblown.

Although the author's analytical framework is well established, some of the new historical details are not. One novel interpretation is that of the sterling crisis in September 1931. James disputes both the traditional view that the collapse of the currency was due to overvaluation and fiscal imbalances and the more recent view that it was due to the fear of high unemployment. According to the author, the 1931 British crisis was a twin crisis triggered by a deteriorating financial system. The monetary authorities threw in the towel, he argues, primarily because they feared the possible insolvency of important merchant banks (if the peg of $4.86 to the pound sterling were to continue), whose portfolios were severely damaged by the earlier crises in Austria and Germany. This interpretation is both controversial and questionable. The British clearing banks were solvent, there was no sign of a classic internal drain (a rise in the currency-to-deposit ratio), and the Bank of England was well versed in the rules a lender of last resort should follow in the event of a real financial crisis.

The author is also controversial in his treatment of the events behind the U.S. crisis of 1931-32, which he views as being similar to the circumstances on the European continent. According to James, the U.S. Federal Reserve was unable to conduct expansionary open market operations to offset the banking panics not because it didn't have sufficient free gold, but because it feared capital flight in the face of a growing fiscal imbalance. This hypothesis also will need serious testing.

In his excellent discussion of the collapse of international trade, James links rising tariffs and nontariff barriers and then the move toward bilateralism with the collapse of the international payment system, the growth of nationalism, and the rise of the extreme solutions of Soviet communism and German national socialism. He also views the movement to restrict immigration worldwide as an extension of policies started before World War I. In his innovative discussion, he links migration with the rise of nationalism and fascism.

James concludes by telling the well-known tale of the rebirth of the globalization of trade, payments, and, later, capital movements following World War II. What happened to the first age of globalization, he says, could happen again. The forces that could produce the next backlash include Europe's inability to innovate, the exclusion of the world's poor nations from globalization, and the political clout of the principal losers in advanced countries—less skilled labor—from today's globalization.

The book is a fascinating read. However, this reviewer, schooled in neoclassical economics and monetary history, had problems with the basic thesis that the Great Depression was a consequence of globalization. An alternative view is that, indeed, the Great Depression ended the first era of globalization but that it was not preordained. Rather, it was caused by the egregious policy failure of the monetary authorities in the United States, France, and other countries. Had the Federal Reserve and the Banque de France not made key mistakes, the world would have continued to advance roughly as it had been doing since the industrial revolution, and globalization would not have been arrested. Moreover, a careful comparison of the forces producing the backlash against the first era of globalization with those at work today suggests that now there are more centrifugal than centripetal forces at work to prevent a comparable backlash from occurring.

Michael Bordo

Paradoxes of Prosperity
Why the New Capitalism Benefits All

Texere, New York and London, 2001, xix + 316 pp., $27.95/£17.99 (cloth).

The unprecedented technology-led economic boom of the 1990s has spawned a vigorous debate in both academic and policy circles about the permanence of the "new economy." Although the prophesied end of business cycles has since been discredited, the permanent increase in productivity remains in question, and the global stock market bubble, fed by the euphoria surrounding the new economy, has since largely deflated. The debate about whether we are truly on the threshold of a new economy is, however, just getting under way, as its most enthusiastic advocates—backed by admittedly brief but powerful evidence—are in partial retreat.

Diane Coyle's provocative book is a timely and intelligent contribution to the debate. Deftly combining her training in economics with her experience as economic editor of The Independent, she argues that the technological revolution is real and has implications that extend beyond economics to society, politics, and the current corporate structures. Rather than side with those who unfailingly extol the virtues of this technological boom, or those who fear that the evolving economic order will lead to an increasingly unequal distribution of the benefits, Coyle holds that the "new capitalism"—made possible by the "new economy"—and the attendant globalization, represents an opportunity to create a more just and equal society.

Arguing that the impact of technology is more widespread than the data suggest, Coyle explains why conventional measures of growth do not accurately capture the impact. She contends that, in the new economy, intangibles like better design and more intelligent functionality are increasingly making a greater contribution to growth than the pure manufacturing content.

A central, and very bold, thesis of Paradoxes of Prosperity is that this new capitalism actually promotes the values championed by the antiglobalization forces—justice, fairness, and freedom. Besides repeating the indisputable evidence that trade and cross-border investment have boosted living standards for all people in countries open to the global economy, Coyle maintains that the environment conducive to success in the new capitalism gives greater voice to those who have traditionally been marginalized. It is this argument that is likely to attract the greatest amount of attention. Although one can disagree with Coyle's proposition, one cannot easily ignore it—she makes her case very persuasively.

Coyle argues that new technology allows more people to share in the successes of economic growth by creating opportunities for acquiring new skills. It is also breaking down old corporate hierarchies, as well as requiring governments to become more adaptive while reducing their scope to become or remain overbearing and intrusive. Coyle argues that experiences specific to location are becoming more important, increasing the need for more heterogeneous groups of people with different skills to work together, especially as education and training become more highly valued. While this concept is certainly true in some respects, to generalize it to the broader economy and to all countries seems a bit of a stretch and is likely to provoke the strongest skepticism from those who fear the implications of the changes under way. She suggests that professional and ethnic diversity actually provides an economic impulse—a clever argument for compatibility of economic and social objectives—and that technology helps harness this diversity, providing a measure of power and democratic control to the grassroots level. The opportunity in this, Coyle says, stems from the need for social capital to grow to work well in the new capitalism, which requires a more educated workforce, strong legal and political institutions, and more responsive government and employers. The new capitalism can be used as a vehicle to reach the goals that both advocates and skeptics strive for.

This book is a realist's delight. It is a refreshing change from both the unfettered optimism that a new golden age will eventually arrive and the pessimistic predictions of impending doom. It suggests that the new capitalism brings opportunities, but that reaping the benefits and achieving wider social objectives will mean embracing change in how societies, corporations, and governments function rather than trying to roll the clock back on these changes or leaving everything to chance. Coyle provides food for thought for those who argue against the global growth of trade and investment and strengthens the arguments of those favoring change while noting the responsibilities that come with it. The golden age is not a done deal by any means. Many would argue that the thesis of this book is wildly optimistic in terms of the potential benefits of the new capitalism while underplaying the dangers. This is the kind of debate that this book pugnaciously seeks to evoke. But given Coyle's logical, provocative, and persuasive arguments, it would take much more than just rhetoric to convince at least this reviewer that the new capitalism is to be feared and resisted.

Subir Lall

Out of the Red
Building Capitalism and Democracy in Postcommunist Europe

University of Michigan Press, Ann Arbor, Michigan, 2001, xiv + 166 pp., $22.95 (paper).

For the past quarter century, opinion about the relationship between neoliberal economic reform and democratization in middle- and lower-income countries has often assumed tension between the two. In reforming economies, the argument goes, the spread of democratic procedures and institutions produces stalemate and instability, limiting the ability of reformers to do their work. In parallel, radical economic reforms elicit populist reactions that obstruct (and even subvert) the development of democracy. In short, political and economic liberalization are at odds in developing countries, whereas, in developed countries, democracy and capitalism coexist in ideological bliss. It is refreshing to see an in-depth comparison of middle-income countries dealing with the dual burdens of economic reform and democratization that shows this conceit to be patently untrue. In Out of the Red, Mitchell Orenstein examines how Poland and the Czech Republic pursued neoliberal economic policies in an environment characterized by all the bickering, opportunism, and backlash that democracy permits. He demonstrates how a democratic setting allowed economic reform to thrive.

In Poland, shock therapy was the rule of the early years of transition, during which, despite the powerful Solidarity movement, right-of-center governments implemented neoliberal economic reforms with international financial assistance. Taking advantage of a window of opportunity after the end of central planning in 1989 (and before Poland's first fully open parliamentary elections in 1991), Finance Minister Leszek Balcerowicz's plan was approved by a special committee appointed by President Lech Walesa, without the involvement of the Polish parliament (Sejm) and with minimal public debate. In Czechoslovakia, by contrast, a coherent economic reform program appeared within the constraints of parliamentary democracy, not outside of it. Czech Finance Minister Václav Klaus was less insulated from politics than his Polish counterpart and realized his program would require electoral support to survive.

Consequently, the Czechoslovak (and later Czech—though not Slovak) transformation strategy consisted of several core components of the neoliberal blueprint combined with measures designed to cushion vulnerable groups from the impact of reform—what Orenstein calls "social liberalism." Typically, these measures promoted employment in ways that did not conflict with the need to stabilize (for example, legalizing collective bargaining and restructuring social security and health care systems). The unmentioned irony is that a country with a powerful labor movement was unable to incorporate any provisions to protect wage earners in its reform, while a country characterized by weak labor unions emerged with a comparably stronger social program.

As expected, when the backlash came, it came to Poland first. Balcerowicz himself lasted just a little more than a year before being replaced. Five governments rose and fell before the right-of-center reformers were defeated in 1993. By contrast, Klaus's politicking succeeded beyond even his expectations. When the Czech Republic split from the Czechoslovak Federation in 1993, Klaus became prime minister, a position he held for eight years. Orenstein argues that the Czech Republic avoided a backlash because its transformation strategy did a better job of protecting wage earners. But this "pacification" of the electorate also came with costs: it allowed certain flawed elements of the Klaus program to continue without correction. Ultimately, backlash came to the Czech Republic after a financial crisis in 1997, when the right-of-center government was replaced by social democrats.

Orenstein draws a simple lesson from this simple story: democracy and democratization were the postcommunist reformers' strongest allies. Polish elections in 1991 elevated an unprecedented 29 political parties to the Sejm. But Poland did not seize up in a fit of democratic overload. Political parties were forced to develop coalitions around reform strategies that both furthered economic development and secured public support. The numerous policy shifts from government to government allowed the Polish authorities to correct earlier mistakes and adjust the course of reform. Meanwhile, in the Czech Republic, eight years of leadership by a right-of-center group meant that such "midstream" corrections could not be undertaken.

The implications extend well beyond postcommunist Europe. Electoral competition is both a mechanism for shoring up public support for reform programs (even if it comes at the expense of the policies themselves) and the chief means of correcting mistaken policies during periods of uncertainty. However, in the international development community, there remains an implicit fear of policy shifts and of electorally induced instability in reforming economies; this view does not show much affection for the messiness of democracy. The evidence in this book should address that fear.

Raj M. Desai

Work Without Wages
Russia's Nonpayment Crisis

MIT Press, Cambridge, Massachusetts/ London, England, 2001, x + 258 pp., $29.95/£20.95 (cloth).

Russia's economic transition has not been easy. Nor has it been particularly popular with Russia's citizens, thanks in part to the economic decline, collapsing real wages, and dubious privatization practices. One of the most politically charged issues, however, has been the growing incidence of delayed wage and pension payments, analyzed in this insightful book.

Wage and pension arrears were just one component of Russia's wider nonpayment problem that emerged during the mid-1990s and peaked just before the August 1998 financial crisis. The authors attribute the growth of arrears to a combination of macroeconomic shocks and the lack of a supply-side response in the form of enterprise restructurings and bankruptcies. In this environment, firms relied on barter and nonpayment to survive. To make matters worse, company directors became increasingly skillful at diverting into their own pockets whatever little cash flow remained in the enterprises. Most important, the state's inability to collect taxes and settle its obligations on time and in cash fostered the proliferation of arrears and noncash payments.

The authors characterize the government's attempts to deal with the nonpayment problem as a string of policy failures. Its repeated efforts to use debt write-offs, tax offset schemes, and short-term debt instruments were ineffective and often made matters worse. The state was too weak to enforce hard budget constraints on enterprises. At the same time, political frustration about the nonpayment of wages led to short-term populist measures, such as ad hoc transfers from the central government to regions to clear arrears without effective control over how the money was spent.

The book's main contribution is an in-depth empirical analysis of wage arrears in Russia, based on household survey data collected between 1994 and 1998. During this period, the percentage of surveyed employees who were owed back wages rose from 30 percent to 54 percent, and the stock of wage arrears rose from about one month of wages to more than three and a half months.

The book examines a number of reasons for the accumulation of wage arrears. Its central thesis is that, because of high labor-turnover costs, laying off workers was often perceived as being more costly than retaining them at reduced hours or withholding their wages. Although workers frequently responded with strikes, they rarely succeeded in collecting overdue wages. The book notes that some firms settled part of their arrears through in-kind payments, but not on a large enough scale to compensate employees for income lost. Indeed, the authors find evidence that nonpayment of wages drove many households into poverty.

Despite its somewhat narrow focus, the book provides an interesting illustration of the political economy of transition in Russia, including such specific topics as the coal industry, the pension system, and the military. The reader is left with a sobering impression of just how difficult it can be in a post-Soviet economy to address a seemingly simple problem like enforcing wage contracts. While the authors rightly point to the weakness of the bankruptcy system and fiscal organizations as root causes, they do not elaborate on practical policy recommendations. One is left wondering what type of reform strategy would have overcome political and institutional constraints to pave the way for a more successful introduction of market economics.

Christian Mumssen