Globalisation’s strength is through domestic demand – that’s why it’s in crisis

13 Jan 2017, by Geoff Tily in Economics

The current debate on globalization is characterised by the idea that trade is becoming more and more important to prosperity. A very standard illustration shows trade growth as a share of GDP progressively increasing over the last 50 years – see Annex. (NB this post is background to ‘Globalisation isn’t a given’ – co-authored by Kate Bell and myself.)

This interpretation is misleading on TWO counts.

ONE: The dominant trend in the post-War era is not that GDP has been increasingly supported by higher trade, but that it has been increasingly damaged by weaker domestic demand.

This is easily illustrated by looking at the decomposition of economic growth since the Second World War. The charts below show annual average growth by decade for various countries.

Plainly: strong GDP growth in earlier decades was dominated by strong domestic demand; weak growth in later decades then followed weak domestic demand. While exports have become more important over time for most countries: i. this does not compensate for the shortfall in domestic demand; ii. in most examples here imports have also increased in parallel and so the benefit from net trade has been negligible.

Annual average growth and contributions (ppts) by decade

Obviously there are exceptions: in Greece the positive contribution from imports in the latest decade reflects the catastrophic decline in domestic demand; Korea has been more successful in re-orienting to exports.

TWO: Trade has grown less strongly over time.

While trade has been more important to the weaker growth of recent decades, exports grew faster in earlier decades.

The charts below show average annual growth of exports and imports by decade. From the 1980s onwards, export growth is not only greatly reduced but also more volatile.

(Note in the earlier years stronger growth translates as lower contributions on the above charts because export increases are smaller relative to the size of domestic demand increases.)

Everything is upside down: trading relations are in fact weaker in the period associated with globalisation, and trading relations are stronger over the decades when globalisation was regarded as in its infancy.

BTW … the OECD now expect trade to be at a 30 plus year low in 2016.

Export and import growth, annual average by decade

Most commentators continue to argue that policymakers should be bending over backwards to not inhibit external trade. But the issue of far greater importance is why domestic demand has caved in. On this topic there is no interest whatsoever, even in spite of the spectre of deflation.

Why? The answer lies in another side of globalisation: finance. (And NB: hence it does not lie in migration.)

The purpose of the post-war global monetary arrangements were to give individual countries autonomy to expand domestic demand. On the monetary side, real interest rates were kept low to support businesses’ capital investment, and on the fiscal side, government expenditure was permitted to play a bigger role than ever before (under peacetime conditions). In the 1970s this arrangement was decisively dismantled: the international exchange rate and monetary regime devised at Bretton were ended, domestic credit was liberalised, fiscal retrenchment began and capital controls were removed.

Outcomes of the early decades correspond to those desired by the architects of Bretton Woods. As Keynes predicted:

… if nations can learn to provide themselves with full employment by their domestic policy … there need be no important economic forces calculated to set the interest of one country against that of its neighbours … International trade would cease to be what it is, namely, a desperate expedient to maintain employment at home by forcing sales on foreign markets and restricting purchases, which, if successful, will merely shift the problem of unemployment to the neighbour which is worsted in the struggle, but a willing and unimpeded exchange of goods and services in conditions of mutual advantage. (General Theory, Chapter 24)

Likewise, when the post-war arrangements were dismantled, international trade was restored to the pre-war norm as a ‘desperate expedient’.

The Bretton woods arrangements were far from perfect, and relentless growth may be far from a sensible goal today. But the world economy is (at best) going nowhere at the moment. So is the debate on globalization, without financial architecture and demand on the agenda.

ANNEX: Trade as a share of GDP

Source: Resolution Foundation: Examining an elephant, p. 11