The collapse of Bretton Woods and its consequences

• Two successive US administrations – Lyndon Johnson (1963-1969) and Richard Nixon (1969-1974) carry out expansionist, inflationary economic policies. Johnson funds generous social programmes as well as increasing US involvement in the Vietnam war.

• Under Nixon the Federal Reserve keeps interest rates low, encouraging more public expenditure and investment. The comparative higher inflation rates in the US meant that the real value of the dollar was declining. This would have required a deflationary policy to bring US prices down. Nixon did not choose to follow that route.

The collapse of Bretton Woods and its consequences

• On August 15 1971, the dollar is devalued and de-linked from gold. i.e. the dollar-gold peg, which was the key of the Bretton Woods system, is terminated. In addition the US administration imposed a 10% tax on imports so as to put pressure on its partners and prevent their easy access to the US market.

• December 1971, the Smithsonian agreement. Major economic commercial powers accept a revaluation of their currencies in return for the end of US extraordinary tax measures.

• From 1976 (Jamaica accords) the “non-system” of flexible exchange rates, and convertible currencies is officially in force.

Stagflation in the 1970s.

• Oil crisis(1973). Opec enforces an oil embargo, which produces a sharp rise in prices.

• Stagnation + Inflation. Western economies slump, experiencing recession, and a fall in demand. At the same time inflation picks up strongly because of sudden rise of costs and prices.

• The stagflation scenario come as a shock to economists who had worked on the assumption that there was a positive trade-off between inflation, and employmen, i.e. growth of the economy (Philipps curve).

• Different economic strategies. The US follows an economic strategy directed at domestic output recovery; West European countries are more concerned with fighting inflation; Japan seeks to maximize its exports, by penetrating foreign markets (especially the US).

Western Europe faces the crisis of the 1970s.

• 1950s- The Europe of the Six. The first treaties: ECSC and EEC

• 1960s- The creation of a Customs Union and the CAP – The UK applies for membership and faces a veto.

• 1970s- The EEC from 6 to 9. Economic fluctuations undermine plans for a single currency.

• The Franco-German axis and the creation of the European Monetary System (1978).

Neo-protectionism in the 1970s.

• Neo protectionism by industrialised countries. Invisible barriers also known as non-tariff barriers

hamper world trade. - Voluntary Export Restraints (VERs) as an

answer the Japanese challenge. Agreement to limit sales on the US market. Leads to higher prices and cartel-like profit sharing.

-1974 Trade Act Section 301, authorizes actions against commercial partners, deemed to carry out unfair trade practices.

1973- Multifibre agreement sets limits to imports of textiles and clothing from developing countries

Anti-dumping actions by the Commission of the European Community.

New economic doctrines: monetarism and supply side economics

• The end of the keynesian consensus.• Monetarism. This is a theory based on the quantity of

money. The state’s function is primarily to regulate the money supply in the economy. It is supposed to keep out of economic matters especially cut back on financing social expenditure. To prevent inflation the Government has to keep a balanced budget and run a tight monetary policy (via high interest rates).

• Monetarists do not believe a healthy economic policy should aim at full employment. They speak of a natural unemployment rate for each economy (NRU), or, in more sophisticated economic terms, NAIRU (Non-Accelerating Inflation Rate of Unemployment).

New economic doctrines: monetarism and supply side economics

• Supply side economics: advocates micro-economic reforms such as flexibility in labour, capital markets, deregulation, privatization to enhance productivity and thereby encourage economic growth.

• Who were the monetarists? The Chicago School (Milton Friedman) was the leading element. Margaret Thatcher endorsed monetarism when she became UK Prime Minister in 1979 So did Ronald Reagan, US President from 1981 to 1989. Monetarist theories spread in most countries, and some version of monetarism is embodied in economic policies throughout the West.

The ISI Model in crisis• ISI achieved industrialization in many countries.• Dual economies, with modern sectors and poor rural and

shanty town populations. Income distribution unequal. Growth rates unable to match the I. Countries.

• Growing balance of payments problems. Import needs rose, but exports were not competitive on world markets. Devaluation became chronic.

• Foreign loans in the 1970s generated large interest payments.

• Huge subsidies generated budget deficits, which in turn caused inflation, which led to more devaluation and/or recession as a cure for inflation. Often military dictatorships took power. See Brazil (1964), but also Chile (1973), Argentina and many other countries

The export oriented industrializers.

• Asian Tigers follow a different path. They protect their industries but strongly promote exports.

• In 1974 South Korea exported 41% of its manufactured goods.

• Low wages, undervalued currencies. Little state social spending. Highly competitive export oriented sectors avoid balance of payments problems.

• Little inflation.

The crisis of the Communist bloc after 1970.

• Reforms of the system in the 1960s are discontinued in the 1970s due to political pressure from the Communist parties. Revolt and repression (Poland, Czechoslovakia)

• Failure to increase productivity, quality production. New technologies require flexibility which the system resisted. Only the military compete with the West. The civilian sector falls behind.

• Growth rates low. Exports uncompetitive. Eastern countries take up loans like the ISI countries. They also increase their imports from the West to keep up their living standards.

• The USSR imports grain from the USA: a declaration of failure

• The only successful exports to the West are oil, gas and other raw materials.

The Western world and the second oil shock

• The US takes on inflation: Volcker as Chief of the Federal Reserve in 1979 raises short term interest rates to above 20%. This generated a domestic recession but eventually beats inflation.

• High interest rate policies are adopted by other European countries. Germany acts as pace-setter in Europe.

Developing countries, the debt crisis, and the

new economic environment of the 1980s. • US and other countries’ commercial banks extended large

loans to developing countries and to the countries of Eastern Europe in the 1970s. The loans were designed to fund state-led industrialization and other government programmes.

• 1979- Paul Volcker, chairman of the Fed, enacted a monetary squeeze to fight US domestic inflation. Debtor countries are confronted with a huge hike in interest rate repayments.

• To remain solvent they had to negotiate new loans with the IMF and reverse their domestic economic policies, embracing market-reforms and cost-cutting, deflationary economic packages.

• This painful development leads many countries to default on their debts. A few countries managed the transition to economic self-sustained growth.

The age of globalization

• Deindustrialization and the growth of the service economy

• Technological innovation: the information era and the telecommunication revolution.

• From the State to the market: privatization and liberalization in the West – the end of state socialism – the emergence of Asian economies – the New economy of the 1990s.

Trends in the global economy since the 1980s

• De-industrialisation and the emergence of the service economy

• From the State to the market:• privatisations and reform in Western Europe;• the fall of Communism;• the rise of the South Asian economy: a

global shift;• the American miracle of the 1990s and the

“New Economy”

The INFRASTRUCTURE of GLOBALISATION

• Technological change in the new era proceeds at an increased rate over a wide number of fields, biotechnology, microelectronics, telecommunications, new materials.

• Broad application of new technologies. Newer technologies, especially in computer and electronics, are relevant to a broad array of economic processes and other activities.

• Shortened process and product life cycle.

THE TELECOMMUNICATIONS NETWORK AND THE COMPUTER AGE

• The space industry and satellites• Telecommunications from the

Telephone to the global highways• ELECTRONICS: from the wireless

telegraph, to the computer, to the modern information age.

• The rise of Internet and its impact on the economy

Questions on trade and multinationals

• Issues surrounding the origins and nature of the WTO.

• Describe the progress and collapse of the Doha round negotiations (2000-2007). Who is to blame?

• Arguments for and against FDI in developing countries.