The Next Globalization

The biggest challenge of globalization isn’t trade. It’s reining in health care and energy costs—and preparing American workers and business to compete.

Beyond health care and energy, the other critical part of the economy redefined by globalization has been finance. For some time, the global capital pool has been growing much faster than global production or trade, with a fair estimate of that pool today reaching $165 trillion, or three times its estimated size 15 years ago. This enormous growth of global capital and its international flows ultimately reflect the rapid increases in the value of savings and assets in China, India, Malaysia, and other developing countries that cast their lots with globalization. Moreover, the globalization of advanced financial services has exchanged much of this new wealth for corporate paper, bank deposits, stocks, and other financial assets that flow into national capital pools where, under the rules of the WTO, they can make their way into the larger, global capital pool. This process ends up bringing much of the real wealth created through globalization into the world’s monetary base, where it gives rise to yet more credit or money.

The good news is that these vast increases in available capital have kept interest rates historically low, even in countries with dismal saving rates such as the United States. The bad news is that when capital and credit grow more quickly than the goods and services they’re ultimately used to purchase, fast-rising inflation usually follows. On the other hand, globalization is also intensifying competition in ways which dampen inflation nearly everywhere in the world. In economic life, all costs come out in the end, and as a result most of the normal inflationary pressures coming from all the new liquidity sloshing around the world have gone instead into new global asset bubbles, notably housing. From 1997 to 2007, housing prices marched up 92 percent in Italy and 103 percent in the United States (175 percent by another measure), 137 percent in France and 126 percent in Sweden, 184 percent in Spain, 205 percent in Britain, and 251 percent in Ireland. By 2006, the bubbles in the most overheated housing markets–such as Britain and Ireland–were beginning to burst, and last year housing prices in the United States began falling, too. Japan, where housing prices soared in the 1980s, provides a glimpse of what homeowners in other countries may expect: When the bubble finally burst there in the 1990s, prices fell 40 percent.

Current asset bubbles are not limited to housing. From 1997 to 2004, stock markets around the world rose and fell at roughly twice the rate of any comparable period since World War II–by an average of 20 percent a year in the United States, for example, and 24 to 27 percent a year in France, Italy, and Germany. All the global liquidity looking for outlets is also a factor in the recent run-ups in the prices of oil, food and other commodities. Already, the fallout from the housing bust has sharply slowed the economy, particularly from homeowners whose incomes were already stagnating and highly leveraged financial institutions who had speculated in risky mortgage-backed securities.

The next president will likely find that this time the usual approaches cannot deliver a strong recovery. The United States normally pulls itself out of recessions by cutting interest rates; the leading interest-sensitive sectors, housing and business investment, then recharge growth. But housing cannot drive an expansion as long as housing prices are falling, a process likely to continue for another one to two years. As for business investment, the severe financial strains triggered by the mortgage-backed-security fiasco have done real damage to the balance sheets of hundreds of financial institutions, forcing them to limit lending for the near future to the most gold-plated, credit-worthy borrowers.

Even if housing and finance were in better shape, the globalization of capital limits the Federal Reserve’s ability to use its power over certain short-term interest rates to move the long-term rates that drive most borrowing. From June 2004 to June 2006, for example, the Fed raised its short-term rate by four percentage points in 17 steps; yet, the rate for AAA corporate bonds was 6 percent in June 2004 and 6 percent in June 2006, and the rate for a conventional mortgage rose just four-tenths of 1 percent. With the principal means of hot-wiring a recovery out of reach, we face real prospects of an extended downturn.

Stimulus and Responses

Given the hand globalization has dealt the next President, the best advice to get the economy moving involves large doses of stimulus targeted to the particular needs of businesses and people. That should start with a big new commitment to public investments in twenty-first-century infrastructure, especially energy-efficient light rail systems for all metropolitan areas and, if he’s serious about increasing the use of climate-friendly public transit, large grants to drastically cut the fares and make them as near as possible to free. The combination could produce thousands of new jobs directly–and many more indirectly, by increasing the disposable incomes of millions of people willing to get from place to place in a climate-friendly way.

A similar model could be applied to broadband: Create new jobs and get a jump on the next-generation Internet by freeing up spectrum and providing tax incentives to promote the further rapid deployment of fiber and wireless systems on the scale that a more advanced Internet will require. Here, if the next President is also serious about opening America’s idea-based economy to everyone, he will take additional steps to promote universal broadband service, develop inexpensive laptops for all public school students, and provide free training in computer and Internet-based applications for any adult. Each of these reforms could help boost demand and create jobs in an extended downturn. And for the longer haul, their combination should help raise productivity and incomes by enabling millions of more workers to be IT-efficient, and help create new jobs and wealth by expanding Internet-based markets and strengthening the foundations for new, next-generation Internet-based businesses.

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