Globalization and its Discontents | Study Guide

Joseph Stiglitz

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Globalization and its Discontents | Context

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Bretton Woods and the Rise of Global Economic Institutions

World War II (1939–45) left the industrialized nations of Europe largely in ruins. The enormous cost of prosecuting the war left most European nations either bankrupt or deeply in debt. The United States and the United Kingdom began meeting to plan a conference of nations to hammer out a new economic regime for Europe. After the first round of negotiations, U.S. President Franklin D. Roosevelt (1882–1945) and U.K. Prime Minister Winston Churchill (1874–1965) issued the Atlantic Charter (1941) to provide all struggling countries with "the trade and ... raw materials ... needed for ... economic prosperity."

By 1942 U.S. and U.K. delegates were planning a meeting of world nations to be held in Bretton Woods, New Hampshire. The meeting, officially called the United Nations Monetary and Financial Conference, convened in 1944 with representatives from 44 nations. Delegates from both the United States and the United Kingdom agreed to use the U.S. dollar, pegged to a specific value in gold, as the fixed global exchange rate.

The most important outcome of the conference was the establishment of global economic institutions, each designed to carry out important economic functions. The International Monetary Fund (IMF) was created to oversee the fixed exchange rate and, according to Stiglitz, to serve as a "provider of funds for countries facing an economic downturn, to enable the country to restore itself to close to full employment." The other key organization created at Bretton Woods was the International Bank for Reconstruction and Development (IBRD), commonly called the World Bank, whose mission was to provide financial aid to rebuilding countries that had been devastated by the war, as well as offer financial assistance to developing countries to grow their economies. The fixed exchange rate the IMF oversaw was eliminated in 1971 when President Richard Nixon (1913–94) abandoned the gold standard and thus began the era of floating exchange rates.

One sticking point at Bretton Woods was what type of organization should be established to promote free trade through the elimination of trade barriers among nations. It was not until 1947 that an agreement was reached and the General Agreement on Tariffs and Trade (GATT) was established. GATT would not only implement agreed tariff cuts but also codify the rules governing commercial relations among nations. GATT oversaw global trade until it was reborn in 1995 as the World Trade Organization (WTO), which had the same mandate of lowering barriers to trade among nations, implementing the rules for global trade, and adjudicating (settling or deciding) trade disputes.

The International Monetary Fund (IMF) was founded at the Bretton Woods Conference in New Hampshire in 1944. Funds came from member nations, which at first were primarily developed countries but as years passed expanded to include developing countries as well. One of the IMF's most important mandates was to provide temporary loans to developing nations that needed money for economic growth or were in economic crisis. The IMF also had a role in promoting international trade and assuring the stability of exchange rates. Although the organization has always been somewhat beholden to U.S. financial interests, for the first decades of its existence it concentrated primarily on its original mission.

At a December 1971 meeting, members of the Group of Ten (a group of the 10 most developed countries) decided to abandon the devalued U.S. dollar as the fixed-value currency of exchange and instead allow all currency values to fluctuate based on capital market valuations. Flexible exchange rates stripped the IMF of its key mandates to stabilize exchange rates. Its main mission then became that of lending money to developing nations. It was at this time that the IMF began to demand that a debtor nation accept increasingly stringent conditionalities (obligatory requirements for granting loans) in order to secure an IMF loan. After the OPEC (Organization of Petroleum Exporting Countries) oil embargo in 1973–74 and the spike in oil prices in 1979, countries around the world experienced economic recession. Developing nations, in particular, suffered because of lowered exports and thus reduced revenue. For this reason, many developing countries sought loans from the IMF to keep their economies afloat. It was at this time that the IMF used its power as an international lender to make its conditionalities harsher and more stringent. It is true that any lender imposes conditions on loans, ensuring that the borrower is solvent enough to repay the loan. However, the conditionalities and austerity measures the IMF imposed became so draconian, or overly strict, that in many cases they undermined democratic processes in client countries.

The IMF has been criticized for acting more in the interests of Western banks than of developing nations. The 1980s saw the rise of neoliberalism, or free-market liberalization, which taught the infallibility of free markets and denounced government interference in economy as inefficient and even damaging. The IMF embraced free-market liberalization, an economic dogma that is sometimes popularly characterized as "profit over people" and whose tenets became central to the conditionalities it imposed on client nations. Without taking into account local conditions or government input, the IMF devised economic policies that, as Globalization and its Discontents shows, frequently did more harm than good. Its liberalization of capital markets often wreaked havoc on a developing nation's currency. Its anti-inflationary policies were often misapplied, and its insistence on rapid privatization of government-run enterprises impoverished citizens and left them with little or no safety net to help them weather the economic storm. The IMF's rigid liberalization policies resulted in anti-globalization protests in many parts of both the developed and developing world. These protests criticized the development of economic policies that were created to benefit worldwide cultures but in fact benefited only a few.

Adam Smith and David Ricardo

Scottish economist Adam Smith (1723–90) is considered the father of capitalism, a system in which the means of production are privately owned and goods are distributed in a free market. Smith explains this economic system in his book The Wealth of Nations (1776). This Scotsman was not only a gifted economic thinker but a moral philosopher as well. He came to prominence after giving a series of lectures on rhetoric in Edinburgh, Scotland, and later became a professor of rhetoric and moral philosophy at the University of Glasgow.

In his seminal work Smith discusses the theoretical foundation for a free-market economy based on the self-interest of individuals acting rationally for their own benefit. His free-market idea is theoretical because it stipulated that everyone engaged in a free market, whether producer, trader, or consumer, had "perfect" information about the transaction and their self-interested action was based on this information. Smith also believed that because of the perfectly rational decisions made by everyone involved in a transaction, markets were always self-correcting. He wrote that an "invisible hand," based on rational decisions and perfect information, guided the market and made it self-correcting. Despite the fact that there is no perfection in the real world, Smith's ideas became the foundation of modern capitalist economics. The free market was the only force for good in economies, and Smith downplayed, though did not dismiss, the role of government in the economy.

If he was somewhat skeptical of government interference in economies, Smith was nevertheless keenly aware of, in Stiglitz's words, the "limitations of the market" and of the need to take into account "the social and political context in which all economies must function." Although modern neoliberals interpret Smith's ideas as a rationale for unfettered and unregulated actions by businesses and the free market, they ignore Smith's wariness about the unbridled and clearly imperfect greed that motivates free-marketeers. Smith conceded that "a voluntary transaction always benefits both parties," but he also condemned businessmen: "People of the same trade seldom meet together ... but the conversation ends ... in some contrivance to raise prices." Further, Smith loathed monopolies, when companies gain exclusive control of a commodity or service, for their "monopolizing spirit of merchants and manufacturers who neither are nor ought to be the rulers of mankind." Clearly, Smith was a capitalist but one who would certainly not have been a proponent of unregulated liberalization policies. He derided the power and influence of corporations on the government: "The government of an exclusive company of merchants is ... the worst of all governments for any country whatever."

David Ricardo (1772–1823), a British economist who worked on the London Stock Exchange, took up where Adam Smith left off. One of the ideas in his book, Principles of Political Economy and Taxation (1817), is vital to the growth of trade and globalization. In this book, Ricardo advances his concept of "comparative advantage," which shows why trade is so important to the countries of the world. Simply stated, comparative advantage stipulates that a country should export those things it is efficient at producing and import those things it is less efficient at producing. In the simplest example, the United States may be able to grow bananas, but its soil and climate make it best suited to growing wheat. So instead of allocating time and resources to growing bananas, the United States should trade its wheat with a country whose climate is best suited to growing bananas. The United States would thus export its wheat and import the other country's bananas. Each nation exploits its climate and resources to grow and trade those crops in which it has a comparative advantage.

Ricardo also showed why even if two countries can produce the same goods, it's still in their economic interest to trade based on the "opportunity costs" of production, or the amount of one good that is sacrificed in order to produce a different good. For example, country A can produce either one pound of coffee or two pounds of tea in one hour. If country A decides to use that hour to produce one pound of coffee, it loses the opportunity to produce two pounds of tea. The two pounds of tea is the opportunity cost of producing coffee, because country A gave up producing two pounds of tea in order to produce just one pound of coffee. It is therefore in country A's best interest to spend its labor hours producing two pounds of tea and trading with another nation, country B, which can produce two pounds of coffee in one hour. Each country trades in products that have the least opportunity cost, and both benefit economically. Country A has a comparative advantage in tea, while country B has a comparative advantage in coffee. Both countries benefit because of this trade.

Neoliberalism and the Washington Consensus

In the 1970s some economists urged the adoption of a new liberalism in economics, which came to be known as "neoliberalism." Neoliberal policies stress the value of unregulated free markets unfettered by government interference of any kind. For neoliberals, the government should have no role in the economy, neither in social programs nor efforts to alleviate income inequality and poverty. Neoliberals believe the free market is, as Adam Smith stipulated, perfect and self-correcting, and any interference in the market is economically unsound and destructive of growth and wealth.

The Chicago school of economics promoted this laissez-faire (government noninterference, literally "leave it alone") approach to economics. For economists at the University of Chicago from the 1930s onward, only an unregulated free market could produce economic benefits. The Chicago school economists stipulated that the free market was self-correcting, that perfect information resulted in perfectly rational actions, and that even monopolies should be left uncontrolled because the free market itself would correct any monopolistic misbehavior. Friedrich von Hayek (1899–1992), an Austrian-born British economist, argued forcefully that any government policy that sought to redistribute wealth more equitably among citizens would lead to totalitarianism. Hayek's work was highly influential among economists of the Chicago school and among neoliberal economists in general.

Neoliberalism is inherently conservative, and it came to the fore in the 1980s when it was adopted by a number of conservative world leaders. During their respective terms in office, both U.S. President Ronald Reagan (1911–2004) and U.K. Prime Minister Margaret Thatcher (1925–2013) instituted neoliberal policies, particularly "trickle-down economics" that catered to the rich and deregulated corporations. Both leaders severely cut back government safety nets and programs to relieve poverty.

The term "Washington Consensus" was coined in 1989 to describe the neoliberal policies imposed by the IMF and the World Bank on developing countries. The Washington Consensus stipulated that these global economic institutions oversee the debts of developing nations, imposing strict conditionalities on them to limit government spending, and force the implementation of a type of trickle-down economics as a pathway to growth. The Consensus also prescribed the imposition of contractionary, anti-inflationary policies, and huge cuts in government spending, called austerity, that led to great suffering among citizens who depended on government services.

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