IIE celebrates twenty-five: founded in 1981, the Institute for International Economics quickly came to dominate global economic policy research. TIE sat down with director Fred Bergsten, who started it all and today remains the dominant force in an important Washington, D.C., institution.

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An Exclusive TIE Interview

TIE: Despite all the talk about the transformative effects of globalization, some things do not change. Looking back on 1981 when the Institute for International Economics was founded, what policy challenges in the international economy remain the same today?

Bergsten: Three big challenges remain the same: global imbalances, energy price pressures, and trade protectionism. In fact, one of the things that led to our creation was the emergence of all three of those challenges in the 1970s. Many felt that the country was not well equipped to handle them and so we ought to create a think tank devoted to that set of issues. A quarter of a century later, have we learned anything? The answer is that we clearly haven't yet learned enough to keep them off the radar screen.

TIE: So how's the policy world performed on these three challenges if you had to give a grade?

Bergsten: The policy world dealt pretty well with the imbalances in the 1980s and even into the 1990s. The United States finally started to get its budget deficit under control and the imbalances--particularly through major changes in exchange rates--were pretty much eliminated by 1990. But then people forgot and imbalances started to rise again in the late 1990s.

Trade protection achieved the second best performance in my view. People bought into the bicycle theory--if you stop liberalizing, you fall back into protectionism--and kept liberalizing negotiations going forward. The reduction in barriers to trade has had a huge impact. Gary Hufbauer from our team quantified it about a year and a half ago and found that the United States is a trillion dollars a year richer as a result of trade globalization in the last fifty years. At the moment, the collapse of the Doha Round may represent a recrudescence of all that risk.

We've seen relatively little improvement in energy policy. The markets did respond a fair amount to the 1970s oil shocks and the United States has experienced a big reduction in energy usage as a share of the economy. That was also partly a triumph of policy. President Carter, helped by the 1978 Bonn Summit, finally did decontrol oil prices, a measure Congress had blocked for five years after the first oil shock. But I'd say the lack of an effective energy policy for the last twenty years is the biggest single threat to global economic stability.

TIE: Does it bother you that while the imbalances always could lead to disaster down the road, so many of the usual rules don't seem to be working? We have a president who's been in office for six years, and he took a surplus and turned it into a significant deficit. If you'd had a crystal ball in 2000 and known this fact, you would have said the ten-year bond would be at 12 percent by now. Yet the long bond has stayed below 6 percent, and for a while was at 3 percent. By the same token, U.S. current account imbalances are such that you've had so many investors--the latest being Warren Buffett--lose their shirts betting on the dollar collapse. There seems to be some temporary revision of the rules on how we interpret these imbalances. How has the Institute come to terms with what is at least temporarily a source of frustration among economists?

Bergsten: I'd stress "temporarily" because, when the Institute was created in 1981, I was already saying the trade deficit is going to rise to $100 billion. People scoffed. I predicted protectionism would erupt. People scoffed. I said the dollar was way overvalued. People scoffed. Well, I was early then too. And in 1983 1 was saying it even more assuredly and I was still premature. It wasn't until early 1985 onward that the dollar dropped over 30 percent on average in two years and by over 50 percent against the deutschemark and yen. Perhaps temporarily the usual rules aren't holding. But Buffett just made a big timing mistake. If he'd sold dollars in 2002, he'd have been an even richer man. He sold in the one year the dollar happened to go up and then whipsawed himself because if he had held on a little while longer he would've been OK.

TIE: The point is just that if you were to imagine a world in which the U.S. current account imbalance is at 7 percent of GDP, most people would say it would never get there.

Bergsten: The specifics always differ but we know that markets as well as governments can make big errors for prolonged periods of time. In this cycle, the European economy is a drag but the U.S. economy has boomed through increased productivity. It's a matter of time until the imbalances and exchange rates are corrected.

TIE: Do you agree with Federal Reserve Chairman Ben Bernanke's assessment that essentially there's a shortage of non-American investment opportunities for the global capital markets?

Bergsten: I wouldn't put it that way but, as I said, Europe's growth is disappointing. Japan's growth has been disappointing. The other big financial markets have not been all that appealing so, in a sense, it's the same thing.

TIE: How has the ability of policymakers to shape the global economy changed since the Carter Administration days when you served in the Treasury? Have the international institutions kept up with developments in the global economy?

Bergsten: Policymakers understand the issues a lot better now, but I don't think their performance is much better. Active policy cooperation has fallen out of style. Some would say that is good news. Central banks have developed more credible monetary policies and anti-inflation reputations, so maybe there's less need for active coordination. But the imbalances themselves reflect in part the lack of adequate policy cooperation.

Most of our institutions have deteriorated. The IMF has clearly deteriorated. The G7/G8 coordinating mechanisms have deteriorated in part because they've lost political legitimacy since their membership no longer tracks with the underlying power structures in the system.

The standing of the WTO is mixed. WTO dispute settlement was a big step forward and continues to work pretty well. But if the Doha Round of trade negotiations does fail then even that process could atrophy. On the institutional side, there's been a failure to keep up with globalization and in fact some retrogression.

TIE: To what extent during this period have advances in technology affected policymakers? When you push a button money speeds around the world almost instantly and so you have this kind of globalization of liquidity. Yet central bank reserves relative to the size of the markets now are much smaller than twenty-five years ago. The central banks used to have more clout. Today, they are like actors on a stage trying to project and magnify what is not really the same amount of clout. How does that limit the scope of institutional management of the system?

Bergsten: I'm skeptical of that premise. There's no doubt the amounts of money are much larger but that doesn't necessarily reduce the central banks' clout and efficiency. All the officials have ever had the ability to affect is the small difference between ex ante supply and ex ante demand at the margin. Whether the total flows are $1 trillion or $10 trillion, the amount that you're trying to affect at the margin is a much smaller share of that.

The size increase is being used as an excuse and a cop-out by officials not to try to do what they used to do. My evidence is that, for all their anxieties about exactly what you said, the Clinton Treasury intervened three times in eight years and every time the intervention worked like a charm. Despite all their protestations, policy officials contradicted themselves with the success of their own measures. They say, "If we tried to do it every month it wouldn't work," but nobody's asking them to do it every month. In short, I think the record on intervention has been pretty good when it is done correctly.

TIE: How do you feel about...