Reshaping the Global Economy

• Author: Jean Pisani-Ferry/Indhira Santos
• Position: Director of the European think tank Bruegel/Research Fellow. Martin Kessler provided research assistance
• Pages: 8-12

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The economic and financial crisis marks the end (for now) of a rapid expansion of globalization

The Economic and financial turmoil engulfing the world marks the first crisis of the current era of globalization. Considerable country experience has been accumulated on financial crises in individual countries or regions-which policymakers can use to design remedial policies. But there has not been a world financial crisis in most people's living memory. And the experience of the 1930s is frightening because governments at that time proved unable to preserve economic integration and develop cooperative responses.

Even before this crisis, globalization was already being challenged. Despite exceptionally favorable global economic conditions, not everyone bought into the benefits of global free trade and movement of capital and jobs. Although economists, corporations, and some politicians were supportive, critics argued that globalization favored capital rather than labor and the wealthy rather than the poor.

Now the crisis and the national responses to it have started to reshape the global economy and shift the balance between the political and economic forces at play in the process of globalization. The drivers of the recent globalization wave-open markets, the global supply chain, globally integrated companies, and private ownership-are being undermined, and the spirit of protectionism has reemerged. And once-footloose global companies are returning to their national roots.

So what role has globalization played in the genesis and development of the crisis? How is the global economy being transformed?

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And what are the possible policy responses? These are the key questions we address in this article.

More than regulatory failures

At the start, many analysts failed to grasp fully the character of the crisis. The focus was almost exclusively on market regulation and the supervision of financial institutions, whereas little attention was devoted to the root global macroeconomic causes of the crisis. Indeed, as late as November last year, when the Group of Twenty (G-20) leading industrial and emerging market economies issued a communiqué at the end of an emergency meeting in Washington, D.C., the main focus was on failures in regulation and supervision and, correspondingly, the remedies were considered to be of a regulatory nature-hence the long G-20 agenda.

Partly, this was because the expected crisis did not occur: there was no precipitous depreciation of the U.S. currency, nor a sell-off of U.S. Treasury bonds. But the truth was that, however real the microeconomic failures, their effect would have been much more contained absent the insatiable appetite for AAA-rated U.S. assets. It was the combination of strong international demand for such assets, largely in connection with the accumulation of current account surpluses in emerging and oil-rich economies, and an environment of perverse economic incentives and poor regulation that proved to be explosive (see F&D, June 2008).

However, the complex interrelationships in the global system helped mask how it operated, and for a long time there was a collective failure to grasp fully the link between global payments imbalances and the demand for safe (or seemingly safe) financial assets and the manufacturing of those assets (Caballero, 2009). Discussion at the international level was further complicated by political overtones: ever since Ben Bernanke's 2005 "global savings glut" hypothesis, the United States has insisted that the key macroeconomic problem in the world economy was not its current account deficit, but rather China's high propensity to save.

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A second related mistake dates to the early stages of the crisis. It was hoped, until autumn 2008, that economies immune from the direct fallout of the subprime crisis would sail through the storm with sufficient strength to pull along the entire world economy.

There were some superficial grounds for this "decoupling" view. According to the IMF, U.S. banks suffered 57 percent of the financial sector losses on U.S.-originated securitized debt, and European banks suffered 39 percent, but Asian institutions took only a 4 percent hit (IMF, 2008). This explains the simultaneous drying up of liquidity on the interbank markets in Europe and the United States in summer 2007 and is consistent with a degree of transatlantic financial integration far more intense than between any other pair of regions (Cohen-Setton and Pisani-Ferry, 2008). Thus, the subprime mortgage-related clogging of the banking system, and the resulting credit...