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[ ] Episode 1: The Battle of Ideas Friedrich Hayek and John Maynard Keynes were contemporaries and economists with rival views. Their two schools of thought dominated Western economic theory in the 20th century. Each had their period of dominance over the mainstream. Hayek was a believer in free markets whereas Keynes believed in strong government regulation of markets. Lenin opposed international trade and only wanted the USSR to trade with fellow Communist nations. He was therefore against the “global economy.” Keynes was a prominent economic advisor to the British government during and after WWI. He strongly opposed the Treaty of Versailles terms that forced Germany to make ruinous war reparations to the Allies because he saw it would destroy their economy, which in turn would lead to sociopolitical instability. During this period, Hayek became a central member of the “Austrian school” of economics. This was a small group of free market economists that formed in Vienna after WWI. They were marginalized during this period. Lenin’s hardcore Communist policies were a disaster in the USSR: Food production and industrial output virtually collapsed and the county started falling apart. He had to abandon the most extreme Communist practices early on because they just didn’t work in real life. Stalin introduced the economic practice of central planning to the USSR. As Hayek predicted, German hyperinflation after WWI completely destroyed the value of all personal bank accounts and bonds held by average Germans. The hard-earned savings of millions of middle- and working-class Germans were wiped out. The German mainstream became outraged and desperate, and they blamed the democratic Weimar government for the problems and became open to extremist alternatives, such as Communism and Nazism. [In Mein Kampf, Hitler cited broad-based anger over German hyperinflation as one of the key enablers behind his rise to power.] In retrospect, the U.S. stock market was in a classic bubble leading up to the 1929 Crash. Of special note were radio company stocks, which can be thought of the as “tech stocks” or “dotcom stocks” of the 1920’s: As soon as a radio company went public, speculative investors bid its stock price up to absurd levels that were totally disconnected from the company’s real-world profitability and long-term business potential. U.S. banks had invested their patrons’ deposits in the stock market so they could earn the biggest returns on their money. When the market crashed, much of the banks’ money therefore evaporated. Average people became afraid that the banks would shut down as a result, taking all their savings with them, so they scrambled to go to their banks and withdraw all their cash. Thus, “runs” on banks happened. Between the stock market losses and average people closing down their accounts, many banks basically ran out of money and went out of business, and the personal savings of millions of Americans were destroyed, as was the case in Germany. FDR imposed heavy regulation on the U.S. economy to finally end the violent boom-bust cycles that had characterized it for decades and now culminated with the Great Depression. During the Great Depression, the economic activity in every country became very low: Consumers were too poor and too scared of losing their remaining money to buy goods or services. Since no one was buying anything anymore, many businesses shut down or had to fire workers in order to save money. Tens of millions of workers were laid off as a result and lost their income and hence money. These laid 1
off workers were also consumers. Consumers were too poor and too scared of losing their remaining money to buy goods or services. Et cetera. Each country became locked into a disastrous cycle where neither consumers nor businesses had the money or will to “break out” of the situation. The Free Market had failed to deliver growth and prosperity. Keynes believed that increased government spending could end the Great Depression and restore economic growth. The government could print new money or borrow money from other countries and use it for mass purchases of goods and services from private firms, and it could also directly hire millions of new federal workers and pay them to build public works or perform other government functions. The government could therefore artificially inject massive amounts of money and jobs into the economy, which would break the aforementioned negative cycle that characterized the Great Depression. Keynes believed that it was OK for governments to finance this stimulatory spending by running budget deficits. As the overall economy improved, the governments would slowly decrease their spending, balance their budgets, and start paying off their debts, and the economy would shift back to being dominated by the private sector. Though many governments implemented some of Keynes’ reforms, it wasn’t until the WWII national rearmament programs that Western countries made the full level of commitment that Keynes envisioned. Around WWII, Hayek was much less influential than Keynes, but he published his seminal economic work: The Road to Serfdom. Today considered one of the most influential economic texts in history, it postulated that economic freedom and personal freedom were inextricably linked, and therefore that government control over the economy would inevitably lead to the destruction of civil liberties. Hayek saw government regulation of the economy as a grave, long-term threat to freedom and democracy and he encouraged people to resist. The mass unemployment and lethargic business output that defined the Great Depression disappeared during WWII as everyone got jobs either fighting in the military or making weapons, and as factories were upgraded, expanded and built new in order to produce the necessary war materiel. However, as the War was coming to a close, the Allies began to worry that the Great Depression would come back once the armies were disbanded and the war factories were shut down. Many of them seriously feared that Capitalism was a fundamentally broken economic system that would start failing again once WWII ended, and that Communism would prove superior and would slowly take over the world. To prevent that nightmare, the Allies developed the Bretton Woods System, which was a series of economic and financial agreements in which they agreed to maintain healthy trade with each other, to give each other loans to help save weaker countries having problems, and to heavily regulate their currency exchange rates. The International Monetary Fund (IMF) and World Bank were created as part of Bretton Woods. Though it would take several years for this to become apparent, the Bretton Woods system indeed saved the Western World from backsliding into depression and in fact inaugurated a long period of explosive economic growth. During WWII, Britain’s various political parties put aside their differences in order to fight the war, but as the conflict was coming to a close, old divisions reemerged. In 1945, there was a general election. Winston Churchill and the conservatives were running against the socialist Labour Party. Labour’s social and economic policies were heavily in line with Keynesianism, which resonated more strongly with most Britons, who were paranoid of returning to economic depression once the War ended. Thus, though Churchill was an undisputed war hero, he and his party lost the election in a landslide. The Labour Party nationalized key industries such as coal and steel production and railroad transit. Profits from these and from private industries were more heavily redistributed to average people. Taxes were increased on the rich, the welfare state was greatly strengthened, and Britain switched to universal health care in the form of the National Health Service (NHS). Many laws were passed also strengthening 2
workers rights. Britain—which up to this point had been a highly stratified and class-obsessed society— was becoming a much more egalitarian country in which all citizens were given a stake. Meanwhile, Hayek continued to hold out on the fringes of economics. He worked hard to keep his free market ethos alive in the minds of people and to maintain his band of international supporters. Wage and price controls are meant to curb inflation, but they usually fail. For example, after WWII, West Germany was controlled by governor from Allied countries, and these governors set economic policies, which included wage and price controls. West Germany’s recovery from the War was almost nonexistent until 1948, when the Germans unilaterally cancelled the wage and price controls without permission. The economy quickly stabilized and began growing. From the start of the postwar period, West Germany actually had a freer economy than the U.K., and it experienced significantly faster growth. In 1948, India also gained its independence from the U.K. and had the opportunity to craft its own government and to choose an economic model. It decided upon a unique mix of a democratic political system coupled with a centrally planned economy. In short, after WWII, state controlled economies were on the rise across the world. Even “Capitalist” countries that were against Communism such as the U.S. adopted higher degrees of state control and expansions of the welfare state. In 1950, Hayek became a professor at the University of Chicago. Many like-minded economists and academics gravitated there, and the college became a strong bastion of free market thought. The “Chicago School of Economics” was thus founded as an ideological school of thought that echoed the Austrian School of Economics. These Keynesian policies reliably delivered strong economic growth to Western countries until the 1970’s, when stagflation began. This exposed disturbing flaws in the widely accepted Keynesian model since the latter held that high inflation, rising unemployment, and slow economic growth could never all happen at the same time, but it indeed occurred during stagflation. Though Richard Nixon was a conservative, he adopted leftist, Keynesian tactics to fight stagflation, most notably imposing wage and price controls. This improved things in the short term and won him votes in the 1972 election, but in the long term it hurt the economy and of course represented a sell-out against his own party’s favored macroeconomic policies. During the 1970’s, the U.K. also experienced stagflation and likewise ramped up Keynesian policies to cure it. In fact, it made their situation worse. These problems began convincing the mainstream of economists that a return to freer economies was needed to restore growth. Hayek’s popularity began to rise, and policymakers began considering his ideas. One aspect of Hayek’s philosophy that was very germane to the time was the theory that excessive government regulation of the private sector undermined competition between firms and drove up consumer prices while also shrinking consumer choice. In 1974, after having spent most of his life having his ideas ignored and criticized, Hayek was rewarded with a Nobel Prize in Economics. Margaret Thatcher and Ronald Reagan both believed in Hayek’s ideas and made the expected reforms to their countries. In the 1970’s there were a series of major strikes across the U.K. involving unionized workers. Key services and industries relating to such things as coal mining, electricity production and garbage collection shut down for long periods, which caused great suffering for the masses of ordinary people who depended on them. Average Britons slowly turned against the unions and the socialist Labour party that backed them, and they voted in conservative Margaret Thatcher in 1979 to be Prime Minister. Thatcher realized that many of Britain’s state-run enterprises had become inefficient and badly run. The same was also true for private businesses that were propped up by large state subsidies. Thanks either to legally ensured monopoly status or to guarantees of money each year regardless of performance, 3
these firms lacked any incentive to innovate or to improve their operations. Traditional price signals no longer functioned. Thatcher cut the subsidies and privatized several of these big firms early on. This caused a sharp, but temporary increase in unemployment as inefficient enterprises collapsed or downsized upon being exposed to real market forces and their workers were laid off. These workers—many of whom were unionized—formed a small yet highly vocal opposition to Thatcher that persisted across her term. President Carter at first attempted to cure stagflation with more Keynesian policies, but failed. He made a dramatic change of course in 1979 by appointing Paul Volcker to be chairman of the Federal Reserve. Volcker massively increased interest rates and reduced the money supply, which was the classic albeit painful cure for high inflation. The high interest rates severely reduced the availability of credit, which hurt businesses and farmers and led to many layoffs and bankruptcies. The credit crunch also hurt average people who wanted to buy houses, cars or other expensive goods traditionally paid for with loans. Many different segments of the American population suffered due to these harsh but ultimately necessary policies, and their anger helped translate into an election loss for Carter in 1980. However, the election of Ronald Reagan did not usher in changes to monetary policy: Reagan understood Carter’s approach was necessary and that the economic situation was slowly improving thanks to it, so he held Paul Volcker on as Fed Chairman and upheld the tight monetary policy. By 1982, U.S. inflation had returned to much lower levels. Carter suffered for making a courageous choice that Reagan got credit for later on. Margaret Thatcher’s policies were very polarizing, and by 1982 it looked like she would lose that year’s election to Labour. Fortunately for her, the Falklands War happened, and Britain’s military victory under her leadership boosted her popularity enough to win her the election. Thatcher’s free market reforms were thus allowed to continue. She next targeted some of the U.K.’s biggest and most wasteful nationalized industries for privatization. The state-run coal mines were her biggest challenge because of the powerful miners union. In spite of their strong protests, Thatcher was able to push through reforms that cut government subsidies for their operations and that destroyed the union’s power. Once exposed to market forces, the British coal mines quickly went out of business and British energy companies started buying much cheaper coal imported from other countries. While this benefitted millions of British consumers, the small segment of the British population that depended upon coal mining for jobs was very hard-hit. Entire towns that existed solely thanks to work at nearby coal mines were essentially destroyed as everyone lost their jobs. The social fabric of these towns was destroyed as people either moved out or just got on welfare and stayed. Crime and substance abuse all increased, and the unemployment-driven depopulation of the towns produced whole streets of abandoned, blighted buildings and houses. This experience typifies the reality of globalism and freer trade, in which liberalized economic policies benefit the vast majority of people in a country a small amount each, a small percent of the people are badly hurt, and the net GDP change to the country is positive. During the 1980’s, the Labour party was forced to moderate and to drop its more hardline socialist stances. The contemporary nature of Reagan’s and Thatcher’s terms in office was critical for restoring the credibility of the free market. When the rest of the world observed simultaneously economic improvements in both countries thanks to the same sorts of policies, more countries started considering the abandonment of Keynesianism. This set the stage for major global economic changes in the 1990’s.
Episode 2: The Agony of Reform After the Bolshevik Revolution, Russia became the world’s first Communist country and became known as the USSR (the Union of Soviet Socialist Republics—“Soviet” is the Russian word for “Council”). For the next several decades, the country seemed to enjoy highly impressive levels of economic growth and development. Noteworthy was the fact that the USSR continued growing and experiencing low unemployment rates even during the Great Depression. In the early 20th century, the numbers seemed to support the conclusion that Capitalism was destined to fail and Communism was superior and would inevitably spread across the world. However, even from the start, Communism never worked as well as most people believed. The USSR systematically lied about the size and performance of its economy, as just one example, by exaggerating the amount of steel it produced in a given year. The dictatorial Soviet government also maintained very tight control over its borders, of the movement of people within the country, and of the media. Because of this, foreigners were only let into the USSR in small numbers and were only allowed to visit the small parts of the country that were well-developed *“Potemkin Village”+. All visitors to the Soviet Union therefore left with skewed impressions of how advanced the country was, which they in turn reported to other people in their home countries, spreading the falsehood. Outsiders never saw the other 90% of the USSR, which was underdeveloped and marginally productive. The government also made it nearly impossible for Soviet citizens to ever leave the country except perhaps to visit other Communist countries, which prevented the people of the USSR from figuring out that standards of living were far superior in Capitalist countries. Foreign news and entertainment were blocked within the USSR, and all media were state-run, which meant Soviet citizens were always told that their country was the best in every way. As a result, they had no idea how bad their lives were and how much better things could be without Communism. Another key element to the Soviet Union’s early economic success was the widespread use of prison slave labor. At any given time, millions of people were in Soviet prison camps where they were forced to work under threat of grave physical punishment or death. Even an inherently inefficient economic system like Communism can be productive given enough manpower and brute force, and that’s exactly what happened. The Soviet government of course kept its dependence upon prison labor secret from the rest of the world, which gave the false impression that Communism was efficient. The Communist countries blocked almost all trade with Capitalist countries and tried to be selfsufficient. However, given the inherent shortcomings of the Communist system and the failure of Communism to take hold in parts of the world geographically encompassing key resources, it became necessary to trade more and more with the Capitalists, including the U.S. For many Communist ideologues, this was humiliating. After the death of Josef Stalin in 1953, the Soviet Union started “mellowing out” in many ways: The level of government-sponsored brutality and the size of the prison population both declined. The slow trends continued up to the end of the Cold War in 1991. The relaxing of Communism’s iron fist was ultimately to prove its undoing: Without the assistance of mass amounts of slave labor and without threat of brutal punishment, Soviet workers became highly unproductive (i.e. - large amounts of time spent doing nothing at work, or small amounts of goods/services produced per hour of labor). The lack of market signals simply did not provide the proper incentives to Soviet workers and firms, which seriously undermined their ability to innovate and produce. [More and more, Communist firms had to resort to copying Western products—including military hardware—in order to stay somewhat competitive. This practice became increasingly pervasive as the Cold War dragged on and the Communists fell behind.]
The arms race with the U.S., other Western countries, and China also severely drained the Eastern Bloc’s resources (by the 1980’s, the USSR was spending almost 1/3 of its GDP on defense, while the U.S. could sustain an equivalent military using less than 10% of its GDP). The size of the USSR’s economy peaked in the 1970’s before actually shrinking in the 1980’s. The same thing happened in the Communist countries of Eastern Europe. There were goods shortages—including shortages of basic foods—across the Communist world that impacted the daily lives of normal people. The problems became too big to hide from the outside, and the rest of the world began seeing at last that Communism didn’t work. Simultaneously, the Eastern Bloc started allowing more freedom for their citizens. At last able to see what things were like in Capitalist countries and to speak their minds at home, average people in Communist countries began expressing their frustration at the shortcomings of their own economic system and at their lack of civil liberties. Reform-minded political groups formed against Communism. By the 1980’s, the USSR’s leadership (Gorbachev) had “gone soft” and did not violently crack down to stop the protesters and reformists as it would have done in years past. Once people living in Communist countries realized this and saw that they at last had a chance to win against their own governments, in various ways they arose to disband the Communist regimes. The Cold War ended with Communism being discredited as a viable social, political and economic system. After gaining its independence, the Indian government decided to adopt a Soviet-style economy in which all major firms would be state-owned and production would be centrally planned. As happened in Communist countries, the Indian bureaucracy expanded to a colossal size in order to manage and run the country’s economy. Rules governing business and trade multiplied to unmanageable proportions. Starting an independent business—even a simple neighborhood shop—became nearly impossible thanks to extreme government regulations. The government-run firms were very inefficient at producing goods and services and at innovating, and as a result, economic growth slowed to a crawl. The Indian government protected national firms from foreign competition by banning the import of goods made outside the country (protectionist trade measures). Indian consumers were thus forced to deal with decrepit Indian businesses and to pay high prices for everything. A large and complex black market arose in India as illegal private businesses sprang up to bypass the government red tape and meet the actual economic demand from consumers. Goods were also secretly and illegal imported. Corruption became commonplace inside the Indian bureaucracy as people engaging in these illegal business activities had to routinely bribe government officials at all levels to keep their operations from being shut down. After WWII, many Latin American countries used “Dependency Theory” to guide their economic policies: They wanted to modernize by building up indigenous key industries through a combination of government subsidies and trade barriers to block competing imports until the key industries were strong enough. Though it made some sense on paper, the strategy was a disaster in practice. Salvador Allende was a very important 20th century Latin American political figure. A socialist, he became president of Chile in 1970 and passed many socialist reforms. A highly polarizing figure who was both hated and loved by large segments of the population from the beginning, his domestic opposition only grew as the reforms almost destroyed Chile’s economy. In 1973, Allende was killed during an American-backed coup in which Chile’s military took over the government. General Agosto Pinochet became the country’s new leader. Pinochet’s economic advisers had studied at the University of Chicago and were pro-free market. They undid Allende’s policies, lowering taxes, eliminating trade barriers, eliminating price controls, and cutting domestic social benefits. These measures were part of the so-called “Washington Consensus”: A battery of free market policies championed by the U.S. as the way to prosperity.
As a result, Chile’s economy quickly rebounded and is now one of the strongest in Latin America. However, while the country’s overall GDP grew, the level of wealth disparity between the poor and rich also grew and some poor people’s lives actually got worse. Also, while Pinochet stabilized and strengthened his country’s economy and ended the political chaos, he was still a dictator who used his security force to oppress and kill thousands of people. His legacy as leader is therefore decidedly mixed. No other South American countries wanted to copy Chile because they didn’t want to be seen as emulating anything related to a strongman like Pinochet. During the 1970’s, the USSR’s economy peaked in size. The rest of the world didn’t realize this because high global oil prices continued to propel the Soviet Union’s GDP upward. However, once oil prices collapsed in the early 1980’s, the stagnation in the Soviet economy was laid bare for all to see, and the country entered into a terminal crisis. Faced with major problems, the USSR’s leadership made Gorbachev—a widely known reformer—its leader in the hopes that he could make the right changes to save the country. Gorbachev never wanted the USSR to fall apart into several smaller countries, nor did he want to end Communist rule over the USSR or see Russia fall into social and political chaos. He wanted to restore the USSR and the Communist system to strength. Problematically, he didn’t know exactly how to do this, nor was he able to predict how making the USSR a freer, less heavyhanded country would lead to the rapid implosion of Communism. One of his important reform campaigns was “Perestroika” (“restructuring”). There was an important economic dimension to Perestroika that eased state control over the economy and allowed low levels of private enterprise for the first time since the 1920’s. Gorbachev admitted that it would take a generation to rebuild the market mentality of Soviet people. In Poland, Lech Walesa and the country’s biggest workers union—the Solidarity Union—turned against the Communist government thanks to major economic problems. Walesa was imprisoned by authorities fearful of losing control of the country. During an official state visit to Poland, Margaret Thatcher visited Walesa, who was under house arrest. This act greatly encouraged and emboldened anticommunists in the country. During the 1980’s, Bolivia was in freefall: Coups happened with unbelievable frequency and the country was experiencing hyperinflation as bad as Weimar Germany. The root of the problem was the government running massive deficits and just printing more money to pay its expenses. Harvard economist Jeffrey Sachs advised the Bolivian government starting in 1985 to make a series of major policy reforms to solve the problems that together would constitute economic “shock therapy.” They would reverse the economic policies that grew out of Dependency Theory. The Bolivian government agreed to make the tough choices and to put Sachs’ advice into practice. There were immediate, harsh price spikes, but the economy quickly stabilized. Bolivia did this while under a democratic government, restoring credibility to a set of policies that had previously been sullied through association with Pinochet. Other Latin American countries began to copy it. Shortly after the Solidarity political party won Poland’s first free elections, Sachs advised the new government on how to dismantle Communism and to rebuild the free market there. Poland tried shock therapy as well. Again, there were immediate price spikes for all types of goods across the country. Within days, open-air markets spontaneously materialized everywhere and prices began to drop. Next, the Solidarity government went about privatizing the huge government-owned firms (under Communism, the “means of production” had been owned by the state). Shielded from competition and numb to market signals, these companies were inefficient and wasteful. Once under private management, thousands of workers were quickly laid off to save money. This led to many big strikes against the government and widespread erosion of support for Solidarity among the working classes. 7
Once again, the shift to Capitalism benefitted Poland overall, but some small groups were made much worse off. Small business exploded in the country but employment in heavy industries contracted. Under Mao Zedong, China had a more purely Communist economy that was driven more by ideology than pragmatism. Mao considered the USSR and most of Eastern Europe to be different from China because they weren’t Communist enough, and he hated them for it. Thanks to Mao, China’s economy remained backward and grew very slowly. After he died in 1976, Deng Xiaopeng became the country’s leader and made the monumental decision to reverse Mao’s failed economic policies and to promote a market-oriented economic strategy (called “Market Socialism”) that was actually much less Communist than the USSR. Deng had observed the stunning economic success of “Asian Tiger” countries like Japan, Singapore and Hong Kong, and he saw that their economic model was clearly superior to Mao’s. In essence, Deng decided to slowly abandon most of the economic elements of Communism while keeping the Communist party in political control of the country. Gorbachev met with Deng several times and considered adopting China’s dichotomous economic/political model, but the economic policies simply couldn’t work in the USSR: Though second place to the U.S. and other Western countries, the Soviet Union was still a highly developed nation whose economy was based around massive, state-owned industrial enterprises. Eighty percent of Soviets lived in cities. A huge “system” of sorts had been built around Communism in the USSR, and changing to Capitalism was impossible without a level of difficulty that Gorbachev considered unbearable. “Shock Doctrine” in the USSR would be even worse than it had been in Eastern Europe. China, on the other hand, was still an undeveloped country where most people were very poor and lived and worked on small farms and there were few factories. The Chinese therefore were closer to a tabula rasa economic condition, so making pro-market economic reforms didn’t entail mass disruptions since there didn’t yet exist anything to disrupt. Shock Doctrine wasn’t needed in China, and the country had the critical luxury of time to change its economy. The Soviets didn’t have that. The Soviet Union collapsed on Christmas Day, 1991, and Gorbachev’s position as leader of the USSR vanished. The USSR disintegrated into several smaller countries, the biggest of which was Russia. Different Eastern Bloc countries handled the transition to democracy better than others. Russia’s experience was particularly traumatic because, even after democracy came, the Communist Party remained a powerful influence in the legislature and bureaucracy. They opposed Boris Yeltsin’s promarket reforms at every step, which prolonged the country’s agony. By contrast, other countries like Poland totally forsake Communism and enjoyed much easier transitions. Under Yeltsin, Yegor Gaidar was Russia’s prime minister during the early post-USSR period and, against strong Communist opposition, implemented many elements of economic Shock Therapy. Predictably, this led to large price spikes for all types of goods. Problems were made worse by the policies of the Russian central bank. Gaidar was forced out of his office by Communists. India’s experiment with central planning ended in failure: By 1990, the country had zero annual GDP growth and was facing bankruptcy. The other Asian countries that had gained independence around the same time as India but which had instead embraced Capitalism were now dramatically richer and more advanced than India. The collapse of the USSR dealt the final blow to central planning’s credibility. The government was forced to enact radical reforms that opened India’s economy. As a result, economic growth began again. Yeltsin, who was Russia’s first democratically elected president — first tried to privatize Russia’s Sovietholdover state-owned enterprises by giving all Russian citizens stock shares in them, and then allowing them to trade shares in a new stock market,. In what would later be viewed as a highly corrupt move, Yeltsin then sold off many other core state industries worth billions of dollars apiece to wealthy, well-connected insiders who went on to become Russia’s infamous Oligarchs. In return, they agreed to give him large amounts of campaign funds for his
1996 reelection, which he won. The privatization of the state firms was also a calculated move that damaged Russia’s Communist party. While Yeltsin’s actions are widely criticized, especially by Russians, the truth is that such corrupt government dealings didn’t start under Yeltsin or only once democracy came to Russia: The government had been incredibly corrupt during Soviet times and insider dealing at the highest levels had long been the norm. Moreover, had Yeltsin not privatized the state-run firms and gotten the support of the oligarchs, he would have probably lost the election and the Communists would have re-taken control over Russia, which could have been horrible. The alternative therefore could have been much worse. [Like Carter, Yeltsin had the misfortune of being in charge of a country during a very bad time in which the only way out was to make choices that he knew would be highly unpopular, and in which the possible choices were never “good,” just “bad” or “less bad.”+ Vladimir Putin became Russia’s president in 2000 and gained widespread popular support for fighting against the oligarchs. The end of Communism marked the start of the Era of Globalization.
Episode 3: The New Rules of the Game In 1992, things looked bad for the U.S. economy: Western Europe was coalescing into a powerful economic bloc (the European Union) to compete with America, Japan’s economy was unstoppable, and the U.S. was in the worst recession in decades. The North American Free Trade Agreement (NAFTA) was a trade agreement between the U.S., Canada and Mexico that lowered (but did not eliminate) many trade barriers between the three countries. In large part, Bush wanted to get NAFTA approved to strengthen the U.S. economy against Japan and Europe. The negotiations for NAFTA began under his term. NAFTA became an issue during the 1992 elections. Bush wanted NAFTA 100%, Perot wanted it cancelled, and Clinton wanted NAFTA, but with important amendments added to force Mexico to raise labor and pollution standards so they would have to compete on more even footing with American workers. Clinton won, and his plan was put into action. In the race, the labor unions gave Bill Clinton the support he needed to win. NAFTA led to a huge increase in the amount of trade between the three countries. Moreover, each country had significant GDP growth that was directly attributable to the freer trade. [The biggest winner was Mexico, which saw its wealth and employment improve by the largest percentage. Mexico remains the most vocal proponent of further North American integration since it has the most to gain] The impact on the U.S. mirrored past cases explored in this documentary: 400,000 American jobs were lost to more competitive workers and factories south of the border, American unions sustained major and lasting damage to their political influence and membership, and the gap between rich and poor Americans grew wider. As in previous cases, deregulation and freer trade benefitted a whole economy in aggregate while severely hurting a small percentage of people and massively benefitting some companies (and their owners) that are able to take advantage of the new trade policies. In the global economy, annual trade in tangible goods and services is worth $8 trillion while trade in currencies (which is entirely electronic) is worth $288 trillion. The vast majority of economic activity is thus intangible. U.S. workers—in both public and private sectors—have trillions of dollars invested in work-related retirement funds. The experts who manage these funds are enormously powerful. A large portion of American workers’ pensions are invested overseas. Thus, most American workers are significantly (if unwittingly) invested in the global economy. After NAFTA, Clinton pursued other important trade liberalization policies across the world. One of his major accomplishments was strengthening the global free market in the aftermath of Communism’s collapse. In 1994, Mexico faced political and economic crisis, and the country came to the brink of defaulting on its foreign debt. There was real fear that the country, left to its own devices, could fall into chaos, and millions of refugees would head north into the U.S. Clinton had crisis meetings with his advisors over the issue and decided to give Mexico a $50 billion loan. It worked to stabilize the country, Mexico repaid the money ahead of schedule, and the U.S. looked like a benevolent actor to the world. However, many critics considered Clinton’s actions to be a prime example of moral hazard: By bailing out the Mexican government, the U.S. was in essence bailing out thousands of private investors who had put money into the country without properly weighing the risks. The bailout signaled the private sector that it could make similarly bad future investment choices without fear since the U.S. would again rescue them. Critics feared this would make sovereign debt crises more likely. “Globalization” is defined as the free flow of goods, services, capital, and labor across national borders. China has a number of “Free Trade Zones,” which are small geographic areas in which companies can build factories to build and export anything with very few restrictions. The Zones are exempt from
China’s otherwise strict business and export laws. Seaports and airports are usually located very close to or within Free Trade Zones. At long last, Japan’s economic bubble burst in the 1990’s and the country slid into a major recession that it never really recovered from. American fears of Japan someday “taking over” the world economically were quickly and permanently dispelled. Japan really has two economies: Export sector – Dominated by big firms like Toyota, Sony and Canon that are highly competitive and efficient and focused on international markets. Domestic sector – Dominated by many small, inefficient, often “mom-and-pop” businesses that aren’t very profitable. Many Japanese are employed in the second area, and they add little to GDP. Moreover, Japan also has a very large and wasteful bureaucracy that has resisted attempts at reform, as well as an overly generous social safety net that, thanks to the aging of the population, badly strains GDP. The growing drains on the Japanese economy reached the tipping point starting in the 1990’s. But during the 1990’s, less-developed Asian economies boomed. Then, the Asian Financial Meltdown occurred: The crisis began in Thailand. During the 1990’s, the government promoted globalism by easing restrictions on foreign capital. Western banks responded by investing massive amounts of money in Thailand. There was a rush to get into the Thai market before competing Western investors bought up all the best deals. In the hurry, the foreign banks failed to do their due diligence and did not research the investments enough. In reality, Thailand had bad business laws and banking regulations (many of the basics of the investment were not sound). *The inflows of foreign money into Thailand accelerated as Japan’s economy tanked. Good investors are mobile and quickly move their money from country to country in search of the highest returns.] One area of the Thai economy that received massive amounts of foreign investment was luxury housing. The number of units constructed quickly outstripped the demand, producing an obvious residential real estate bubble. Like China, Thailand had a fixed exchange rate, which meant the government had to keep large amounts of foreign currency in its possession to “defend” the exchange rate. At the first sign of economic trouble in 1997, some foreign investors began selling off their investments in Thailand and taking their payment in more stable foreign currencies (mainly U.S. dollars). This depleted Thailand’s foreign currency reserves to the point that it was forced to devalue its own currency. This in turn triggered major problems. The devaluation of the Thai baht made Thai exports very cheap but imports very expensive. This hurt millions of average Thai people who relied upon imported foods and products to get by each day. The cost of living thus increased greatly in a short period. The IMF gave Thailand a bailout package, but it didn’t solve the problem. Unlike in Mexico, the U.S. didn’t intervene. International investors saw similarities between Thailand and several other East Asian countries like Indonesia and South Korea. Western banks had also injected huge amounts of capital into those countries without adequately understanding the risks and local laws. In reality, each country was unique and some were fine. Nevertheless, panic ensued as investors rushed to get their money out before these other countries experienced Thai-style meltdowns. The actions of
the investors, of course, led to a self-fulfilling prophecy since the Asian countries needed foreign finance to remain stable. More than $100 billion was quickly divested from East Asia. The IMF (which was dominated by wealthy Western countries and the U.S. in particular) responded with many loans to East Asian countries, but they came with tough conditions requiring many reforms to banking and finance laws. This humiliated many Asian nationalists and was characterized as a modern incarnation of European colonialism. South Korea was the biggest shock: Considered a powerful, advanced economy that was much different from countries like Thailand, it needed a $55 billion IMF loan to survive the crisis. Many of the foreign investors moved their money into Russia, which was seen as a healthy economy and a sound alternative. Unfortunately, Russia defaulted on its debt in 1998 and its stock market quickly crashed. The Asian Contagion spread across the world but petered out as time passed and as new laws and regulations were emplaced in various countries to shore up investor confidence. The derided IMF-mandated reforms actually made the Asian countries stronger and less vulnerable to future crashes. The Logic of Collective Action (1965) was an important economic study that, among other things, concluded that small groups of people with a strong, shared incentive can have an outsize influence on policymaking in a democracy, even if it disadvantages the country as a whole. This has an important application to economic policy: As has been repeatedly shown, globalization always benefits countries as a whole but also always creates great hardships for small groups that can’t withstand international competition. These small groups tend to be highly vocal and highly visible, and they are very effective at rallying support for protectionist, anti-globalist laws. [NAFTA, for example, helped the U.S. economy as a whole, and hundreds of millions of American consumers benefitted a little bit through being able to buy the same quality products at lower prices once the factories making them were relocated to Mexico. The small amount of per person costs savings multiplied by so many millions of people equaled billions of dollars in benefits to the U.S. economy. However, since the per capita benefit was so small, few Americans who gained from NAFTA were passionate about the benefits of free trade. On the other hand, the losers under NAFTA (the 400,000 Americans who lost their jobs) lost almost everything. Even if their summed economic loss is far less than the summed economic gains everyone else experienced thanks to NAFTA, the losers will understandably be more passionate and more likely to demand government action against free trade laws. Often, and in spite of their relatively small numbers, they will get their way. ] [The U.S. still has a colossal number of byzantine trade impediments that such groups have managed to have written into law (textile import laws are a notorious example). The U.S. does not practice truly “free” trade with anyone.+ The anti-globalist, anti-free-trade movement first became big in the 1990’s. Their presence was shown to the world in spectacular fashion during the 1999 WTO conference in Seattle. [Human beings have existed for about 150,000 years. For the vast majority of that period, humans lived in small tribes where everyone looked the same, everyone knew each other, everyone spoke the same language, there were no wealth disparities, and no one had any idea what was happening elsewhere in the world. Humans evolved over thousands of years to suit this type of existence. Only very recently has technology and trade changed our way of living.] The concept of a “wealth divide” and especially of a “global wealth divide” is very new, and it poses new challenges we are still trying to address. Capitalism only works if the right laws are in place to promote cooperation and trust. A strong government with the right policies is therefore necessary to promoting economic activity. This is why so many Third World countries have bad economies even though they are ostensibly “Capitalist”: The government has not created the right institutions or environment to support Capitalism. 12
A failure to legally define property rights is a common and highly damaging problem in Third World countries. In many poor countries, huge tracts of land are owned by rich people, companies, or the government, even if the land isn’t being put to use, and in some cases, the government doesn’t have clear records showing who owns what piece of land. Masses of people (usually poor) end up living on the land anyway and building houses, but since they don’t officially own their homes or any piece of land, they don’t have collateral for loans or credit. Without loans or credit, these people can never get enough money to get out of poverty, and they can’t take advantage of the Capitalist system. Rich countries should help poor countries to eradicate poverty because extreme poverty and the poor’s anger over wealth disparities can lead to social and political instability, which in turn breeds international violence that hurts rich and poor countries alike.