Abstract
Globalisation and free trade have come under pressure, and nationalism is on the rise. Responding to this mélange, this thought-provoking book argues that the origin lies in rising intra-country inequality and the structure of international finance, and not in competing interests between countries. To balance trade and avoid war, the authors call for reducing inequality and creating an international reserve currency.
The epigraph from John A. Hobson’s 1902 study of imperialism properly sets the stage for this book. He argued that rising inequality in Europe caused nationalism and resulted in financial follies in the colonies and wars. Klein and Pettis have observed the occurrence of similar processes globally since the 1970s, and their book cogently explores how seemingly imbalanced national trends have systemic, international effects. The analysis frequently describes how these processes show up in national accounts, or how, for example, trade in intangibles changes the interpretation of current account data.
The first chapter engages with Alexander Hamilton’s and Friedrich List’s notions of a developmental state. They argued that free trade would inhibit the USA’s development, disagreeing with their contemporary David Ricardo who argued that due to investors’ unwillingness to invest money abroad, trade imbalances would mainly cause price-level adjustments, and that this would ensure that initial relations of absolute advantage would relatively quickly turn into mutually beneficial trade governed by comparative advantage. Disputing Ricardo’s assumptions, Klein and Pettis argue that since the nineteenth century, cross-border financial claims have in fact increasingly shaped trade. Today, these claims stand at four times the size of global output. They argue that bilateral trade data is misleading if we are to understand this complex system, for example because multiple border crossings inflate the data and, for purposes of tax avoidance, profits show up as FDI income. Thus, they prefer considering overall current accounts.
The second chapter argues that cyclical, speculative financial flows have shaped trade and global growth. It describes nine cycles between the 1820s and 1990s in which large savings accumulating in financial centres led to credit flows to the peripheries. The authors argue that throughout history, large and sudden monetary flows have had disastrous effects on any country: the resulting asset inflation, investment bubbles, and rising aggregate demand in the peripheries created demand for goods from the financial centres. Yet, upon each stock market crash, financial capital left the peripheries with contractionary economic effects.
To buttress this claim, the third chapter discusses how high savings in one country can lead to such imbalanced processes by drawing on two ideal typical models with which the authors explain how savings can turn into investment: the ‘high savings’ model (i.e., low consumption) uses government coercion to create investment, either via a social contract as in Japan or unwillingly as during the Soviet Union’s collectivisation and farmer subjugation. The early USA, the authors claim, followed the ‘high-wages model’, in which high aggregate demand creates profit expectations and, thus, incentivises savings. Yet, they do not explore to what degree the Southern slave economy and the colonial dispossession—which only seems to be mentioned with the term ‘abundant land’ (p. 70)—was a high-saving model, subsidising the income of the White population. A closer look at the literature on imperialism would have allowed the authors to fill this lacuna and discuss to what degree dispossession is relevant for understanding even the high-wage model and the development of different varieties of capitalism.
In any case, Klein and Pettis argue that since the 1970s, the world has moved towards a high-savings model. At the global level, they see a higher availability of financial capital coinciding with higher rates of under- and unemployment, a stagnant rate of global investment, and a stagnation or fall in most workers’ share of global GDP. They state that this increased inequality has depressed global demand and explains why higher business savings translated to increased stock buybacks rather than investment. They propose that in this global system, an individual country’s current account deficit is insufficient to decide whether that country attempts to pull in money or not, but that rising interest rates hint at a pull.
The second part of the book focuses on applying these insights to global trade imbalances today. The fourth and fifth chapters discuss intra-country inequality and its trade effects for the two largest current account surplus countries, that is, China and Germany. The sixth chapter discusses these surpluses’ effects on the USA’s current account. Both China and Germany are described as suppressing wage growth relative to GDP, leading to production outpacing consumption. This internal imbalance shows up in their large trade surpluses, with the accounting flipside of high savings resulting in financial outflows. Yet, in parallel to the financial cycles theory, both China and Germany are described as suffering from bad investment decisions during the past decade: China’s ballooning debt-to-GDP ratio is assessed to be closer to 300% compared to the official 250% coinciding with a drastically fallen investment quality. They describe ‘Made in China 2025’ as import substitution—which China can achieve without WTO-infringing tariffs by commanding companies to prefer Chinese—and the Belt and Road Initiative (BRI) as an only partially successful attempt at increasing demand for Chinese products in developing countries. It would have been interesting to have an in-depth discussion on the Chinese government’s perception of international debates on this topic and their role in international governance.
For Germany, like China, the authors argue that low wages and high savings led to underconsumption, a large current account surplus, and high investments abroad. They write that between 1992 and 2017, since Germany’s reunification, real wages and disposable income fell for most German workers. Though the average German is far richer than most Europeans, Pettis and Klein state that in 2017, the median household’s net wealth was comparable to a Greek or Polish household. Blamed for this are primarily regressive taxation reforms and a strong focus on balanced budgets, coinciding with consistently negative infrastructure investment net of depreciation since 1988. Large savings are the flip side of this inequality. And these savings are described as having fueled the Euro crisis through a large lending growth between 2002 and 2008 to foreign markets and higher-risk investments in which even the primarily local Landesbanken strongly participated, ultimately leading to large investment losses. However, in reaction to the Euro crisis, Germany did not increase its wages and government spending to increase internal demand and balance intra-European trade; rather, the European Fiscal Compact of 2012 has essentially exported the German Schuldenbremse (‘debt brake’) to Europe as a whole: they write that the European ‘crisis countries’ had to contract their government spending drastically, implenting regressive taxation reforms, reducing corporate and wealth taxes, and that the resulting fall in aggregate demand reduced imports. In Italy, for example, real consumption and investment were still 8% lower in 2019 than in 2008. The chapter argues that this contraction moved the Eurozone from a balanced current account with the world before 2008 to an external surplus of about 4% of the bloc’s GDP in 2019. As with China’s surplus, this has effects on the international level.
The sixth chapter sets out to solve the puzzle why, contrary to the above examples, the USA’s rise in inequality has not led to a trade surplus. They reject the explanation that trade deficits stem from government deficits by pointing out that the private and public current account contributions mirror each other almost perfectly; instead, they argue, the USA’s current account deficit is due to the USA’s exorbitant privilege of issuing the world’s reserve currency. They propose two main factors for the increase of globally held US reserve assets between 1997 and 2019 from roughly USD1–USD8 trillion: the fate of the countries gripped by the Asian Financial Crisis reduced trust in international financial governance, and to insure against large, sudden financial outflows, developing countries have been buying large quantities of US assets. Secondly and more recently, oil exporters and Europe have bought large volumes of US assets. These inflows, they argue, consistently depressed the USA’s interest and savings rates, raised the dollar’s value, and fuelled asset bubbles (including the subprime mortgage crisis), all of which reinforced deindustrialisation. This analysis supports Klein and Pettis’ argument that there is a considerable tension between the dollar’s monetary policy requirements for the international economic system and for the USA: to support growth, the international economic system needs a rise in the amount of dollars far beyond sensible levels for internal US policy. This ‘Triffin-dilemma’, they write, has decidedly turned the exorbitant privilege into a burden for the USA.
To reduce persistent current account imbalances and to avoid trade wars, they propose to reduce intra-country inequality in surplus countries to increase local demand and (especially green) investment, and to free the world from the disturbing effects of the Triffin dilemma, they refloat Keynes’ idea of the Bancor, an international unit of account not bound to any nation, embedded in a system limiting large Bancor accumulation (to incentivise internal reductions in trade imbalances for surplus countries).
This is a cogently written book, forcefully arguing that rising inequality leads to persistent trade imbalances and economic disturbances. They base their argument on Hobson’s theory of imperialism and underconsumption which influenced both Lenin and Keynes in their understanding of the First World War and its aftermath. Yet, the imputed connection to nationalism, imperialism, and the connections between different capitalisms and dispossession remain underdeveloped. Still, their main argument stands on a lucid and detailed discussion of pertinent global patterns of trade and finance, and the book’s epigraph forcefully underlines their warning that without reducing inequality, we might again hurtle towards global war. The current pandemic’s impact on inequality has only raised the importance of this book since its publication, and, as an addition to the discussions over a just transition in relation to the ecological crises, Pettis’ and Klein’s insights into global economic governance are a welcome and important contribution.