International Politics and International Economics

It is with great pleasure that I accepted the invita-
tion to deliver the First Mocatta Lecture. It is not
often that I find myself before a captive audience of
economists and bankers--for reasons some of my former colleagues
consider compelling. You should understand that I do not
claim to be a technical expert on economics. My preoccupation
is with international order: what makes an international
system function, the causes of its dislocation and the
possible remedies. My theme here is that the political and
economic global systems are no longer congruent. As a
result a number of countries sufficient to upset the equili-
brium lack a consistent domestic discipline and pursue
incompatible policies and the global economic system seems
incapable of generating--indeed it does not even attempt--
a coherent strategy for overall growth.

The nineteenth century was a period of unprecedented
economic growth which produced what we now call the
"developed" world. The principal causes were a combination
of technological breakthroughs and the compatibility
between political and economic philosophies in the countries
that shaped world affairs. Governments acted on the
premise that the economic sphere was beyond its power
or even competence. The accumulation of capital was
left to the operation of the market. The mechanism of
adjustment between economies was provided by the gold
standard to which all major trading nations subscribed.
All this had the advantage of automaticity. The market
gave the signal when economic adjustment was needed; no
additional political decision was required to trigger
adjustment policies. Politicians could either accept the
gold standard or reject it. But once that decision was made,
they were forced to conform spending, taxing, and monetary
policies to its discipline.

There were of course costs, sometimes heavy human
costs. Severe unemployment and periodic deflation were
considered "natural"; the business cycle was believed
to follow laws beyond the capacity of governments to
repeal or amend. International trade was dominated by
a very few countries whose competition was more often
governed by strategic than by economic criteria. Colonial
empires provided the safety valve of assured markets and
sources of raw material.

But this combination of gold, colonialism and laissez-
faire is not the current condition. In the 19th century
the economic world order was established by a very few

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dominant countries which set the rules of the game, that is of the market. Industrialization had been invented in Great Britain which for a while had a near monopoly on the relevant technology; free trade is easy to manage for the monopolist. The circle of industrialized countries gradually expanded (initially always behind tariff walls) but the economic system remained under the control of a small group of European countries with similar political systems and economies.

Even then the dominant countries did not adjust gracefully to the emergence of rivals. At the turn of the century Britain had trouble accomodating Germany. In the 1920's and 30's when rising Italy and Japan wanted "a piece" of the action, the failure of the economic system to accommodate them contributed importantly to rampant economic nationalism. In the fifties and sixties the United States became the balance wheel of the world economic order. Backed by the industrial democracies it was strong enough to make and enforce international rules. This arrangement collapsed in the seventies under the twin blows of resurgent economic nationalism (including American) and the oil crisis.

The economic world order of the past cannot be resurrected and a new one cannot be created by the old players. Too many newcomers insist on participation. China, Brazil, India, Korea, in time Mexico and Indonesia to name just a few will insist on helping to reshape the rules which affect their economic and hence their political destiny.

The task of constructing a new international economic order is made more challenging because the most important economic powers are governed by a kind of popular democracy unknown in the 19th century. Suffrage is universal; the public insists that governments assume responsibility to alleviate suffering and to improve the quality of life, if necessary even at the cost of slowing economic growth. Few, if any, excuses are tolerated; the political landscape of the last ten years in Europe and in the United States is littered with the wreckage of governments that failed to produce economic results acceptable to the electorate--regardless of who was at fault. After the fall of the Shah triggered a new inflationary spiral, no national leader in office in a major democracy survived the next election.

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For this reason alone the present international political environment is hostile to automatic mechanisms. Unlike their 19th century counterparts office holders today are not willing to limit themselves to "on or off" decisions; they insist on controlling the economic policy levers directly in order to achieve immediate political goals.

This process puts a premium on short-term approaches; it encourages leaders to wait for crises to mature until action is unavoidable; simultaneously it tempts them to shift their economic problems to other countries for as long as possible.

The growing political nationalism runs counter to the dominant economic trends of this century. For the first time in history the world economy has become truly international. No geographic region is excluded from international commerce; each, with the possible exception of Africa, contains some major actor. But none is strong enough to impose its design. They compete through national decisions while being simultaneously linked by global markets. Not even the sharp political differences between the Soviet bloc and the West have proved an obstacle to these dominant trends. A conservative American administration has avidly encouraged Soviet grain purchases. Many European industrialists pursue in the less developed economies of the Soviet bloc the opportunity or the mirage--depending on one's point of view--of a market sheltered from Japanese and U.S. competition.

The incongruity between the internationalization of the world economy and the dogged strengthening of national autonomy in economic decision-making is the deepest cause of the gyrations of markets and exchange rates. Tax, spending, social employment, industrial and trade policies are insulated behind national borders despite the fact that such decisions have global consequences in direct proportion to the economic importance of the country involved. A case in point is the unilateral decision by the United States in 1971 to suspend the convertibility of the dollar and to impose a 10 percent surcharge. The effect was to overthrow the Bretton Woods arrangement affecting all countries--without prior consultation or notice to anyone. Comparable unilateralism has marked the Japanese restrictions on foreign investment and Europe's management of agricultural policy.

We live with the paradox of a global economy which lacks a system for setting agreed long-range goals. Automatic mechanisms to force coordinated decisions have proved politically unacceptable. But the industrial democracies have recoiled as well from the alternative

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of political coordination of fiscal and monetary policies. Forums where national economic policy makers meet exist, of course: the Bank for International Settlements, the International Monetary Fund and most dramatically the economic summits. But these occasions provide little more than an opportunity for an exchange of national views; they have not succeeded in shifting the framework of thinking and acting to a global perspective.

In recent years those charged with international monetary arrangements have tried to establish the International Monetary Fund as the global disciplinary force. The 1976 amendment of the Fund's Articles of Agreements give the IMF the authority to "promote stability by fostering orderly underlying economic and financial conditions" as well as "to seek orderly economic growth with reasonable price stability." In theory at least this implies the right to review national economic policies for their international compatibility.

This "technicians' automaticity" works better in theory than in practice. The Fund, though it may police a few troublesome cases, is far from being the governor of the general system. The U.S. and other major industrial democracies have been unwilling to modify their policies in response to IMF criticism. In fact the U.S. has been tacitly conceded a dominant role for the dollar and a disproportionate autonomy for its decisions. IMF discipline has in practice been applied primarily to those countries in economic trouble; most recently to developing countries facing a mounting burden of international debt.

In theory, of course, no mechanism such as the Fund or a commodity such as gold should be necessary. The market should be an incorruptible judge of the appropriateness of economic policies. In practice, however, the dominance of the United States in economic affairs, the imperfections of financial markets and the ability of countries to delay remedial adjustment through borrowing has meant that the market can be ignored at least for a while. To be sure the ultimate reckoning is all the more severe. But the temptation of governments to delay the bitter medicine of reform of economic policies--usually involving some contraction of non-affordable expenditures--beyond their electoral period tends to be irresistible.

In these circumstances the economic system operates--if at all--as crisis management. The risk is, of course, that some day crisis management may be inadequate. The

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world will then face a disaster its lack of foresight
has made inevitable.

The biggest politico-economic challenge to statesmen
is to integrate national policies into a global perspective,
to resolve the discordance between the international
economy and the political system based on the nation state.
The goal can be stated as simply as it is difficult
to achieve: a dynamic and free global economy which will
be sustained by key developed and developing countries
because they have a stake in it.

In what follows I will discuss this challenge in
relation to three issues: trade, exchange rates and
international debt.

Trade Policy and International Politics

According to the maxims of the prevalent trade theory,
the free exchange of goods and services potentially benefits
everybody; tariffs and other trade barriers reward ineffi-
ciency, restrict commerce and lower the overall standard
of living. The professed objective of all trading nations
is to remove political obstacles to trade and to rely on
comparative advantage. But the gap between theory and
practice is wide. Many nations, while paying lip service
to free trade, systematically impede it in practice.
Clearly important political realities are at work.

For one thing, Adam Smith and David Ricardo developed
their theories when Britain had an effective monopoly
on industrialization and a large advantage in the generation
of energy based on coal. There is no doubt that free
trade benefits a country which enjoys such a comparative
advantage. Inefficient industries are replaced by more
efficient ones within the same national borders: labor
can move, at least theoretically, from one sector to
another. Productivity, income, growth and employment
are certain to benefit--though the adjustment process
in the 19th century was never as free of friction as the
theory maintained. This state of affairs continued for
a while after other European states industrialized. Cultural
homogeneity prevented any country from achieving a unilateral
advantage and colonial empires cushioned the shock of
competition. Even with these safety valves the German-
British trade rivalry contributed to the tensions that
ultimately produced the first World War.

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In our period, the number of actors has multiplied dramatically. There are over twenty major trading nations including the traditional industrial democracies and such significant exporters as Brazil, Korea, Singapore, and Hong Kong. The wage scales and cultural background of the major trading nations and exporters are dissimilar. With the best efforts to improve productivity, some nations-- especially in Europe--will be unable to compete with substantially lower standards of living, at least in industries that are labor intensive. Thus whole sectors of industry move from one country to another, indeed from one continent to another. This compounds the congenital unemployment produced by automation and rigid management-labor practices and generates pressures for protectionism.

The maxims by which the debt crisis is being combatted also tend to inhibit free trade. A key provision of every IMF adjustment program is to limit imports and to encourage exports. But by definition it is impossible for every nation to pursue such a strategy which is in effect mercantilistic. The limitation of imports must be at somebody's expense, especially if coupled with the systematic promotion of exports. And if the strategy works developing nations are transferring real resources to the industrialized ones, the precise opposite of what is needed for global development.

Two results are probable: Either the quasi-mercantilistic structure will collapse because there is simply not enough demand to sustain the exports required by the developing world. Or these export surpluses will be sustained on a temporary basis by extremely unfavorable trade balances in a very few countries, especially by the United States. The U.S. trade deficit is officially forecast to exceed $120 billion this year--a level unimaginable until very recently. Such a situation cannot possible be maintained without causing our government to take some remedial, probably protectionist, steps which could collapse the whole fragile edifice of current international trade practices.

In short, free trade is being stifled by the same political factors which prevent automaticity as the adjustment mechanism of the economic system. The growing influence of domestic political considerations in all democratic countries threatens the open trading system as we have known it. Protectionism, trade restraint and unfair trade policies are on the march.

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A paradox follows from these considerations: for free trade to work, governments committed to it must to a degree retreat from complete laissez-faire. International rules are needed to avoid monopolies, restrict dumping, inhibit export subsidies, predatory practices and excessive uncertainties. National policies must ease the adjustment imposed by foreign competition and distribute the benefits of foreign trade equitably. Otherwise the system will not function; it will be overwhelmed by the political process.

To state these principles is to illustrate how far the national behavior of the major trading nations has strayed from them. The United States remains formally committed to free trade but it clearly lacks a coherent strategy to deal with the distortions caused by the protectionist and mercantilistic measures of other nations. Hence it is unable to insist on a coordinated policy. In practice our trade policy is a series of disconnected ad hoc decisions taken largely in response to the specific complaints of political interests most directly affected. These are by definition usually the least competitive sectors. So long as the impetus behind policy is the desire to localize the pain of a particular economic sector, the result can only by accident be the promotion of the common good of either the United States or of the world economy as a whole.

When theory and practice diverge one or the other must give way. My strong preference would be for a firmly based system of liberal free trade. But this requires a major act of international statesmanship. Specifically new and binding international rules need to be established to encourage direct foreign investment and to define codes of conduct for multinational corporations. These rules should apply as well to international trade in services and perhaps even to immigration. GATT must be revamped to bring it closer to the ideals of the International Trade Organization which was proposed by Bretton Woods but proved stillborn. It should be given greater authority to act against restraints on trade and investment as well as predatory trade practices. The newly industrialized nations, like Brazil or Mexico, should be drawn into more active participation.

But if such a policy proves unachievable it would be foolhardy to pay lip service to a theory daily rejected

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by political attempts to maximize national advantage--
in short a mercantilistic world.

Japan seems to have come to this conclusion. It
makes little pretense that its foreign economic policy
is guided by a commitment to the free play of market
forces. It is instead more or less explicitly geared
to manipulate the trade system as it really operates
to the national advantage. Japan is widely criticized
for acting counter to existing economic theory. In fact,
it is possible to argue that it is simply playing the
de facto game more systematically and with greater
coherence than anyone else.

But if we are driven to it we can play the same game,
however reluctantly, and thereby enhance our competitive
position in a world of unilateral trade practices and
bilateral agreements. We need not fear such a world;
its chief peril is if we fail to recognize its emergence.
At some point the sheer weight of the United States
managing-in cooperation with like-minded countries--
its foreign trade interests with determination and vision,
will probably convince the rest of the world--to put
it politely--of the need for more coordinated trade and
economic policies. We would then have achieved a more
coherent world trading system by the back door.

Exchange Rates and International Cooperation

Ever since the United States unilaterally abandoned
the Bretton Woods agreement in 1971 there has been a
debate about the relative merit of a floating system as
against fixed parities and at the margin even of the advantages
of a return to the gold standard. I will not enter into
the debate over the economic merit of the various schools
of thought. The original argument that the floating system
would automatically produce stability was falsified by
the oil shocks. No exchange system could have produced
stability when the price of oil quintupled with a two-year
period. But even after the oil price leveled off the floating
system has not worked as smoothly as its proponents had
predicted. Countries, it was held, would not accept an
overvalued currency because it would reduce the competitiveness
of exports or an undervalued one for fear of generating
inflationary pressures. Hence, almost like the gold standard,
the floating system was expected to force an adjustment
of irresponsible or extravagant policies nearly automatically.

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This has not happened because the impact of the market
has been partially obscured by political decisions. In
order to escape--at least for a while--the need to toughen
internal economic policies, governments often ignored
the market's warning signals and borrowed to finance current
account deficits. And countries promoting their exports
have avoided strenuous efforts to correct undervalued
exchange rates.

In a sense, of course, exchange rates tend to reflect,
not cause, domestic economic conditions. Incompatible
national economic policies inevitably lead to uneven
development and crises which will be reflected in the
constant need for exchange rate adjustments. The United
States is therefore surely right in arguing that correct
economic policies are the irreducible precondition to
exchange rate stability. Confusion and growing resentment
result however when the U.S. insists that it is the sole
judge of what is the right mix of its own economic policies
without regard to their impact on the rest of the world.

The problem becomes more acute because we have the
strength to impose our views--at least for awhile. The
dominance of the American economy explains why no matter
what the value of the dollar we are criticized for its
allegedly harmful impact on the world economy. Five years
ago at the IMF meeting in Yugoslavia the weakness of the
dollar was the dominant theme. Today the strength of our
currency is blamed for our presumed policy to use the capital
of the rest of the world to finance the deficits which stim-
ulate our economy. In the seventies the "market" belatedly
corrected the imbalance but not until the Federal Reserve
Bank pushed up interest rates. Today these same high
interest rates, coupled with the possibility of attractive
capital appreciation and political stability contribute to
exorbitant exchange rates. The strength of the American
economy is such that whatever the value of the dollar the
United States can take away with one hand what it gives with
the other. Today the growth in imports which is the con-
sequence of a high dollar is balanced by higher debt ser-
vice costs and lower commodity prices for developing countries.
Tomorrow a sharp and sustained drop in the value of the dollar
could produce--as it did in the seventies--major disruptive
effects on international trade and finance. The policy
question--unanswerable in the abstract--is whether a desirable
one-time drop in the dollar is conceivable. Or whether once
the dollar starts weakening it will be difficult to reestablish
confidence. In economics as in other fields the gods sometimes
punish humanity by fulfilling its wishes too completely.

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Three political consequences seem to me to flow
necessarily from existing arrangements:

-- One of the principal virtues of floating exchange rates--economic policy flexibility--too often has been turned into a vice. Countries have been able to support overvalued exchange rates by borrowing, or to encourage undervalued rates to foster exports. In practice, the system has allowed too much flexibility.

-- Exchange rate arrangements have been a profound source of political controversy among the industrial democracies for over a decade. The political impact of unilateral economic decisions mortgages other relationships.

-- Disagreement over exchange rates is the way underlying disagreements over broad economic policy goals and methods are made explicit. The exchange rate regime now in place tends to magnify these differences but it does not cause them.

The fundamental issue is that the international financial system cannot be sustained indefinitely by unilateral American decisions, however advantageous these might be to us in the short run. Leaders concerned with cooperative international foreign and economic policies must undertake a systematic review in order to find the basis for new, more equitable and less volatile exchange arrangements. Its test will be whether the industrial democracies are able to agree on coordinated economic policies. No international system can meet everybody's maximum demands; but it must respond to enough common aspirations so that maintaining the system seems more important to its members than insisting on any specific dissatisfaction. A system that does not meet this test--and the present system does not--is congenitally volatile.

## The Politics of International Debt

I have expressed myself on other occasions on the international debt problem--not always to the entire satisfaction of banking audiences. Let me begin by stating two propositions:

-- In the seventies neither governments nor the IMF intervened seriously in the process for recycling the huge accumulated earnings of the oil producers. The commercial banks thus played an indispensable role in cushioning the financial consequences of the sudden and dramatic rise in oil prices. Had they not done so a financial crisis would have occurred much earlier and under much worse circumstances.