Falling Behind: Globalization and Its Discontents

For the first time in history, a genuinely global economic system has come into being with prospects of heretofore unimagined well-being. At the same time - paradoxically - the process of globalization tempts a nationalism that threatens its fulfillment.

The basic premise of globalization is that competition will sort out the most efficient, a process that, by definition, involves winners and losers. If there are perennial losers, they will turn to their familiar political institutions for relief. They will not be mollified by the valid proposition that the benefits of global growth far outstrip its costs.

Moreover, to remain competitive, many countries are obliged to abridge their social legislation - a task bound to generate domestic protests. In periods of economic distress, these trends are magnified. The debate over trade policy in the U.S. presidential campaign is a case in point.

In industrialized countries, globalization impacts domestic politics in two ways: Improved productivity generates the paradox of enhanced well-being, accompanied by higher unemployment. At the same time, there occurs a migration away from menial jobs, which are then filled by workers from abroad. A clash of cultures and a nationalism advocating exclusion develop. Variations of protectionism thereby acquire a domestic base.

That trend takes place even within the productive sector of the industrialized world. Connected by the Internet to similar industrial and financial institutions around the world, transnational enterprises operate in the global marketplace served by staffs that often have longer tenure than those of governments and fewer restrictions on their analyses.

Enterprises that remain dependent on the national economy generally do not have the same opportunities. On the whole, they employ the labor force with the lowest wages and bleakest prospects. They tend to rely on more limited markets and on national political processes. The transnational companies advocate free trade and free movement of capital; the national companies (and trade unions) often push for protectionism.

Economic crises obviously magnify these tendencies. And the globalized financial system has produced periodic crises almost as predictably as its sustained growth: in Latin America in the 1980s, in Mexico in 1994, in Asia in 1997, in Russia in 1998, in the United States in 2001 and then again starting in 2007.

While each crisis had a different trigger, their common features have been profligate speculation and systemic under-appreciation of risk.

With each decade, the role of speculative capital has magnified. For speculative capital, nimbleness is the essential attribute. Rushing in when it sees an opportunity and heading for the exit at the first sign of trouble, speculative capital has too often turned upswings into bubbles and downward cycles into crises.

The strategic impact of globalization raises perhaps the most important issues on two levels: Are there industries indispensable for national security in which foreign investment should be limited or even precluded? Second, what industries must be kept from collapsing to maintain America's defense capability? The answers to these questions clearly lend themselves to abuse. But this is not an excuse for avoiding what the national interest dictates must be faced.

The international system thus faces a paradox. Its prosperity is dependent on the success of globalization, but that process produces a dialectic that can work counter to its aspiration. The managers of globalization have few occasions to manage its political processes. The managers of the political process have incentives not necessarily congruent with the economic managers. This gap must be eliminated or at least narrowed.

As a start, I offer the following prescriptives:

The first imperative is to recognize that these problems are the blemishes of great success. Debate about shortcomings of the process should not degenerate into attacks on its basic conceptual framework, as has happened too frequently in the U.S. presidential campaign. Political leaders must avoid - not encourage - the protectionism that led to disaster in the 1930s.

The parameters of the national security limits to globalization should be established on a national basis rather than left to pressure groups, lobbyists and electoral politics. In the United States, the next administration should establish a bipartisan commission at the highest level to study what constitutes an indispensable strategic U.S. industrial and technological base and the measures to preserve it. High among its priorities must be a hard look at an educational system that creates too few engineers and technologists in comparison with our competitors. The criterion should be what is essential for national security, not to shield enterprises from the competition essential for global growth. That line will not be easy to draw, and the effort risks political manipulation. But the problem will not go away and at some point will become unmanageable.

International economic institutions need to be made relevant to current challenges. The annual Group of Eight summit originated in 1975 as a meeting of six industrial democracies to chart their economic and social futures during the first energy crisis. (Canada was added in 1976; Russia in 1998.)

At the first meeting in Rambouillet, France, each country was allowed only three participants, including the president, to facilitate frank discussion. Since then, the meetings have degenerated into large assemblies serving essentially political functions.

They should be restored to their original purpose, devoted primarily to issues affecting the long-term health of the global economy, including giving opportunities to societies that have been left behind to participate in global growth. In that process, India, China and potentially Brazil should be included.

The original Group of Seven industrial democracies should continue to meet at the level of finance ministers during the G-8 meetings. This G-7 should be charged, above all, with addressing the domestic and social distortions caused by globalization.

The International Monetary Fund as presently constituted is an anachronism. It has been a bystander in the financial crises of the 21st century, which have been produced by practices within the private sectors. The IMF has sought to adapt, but too slowly; it needs to be reformed.

The lending practices that produced the U.S. economic crisis require urgent attention and greater international cooperation. Profligate and obscurantist practices were evident long before the crisis struck. They were made possible by the invention of financial instruments that encouraged speculation while obscuring the nature of obligations. In the subprime mortgage debacle, lenders lost the ability to estimate the extent of their obligations and the indebted to understand the implications of their commitments.

Moral hazard needs to be faced. There is an inherent contradiction when financial entities are permitted to reap extraordinary profits and manage vast assets and then, when conditions change, are declared too large to be permitted to fail, requiring taxpayer bailouts. Financial institutions, whether investment banks or hedge funds, need oversight in a way that protects the taxpayer's interest.

In sum, if the gap between the economic and political orders is not substantially narrowed, the two structures will wind up weakening each other.