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Ec1400 Review Sheet

    Alex Sloane

    Richard T. Ely LectureInternational Financial Crises: Causes, Prevention, and Cures

    by Lawrence Summers

    1) The Goal of an Efficient Global Financial System

    a. Even small increases in the efficiency with which capital is allocated have enormous social benefits

    b. International financial integration represents an improvement in financial intermediation which offers a potentially significant increase in economic efficiency with benefits both for consumers and investors around th world

    c. Financial flows can provide important benefits

     a. They finance real trade and related financial transactions and provide cross-border liquidity to the interbank market

     b. They provide capital to local businesses on what are often the best available terms

     c. They are closely associated with the presence of foreign businesses and foreign financial institutions

    1. It is impossible (and counterproductive) to distinguish between good and bad capital flows d. Jet airplane analogythe jet airplane made air travel more comfortable, safe, and efficient but the accidents were larger and more frequent for a short time. This is how Summers views modern global financial markets and their potential impact on the global economy.

    2) Understanding International Financial Crises

     a. Every crisis is different but have some common elements--a large real depreciation, a dramatic swing in the current account, a significant decline in real output

     b. Common elements1) after a period of substantial

    capital inflows, investors decide to reduce the stock of their assets in the affected country in response to a change in fundamentals, 2) after a period of substantial capital inflows, investors shifted their focus from evaluating the situation in the country to evaluating the behavior of other investors, 3) the withdrawal of capital and associated sharp swing in the exchange rate and reduced access to capital exacerbated fundamental weakness

     c. The presence of international ―contagion‖ is another

    feature of 1990‘s financial crises

    1. Summers argues that preventing crises is heavily an issue of avoiding situations where the bank run psychology takes hold, and that depends heavily on strengthening core institutions and other fundamentals

    3) Crisis Prevention at the National and International Level

a. Conclusions of underlying reasons for financial crises

     a. Serious banking and financial-sector weaknesses usually play a role

     b. Fixed exchange rates without the concomitant monetary-policy commitments causes crises

     c. Overly inflationary monetary policies, large fiscal deficits, and large current account deficits

     d. National balance-sheet weaknesseslarge short-term


    b. These four underlying causes have solutions

     a. Maintain a strong domestic financial system. When well-capitalized and supervised banks, effective corporate governance and bankruptcy codes, and credible means of contract enforcement, significant amounts of debt are sustainable, but if these things are not present, no debt is sustainable

     b. Choose appropriate exchange-rate regimesif a

    country has access to international capital markets, it should either have flexible exchange rates or a fixed exchange ratenot a pegged fixed rate

     c. A sound and stable macroeconomic policy environment where monetary and fiscal policy vulnerabilities are minimized

     d. Countries should reduce their vulnerabilities to liquidity/rollover risk and balance-sheet risk. Foreign reserves must be compared to meaningful measures of liabilities that can become a claim against a country‘s reserves

    c. The international community can help prevent crises by encouraging sound national economic policies

     a. Best way to do this is by promoting transparencyall

    countries should use GAAP

    d. The only real motivation for these countries is self-interest.

     a. Better economic outcomes and a higher standard of living for a country‘s citizens

    4) National and International Crisis Response

    a. The best national response to a crisis is simply not to have one

    b. The next best response is to have a sufficiently robust set of domestic institutions and national economic system that the crisis is contained and does not reach the stage where a country‘s capacity to

    meet its international obligation comes into question

    c. In situations where confidence is paramount, it is a mistake to only worry about the substance of what national authorities do—―markets overreact, so policy needs to overreact as well‖

    d. Effective policy responses:

     a. Provide confidence to markets and investors that a

credible path out of the crisis exists(transparency is key

     b. Tighten fiscal policy if lax fiscal policy caused the crisis

     c. Set the right monetary policy to establish confidence

    in times of crisis, the right monetary policy has to be the one that will minimize the average interest rate over the medium term

     d. Support healthy institutions and intervene in unhealthy institutions—don‘t delay in doing so

     e. Put strong and effective social safeguards in place to ease the task of adjustment during times of crisis, help build support for necessary reforms, and ensure that the burden of adjustment does not fall disproportionately on the poorest and most vulnerable groups in society

    e. The international community‘s response should be through a) financial provisions or b) through some coordination of private creditors to reduce outflows or roll over obligations coming due f. Issue of moral hazardthere are systematic implications when bailouts are expected, so the international community must be careful

A Future Perfect- The Challenge and Hidden Promise of Globalization

    by John Micklethwait and Adrian Wooldridge

    1) The Story of the Bruderhof‘s

    a. An Amish-style religious community of 400 people which bans radios, televisions, and homosexuality, and practices ―Christian communism‖

    b. Since the 1950s, to sustain their lifestyle, the Bruderhof‘s make children‘s toys

    c. In the 1980s, the company began to have difficulties competing with international competitors d. To combat the problem, the community learned and adopted Japanese management techniques and turned each of their communities into specialist centers, with some responsible for metalwork, others for carpentry, etc. They also adopted other international business practices and negotiating techniques.

    e. The gains in efficiency were dramatic and they were able to deliver most of their orders on the same dayan unparalleled feat in the industry

    f. The Bruderhof‘s business is booming—they did forty million in revenues in 1999

    2) The Walls Come Tumbling Down

    a. The Bruderhof‘s exemplify the benefits of globalization

    b. Critics of Globalization argue:

     i. Communities are becoming the playthings of international speculators

     ii. Complain about the rise of a homogenized airport culture

     iii. Complain about the loss of democratic accountability

     iv. A global race to the bottomcountries ruin themselves

    by reducing taxes, benefits, and environmental controls to woo rootless companies

     v. Globalization helps spur inequality

    3) The Maelstrom

    a. The book attempts to argue the benefits of globalization in a concrete, fact-based way and dispel the myths and rumors about the phenomenon

    b. Globalization is in fact here and it affects us in all different waysthe way we make international

    calls, the angry factory workers in Flint, MI, the fact that you can get cappuccino in Shanghai, the availability of Viagra and Harry Potter all over the world, the clothes people wear, etc c. Globalization is ―accelerating and cumulative‖

    4) A Cause Worth Fighting for

    a. Globalization is a commercial, rather than political phenomenon, driven by currency traders and entrepreneurs rather than by politicians and bureaucrats.

    b. The one trillion dollars worth of foreign investors that poured into the third world since the early 90s, it is generally acknowledged, did more (good or bad) for these economies than any government aid program of the previous three decades—―Silicon Valley and Bangalore have generally played more

    important roles than Washington D.C. and New Delhi.‖

    c. NAFTA and other such trade agreements are blurring the boundaries between countries d. Globalization leads to a more efficient use of resourcesit does not simply relate to economic

    efficiency, but also to do with freedom.

     i. ―Globalization offers the chance to fulfill the goals that

    classical liberal philosophers first identified several centuries ago that still underpin Western democracy‖

    e. The concern that globalization is the only reason why Western countries are losing manufacturing jobs and replacing them with service jobs is not correct

     i. It has become the scapegoat for economic distress that has much more to do with the introduction of new technology or the repition of old mistakes f. Service jobs, furthermore, are higher paid than manufacturing ones, so they should not be scoffed at

    g. Globalization has brought us better, cheaper cars ,computers, and holidays- it has forced our governments to spend more prudently and control inflation more vigorously

    h. Globalization has done mixed things for the environment, but at least it has forced countries like China to come clean about their pollution

    i. Globalization has exacerbated all of the weaknesses of modern society and forced countries, companies, and people compete with the best in the world

    5) Where I Stand

    a. Globalization brings down political, social, and economic barriers and helps to hand the power to choose to the individual

     i. Globalization widens the concept of what the maximum degree of individual freedom could be

    b. Globalization presents the world after the Cold War with the same economic opportunities that the world enjoyed after the Second World War

    Jeff Witt

    John Gray, “False Dawn: The Delusions of Global Capitalism”

    The creation of the free market has been called the Great Transformation. The fundamental idea

    behind free market economies is for all goods, including labor, to change without regard to their effects on society. The free market economy, which arose in America and Britain in the 18th century, is a new idea in social engineering. In the past, economic life had been constrained by the need to maintain social cohesion.

    According to the Washington Consensus, ‗democratic capitalism‘ will soon be accepted throughout the world. A global free market will soon become a reality in which the various economic systems and cultures of the world will ultimately be merged into a single universal free market. However, democracy and the free market are rivals, not allies. The natural counterpart of a free market economy is a politics of insecurity. In the normal course of democratic political life the free market is always short-lived since its social costs are such that it cannot for long be legitimated in any democracy.

    The emergence of a truly global economy does not imply the extension of Western values and institutions to the rest of humankind. In the same way, the emergence of a truly global

    economy does not promote the universal spread of Western liberal democracy. The history of

    our time reflects that neither the American free market system nor the regime of ‗democratic capitalism‘ are necessarily replicated through economic globalization. In fact, economic globalization

    works against the free market and the Western democratic ideals attached to it, spawning indigenous types of capitalism and new regimes that owe little to the Western model.

    The global economy that is currently under construction will not assure the free market’s

    future. Economic globalizationthe worldwide spread of industrial production and new technologies that is promoted by unrestricted mobility of capital and unfettered freedom of tradeactually threatens

    the stability of the single global market that is being constructed by American-led transnational organizations (WTO, IMF, OECD, etc).

    Economic globalization does not strengthen the current regime of global laissez-faire, but

    rather works to undermine it. There is nothing in today‘s global market that buffers it against the

    social strains arising from highly uneven economic development within and between the world‘s diverse societies. In the absence of a strong state dedicated to a liberal economic program, markets will inevitably become encumbered. Encumbered markets are in fact the norm in every society (markets naturally tend to react to spontaneously arising social problems), whereas free markets are a product of artifice, design, and political coercion. Free markets are in essence creatures of state power, and

    persist only so long as the state is able to prevent human needs for security and the control of economic risk from finding political expression.

    A global free market works to set sovereign states against one another in geo-political struggles for dwindling natural resources as states animated by the laissez-faire philosophy are

    impelled to become rivals for control of resources that no institution has responsibility for conserving. A reform of the world economy is needed that accepts a diversity of cultures, regimes, and market economies as a permanent reality. (Note: no manner of recourse is actually given by the author in the


    At the global level, as at that of that nation-state, the free market does not promote stability or democracy. Global democratic capitalism is as unrealizable a condition as worldwide


Klein, Naomi, The Tyranny of the Brands

    According to the author, over the past two decades or so big corporations have undergone a great change, and this mainly has to do with corporate branding. Whereas branding used to mean putting a logo on a product and stating that ―our mass-produced product is of the highest quality‖, now, ―rather than serving as a guarantee of value on the product, the brand itself has increasingly become the product.‖ Production (making tangible products) now is only a small part of the operations of these multinational corporations; what is of real importance for them is coming up with ideas and images for the brand, that is, the lifestyle or the attitude that the brand represents. This creates a kind of race among companies to become the least clunky and most efficient: ―the companies which own the least, keep the fewest employees on the payroll and produce the coolest ideas (as opposed to products) win the race.‖

    This has two main effects: first, in their quest to expand their brand image companies invade more and more public and cultural space. Second, even though these companies have never been more omnipresent in our lives, they have become absent from them in a crucial way: as steady employers. Also, production has become much devalued and lies a distant second priority after branding. By severing the bond between employer and employee, they are however much more vulnerable to public rage.

    Also, by having become so dependent on the image of the brand, this is the Achilles‘ heel of these companies. Their brand image can be subverted by individuals who want to protect themselves against the rule of the brands. This is all the more successful since these individuals can tap into the great resources spent to make the logo meaningful in order to lead these campaigns against corporations. Indeed, these companies are faced by a sort of brand boomerang: the power of brand-names being used against themselves. Thus brand image is both the source of a great amount of corporate wealth as well as one of the corporations‘ greatest weaknesses.

Mark Hoadley

    Martin Wolf, Why Globalization Works, Chapter 8, “Rise, Fall and Rise of a Liberal Global Economy”

    1820-1870: Beginning of global commodity price convergence (growth: per capita 0.5 %)

    1870-1913: Liberal heyday (growth: per capita GDP 1.3 %; world merchandise exports 3.4 %)

    -Commodity market price gaps cut by 81%: 72% from transport and 28 % from policy

    the most impressive episode of international economic integration,‖ accompanied by the most significant

    declines in ―intercontinental barriers to trade and factor mobility‖

     -Century of relative peace after Napoleonic Wars in 1815

     -Bilateral trade treaties and onset of convertibility through gold standard

     Problems: Nationalist/imperialist goals to satisfy demands of a working class suffrage

    -Social security makes sharing citizenship less attractive, less labor mobility

     -Rising tariffs begin with Bismarck raising Germany‘s in 1879

    1914-1950: Decline of the liberal world economic order (growth: GDP 0.9 %; exports: 0.9 %)

     -Commodity market price gaps double due to trade barriers

     -Failure to re-establish monetary stability (inflation and high public debt)

     -Depression 1929-1932: world trade fell 70 % in value terms, 25 % in real terms

     -Open economies gave way to protection of national markets

    -Essential US failures: exacerbated reparations crisis; failed to abide by restored gold standard rules; triggered Great Depression; central bank failed to halt monetary collapse; accelerated protectionism with Smoot-Hawley tariff

    1950-1973: “Golden Age” (growth: GDP 2.9 %; exports: 7.9 %); 1973-1998 (1.33 %; 5.07 %)

     -Commodity market price gaps cut by 76 %: 26 % from transport and 74 % from policy

     -GATT in 1947 and 8 rounds of trade negotiations since

     -Substantial tariffs remained on labor-intense goods such as clothing and agriculture

     -Inwardly-focused development / import-substitution proves ineffective in the long-run (i.e. Soviet Union)

     -New economic order: free capital movement and domestic stabilization, with floating exchange

     -Developing countries borrowed excessively and liberalized capital flow controls incompetently: financial crises in 80s and 90s; 10 % to 50 % of developing countries move to floating exchange from 1975 to 1997

    Other notable points

     -Trade has risen slower than GDP because service-based sectors integrate more slowly

    -Capital flows increased (18% of world GDP in 1914 and 57% in 1995), but: many foreign-asset holdings are short term; many capital transactions are ―diversification finance,‖ transactions from the rich to the rich; and

    high-income nations are net importers of capital (because of the U.S. deficit).

     -1890s US immigration was 9 % of the initial population; it was 4 % in the 1990s. All real wage convergence before World War I was attributable to migration, and real wages for an unskilled person in a poor nation are a small fraction of wages for that worker in a rich nation.

Katherine Prescott

Frieden, Global Capitalism Chapter 8: The Established Order Collapses

     Overview: This chapter discusses the international economic collapse of 1929-1934: economies of industrialized world disintegrated for five years:

     Output dropped by one-fifth

     Unemployment spiked to one-quarter of the labor force almost everywhere

     Financial currency crises around the world

     The End of the Boom

     American stock prices doubled in a little over a year: result was that American money that had fueled international growth was instead invested in American markets, turning a mild recession elsewhere (Europe) into a full-fledged crisis

     In October 1929 American stock market crashed: prices of commodities, raw

    materials, farm products dropped

     Industrial production dropped, unemployment rose around the world Most governments around the world responded passively, following the lessons of classical economics, which dictated that in a cyclical economy a recession would naturally correct itself Belief was that allowing for natural deflation and liquidation would rekindle

    economic growth by lowering prices and wages enough to encourage new investment and consumption Boom of the 1920s had to be unwound in order to set economy back on a healthy path

     The strategy of inaction did not work

     Reduced flexibility of prices and wages (due to rise of labor unions) meant that postwar economy was not responding as it had in the past

     For example, while almost a quarter of the American labor force was out of work, real wages in many industries were high and rising because of labor unions Most governments turned inward, enacting trade protection such as the 1930 Smoot-

    Hawley Tariff Act, which substantially raised American trade barriers

     Gold and the Crisis

     Deflation and prolonged depression triggered financial and currency panics around the world: countries that wanted to halt deflation and raise prices could not due so because of their commitments to the gold values of their currencies (they could not raise prices without the ability to back up currency with more gold, which they did not have)

     Major problem: Governments were unable to carry out open monetary policy

    to stimulate economies while on gold standard

     International gold standard retarded government response to crisis and sped the transmission of financial shocks

     Rumors that a currency would be taken off gold and devalued caused complete loss of confidence in national banking systems and runs on national banks: people would rather have their money in gold or a reliable currency than in a currency that was potentially going to be devalued and worth a lot less


     In 1931, Germany closed banks and suspended convertibility of currency into gold Also in 1931, British government took the sterling off gold, devaluing it Scandinavian and Baltic states, Japan, much of Latin America followed Britain By 1932, US and French-centered states (Belgium, Luxembourg, Netherlands, Italy, Switzerland) still on gold standard

     US: ―Without the commitment to gold, the Fed could have lowered interest rates, stimulating the economy by making borrowing, spending, and investment easier. Instead, shackled to gold standard requirements, the world‘s most important central bank imposed ever more austere and restrictive monetary policies.‖

     By end of 1932, world trade still barely at one-third of 1929 level: world had turned toward protectionism

     US finally came off gold standard in 1933

     Resulting run on the bank: expectation of devaluation caused people to cash in dollars and buy gold

     Out of the Darkness

     US government, finally freed from the constraints of gold standard, could not expand the money supply, raise prices, and put the economy back on track

     This reversal of deflation was instrumental in bringing the economy out of the Depression

     Between 1932 and 1935, industrial production in countries off gold grew by 6% annually, while it declined by 1% annually in the gold standard countries

     Central, eastern, southern Europe and Japan turned inward when crisis hit and were soon ruled by new fascist or protofascist governments that continued to reject the international economy Concept of autarky forceful separation from the rest of the world as an

    economic policy

     Nazis engineered most rapid and lasting reduction in unemployment in the industrial world

     Soviets constructed a Communist autarky, which saw the most rapid industrialization in history

     Out with the Old

     In the face of the original downturn, governments mistakenly followed policies inherited from classical global capitalism

     These presupposed an earlier economy of small firms, disunited workers, and textbook conditions of perfect condition, as well as a political system that could resist pressures to alleviate the suffering of workers and the poor

     Industrial economies were now dominated by huge corporations, mass production, and complex consumer products: labor unions were much stronger than before WWI, and political systems were far more democratic

     In the industrial setting, classical policies were counterproductive **Depression’s harshness reflected the fundamental inconsistency between the traditional principles of the pre-1914 classical world economy and the new organization of domestic and international societies**

     Classical world economy had failed: many countries looked to political extremes of communism or fascism for solutions to the problems of orthodox capitalism

Frieden, Global Capitalism Chapter 9: The Turn to Autarky

     Overview: The Depression had convinced almost the entire world that traditional economics

    and politics no longer worked under modern conditions

     Ancien regime global markets for capital and goods, gold standard, and minimal government involvement in the economy worked well before 1914

     During the 1930s markets collapsed, governments were forced to intervene, and people looked to replace failed traditionalism

     Many countries found economic self-sufficiency to be a desirable alternative

     Countries across southern, central, and eastern Europe, including Portugal, Latvia, Germany and Greece, adopted some variant if autarkic fascism

     Semi-industrial countries also embraced the new economic nationalism: Romania,

    Mexico, Argentina, Japan, Italy, Russia:

     Rejected the gold standard

     Imposed prohibitive trade protection

     Tightly controlled foreign investment

     Denounced foreign investment

     Defaulted on the debts they owed

     Force-marched toward modern industrial growth

     This path diverged from that of western Europe and North America Semi-Industrial Self Sufficiency

     Every debtor country moved toward autarky and authoritarianism, while creditors remained democratic and committed to international integration

     Debtor countries were poor enough that they relied on exports of primary products, but were rich enough to have thriving urban industries to produce for the domestic market Autarkies turned away from international competition and toward the use of national resources to meeting national demands

     Debtor countries rejected foreign debts, reliance on world markets, and

    comparative advantage

     Previous areas of specialization were taxed to stimulate less developed sectors of the economy

     Two factors caused semi-industrial countries to turn inward:

     1. New groups that were less enthusiastic about global economy: industrialists producing for the domestic market wanted protection from foreign companies 2. Collapse of the economic theoretic basis of traditionalism with the Great


     Schacht and the Nazis Rebuild Germany

     Nazis needed Schacht to bolster their ties to Germany‘s business leaders; Schacht and his business supporters needed the Nazis to address the country‘s economic problems [Lots of detail in reading on Schacht, not important for exam]

     Schacht saw the Nazis as capable of exercising power to reassert German nationalism and implement the strict economic policies he believed were necessary to bring Germany out of the Depression

     Nazis sought to destroy the political Left and labor party; economic priority was to end unemployment

     Nazi government ended unemployment within three years by creating jobs

    for young adults: community chores, farm work, road building, bridge repair, public works Large increases in government spending as a percentage of GNP from 1929 to

    1934 to create jobs

     1936 economy at full employment

     Prevented inflation and wage increases through Nazi ‗reign of terror‘: violent

    repercussions for store-owners who tried to raise prices or laborers who rallied for higher wages Hitler‘s regime centralized political power and financial resources such that private

    capitalists were no longer important

     Nazis had no intention of rebuilding ties to the West

     Schacht disagreed with these policies and ultimately resigned position Autarkic Economic Policies

     Germany and Italy‘s shared goals: (1) strengthen industry, (2) avoid dependence on hostile foreigners, (3) provide resources for reassertion of military capabilities Method was to pursue industrial modernization:

     Channeled money away from agriculture and consumption (through low

    wages) toward industry

     Subsidized industry: Higher prices for industry required controls on foreign trade to keep out cheaper competitors

     Result was steep protection, which led to import substitution Governments controlled foreign investment by reserving national industry for

    nationals to invest in

     Governments defaulted on foreign debts to save capital and foreign currency for industry

     Governments imposed tight controls on capital movements to keep money at

    home to for capital investment in domestic industry

     Artificially over-valued currency: made foreign goods cheaper (imported raw materials) and domestic goods more expensive (finished products), which helped domestic industrial producers

     In past over valuation would have hurt exporters, but this no longer mattered

     Europe Swings to the Right

     By 1936, every country in southern, central, and eastern Europe was a reactionary despotism; by 1941, Nazi occupations had felled most remaining European democracies The constituency of the New Right was drawn from the urban lower-middle classes and small farmers with more measured support from traditional conservatives in big business and big agriculture

     Fascists had a tough time satisfying these two broad constituencies anti-labor

    capitalists and landowners versus discontented lower-middle class

     Fascists celebrated agrarian tradition but also accelerated industrialization Fascists were able to pull economies out of the Depression:

     Fascists stimulated economic recovery by signaling to the business community that its troubles were over

     Use of violence to achieve economic goals

     Willingness to pursue new paths and stray from traditional economic theory Fascists‘ longer-term goals:

     Unquestioned political control

     Accelerated industrial development


     Military Expansion

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