International Economic Relations since 1945

Catherine R. Schenk

• Publisher: Routledge
• Year: 2011
• ISBN:
  9781136727931
• Edition: 1
• Topic: Economics
• Subtopic: Economic History
• Index: Economics

The international economy since 1945 has endured dramatic changes in its balance of power, from the early period of prosperity for industrialised nations, to the 2008/9 global crisis. In this volume Catherine Schenk outlines these huge changes, examines how the world's economic leaders have tried to organise and influence the international economy and presents the key frameworks in which international economic relations have developed.

Focusing on the pattern of international trade, international investment and the changing organisation of the international monetary system, this volume takes a chronological approach of key time-frames, and shows how policy has impacted the balance of the international economy. Major events such as European integration in the 1960's, the collapse of the international monetary system and oil crisis in the 1970's the return of China to the international economy in the 1980's and emerging market crises in the 1990s are discussed within the context of key themes including global economic and regulatory co-ordination, the role of American economic hegemony, the evolution of exchange rate policy and unequal development.

International Economic Relations since 1945 is the perfect guide for all students of economic history and international history, and for those seeking to understand recent economic trends in a longer term perspective.

1 Introduction and overview

The international economy is essentially composed of flows of people, goods, capital and ideas. These four categories correspond to the main factors in the production of economic wealth, so the global distribution of these elements is clearly vital for how national economies perform. The most basic link between national and international economic performance is through the trade of goods and services. Until the eighteenth century it was believed that national accounts operated rather like household accounts; which is to say that the greater the surplus a country could earn through its sale of production the better. Selling more goods to foreigners than was bought from foreign states ensured the accumulation of reserves of gold that were vital for the conduct of war, which was the main preoccupation of most state rulers. From the eighteenth century, however, understanding of the gains from international trade was promoted through the writings of Adam Smith and, later, David Ricardo and others. They described how if each country or region specialised in producing those goods and services in which they were most productive and efficient, they could then sell surplus production to buy what the country was less efficient in producing. If each country took this approach of international specialisation of production, then the world’s resources would be used as efficiently as possible within and between each nation. Through the more efficient use of resources, international trade allowed the best prospects for growth overall.

Intuitively, this principle of the gains from trade is as easy to understand as the seventeenth-century mercantilist quest for ever greater surpluses. At an individual level, with well developed markets we specialise in what we are best at doing and then sell the goods and services that we produce for cash to buy what we want but are less able to make well. By not having to grow our own food, raise our own sheep to make our own clothing and build our own homes, we achieve higher standards of living than we would through individual independent subsistence. So it is that countries that do not engage in any international trade subsist at a relatively low standard of living (one of the only remaining examples is North Korea). Of course, the gains from trade require markets that bring buyers and sellers together and finance to bridge the lag between production and consumption to allow goods to travel over time and distance. The character and efficiency of these markets and the speed and ease of flows of goods, people, money and ideas determine how much international specialisation can occur and how much (and who) will gain from international trade.

It is clear that not all individuals benefit equally from the exchange. When Wal-Mart increases imports of Chinese clothing produced by low-wage workers in a factory in Shenzhen and sells these products in their stores in the US, American consumers will tend to buy less of their own (more expensive) domestically produced clothing. The result may be fewer jobs for some Americans in the US clothing industry, but this international trade will increase the disposable income of a much broader range of American consumers, who now have access to cheaper clothing and can spend more of their money on other goods and services. Such distributional effects of international trade on different groups of people have attracted policy-makers to interfere in international economic relations to try to maximise the benefits and minimise the losses. Government-imposed barriers to trade include quotas (limits on the number of an item that can be imported) and tariffs (a tax on each item imported across the border). Each form of trade barrier raises the domestic price of foreign goods either by contracting supply, in the case of quotas, or increasing costs for importers who then pass these costs on to the final consumer, in the case of tariffs. The welfare effects of tariffs and quotas differ since the government gains revenue from a tariff and can spend that income to compensate consumers for higher prices while still protecting domestic producers. In the case of quotas, however, the benefits of higher prices go to the company or individual who has been granted the license to import a quantity of foreign goods, so there is a net welfare loss to the population. Quotas may also lead to corruption as individuals lobby the government or offer bribes to gain import licenses. These distributional effects mean that in the post-war years quotas have been considered a worse barrier to trade than tariffs.

The benefits of buying from the cheapest producer and selling wherever the product commands the highest price might be extended to the other elements of international economic relations. Thus, the ability of people to migrate across borders will allow labour to flow where it attracts the highest wages or the best standard of living. In the nineteenth century, the redistribution of labour from relatively crowded and poor European countrysides and cities to economies with greater natural resources and higher per capita income such as the United States, Canada, Australia and Brazil was one of the defining characteristics of the economic growth and globalisation of this era. This movement of people was greatly assisted by advances in transport technology – such as steam shipping and railways – that made long journeys quicker and less risky. The people brought their skills and savings with them as well as their ideas and creativity to contribute to economic growth in their new homelands. These farmers and labourers produced food and raw materials that could be exported to Europe in return for imports of manufactures, thus linking international migration with international trade and rising real incomes. From the early twentieth century, however, fears about the depressing effect of immigrants on the wages of existing local populations led to restrictions on international migration. As with movement of goods, flows of people also induce effects that are felt unequally among the population and make this exchange a source of contention.

The international exchange of ideas such as the communication of opportunities, the spread of innovation and other information flows over long distances also contributed to economic growth. As well as being embedded in the human capital of migrants, in the nineteenth century this flow of ideas and information was enhanced by technological advances such as the telegraph, which helped collapse the psychic distance of international economic relations by reducing the risk and time-lag for exchange. In the later twentieth century, information technology based on a much wider and extensive infrastructure of fibre-optic cables and satellite transmission was a driving feature of renewed social, cultural as well as economic globalisation.

The final element in our list of international economic relations is the flow of capital. Allowing international capital to flow to where it attracts the highest return is a vital element in the promotion of global economic prosperity. Capital might take the form of portfolio investment – such as the millions of pounds invested by middle class British savers in Canadian railway bonds in the nineteenth century. This international investment integrated the markets of vast resource-rich territories and enabled them to supply raw materials and wheat to the industrial heartlands of Europe. Capital flows might also take the form of foreign direct investment (FDI) by a company that establishes an office or factory to produce or distribute overseas. This was an important feature of nineteenth-century globalisation, but became even more prominent in the post-1945 decades as innovation in communication technologies and faster transport made it easier for companies to expand their activities. With the development of global supply chains shipping parts for assembly and finished products to final markets, foreign investment became closely linked to international trade patterns.

Developed in the 1960s, Raymond Vernon’s product-cycle theory of global production posited that goods invented in countries with high levels of human capital would initially be produced in these advanced economies in small numbers at high cost and high price.¹ As international demand for the product increased in other wealthy economies, production would move to these high income economies to replace imports. As a product was further standardised, its production became more mechanised and less skilled, so the location of production would move to where labour costs were cheaper. This idea helps to explain the global spread of manufacturing for twentieth-century products such as televisions, semi-conductors and computers, where production originated in the US, moved to Europe and Japan in the middle of the century, and was mainly located in emerging economies by the end of the century.

In order to record flows of international exchange, governments collect this information in accounts known as the balance of payments. These accounts measure all the flows of funds across the border in each direction and the overall balance therefore comprises the net flow of funds in and out of the country. In its simplest form, the balance of payments is divided into three sections, including the current account, the capital account and balancing movements in foreign exchange reserves. The current account measures net trade in goods and services, net flows of migrants’ remittances, net interest and profits earned on overseas investment and tourism. The capital account measures net flows of short-term and long-term investment, including foreign direct investment. A surplus in the current account, for example, might be balanced by a net outflow on the capital account. Any leftover overall surplus or deficit must be accommodated through accumulations or sales of foreign exchange reserves held at the central bank. The three accounts in the simple balance of payments must always balance since the net money spent on international economic transactions must have been generated somehow, either by earnings or other inflows from abroad or sales of reserves. The accounts are related in many ways; for example, foreign direct investment by a company setting up a factory overseas will appear as an outward flow in the capital account and may generate exports of equipment and machinery, imports of final production back to the home country, and repatriated profits, which all appear in the current account.

Table 1.1 The balance of payments

Current account	Balance of trade in goods
	Net flows of interest, profits and dividends
	Net flows of tourism, royalty payments and other trade in services
Capital account	Net long-term investment
	Net short-term investment (including sales of government debt to foreign holders)
	Net foreign direct investment
Foreign exchange reserves	Net sales and purchases of foreign exchange by central monetary authority

This section has introduced the key international economic relations with which this book is concerned, and has also suggested that the distributional effects of international exchange have prompted policy-makers to interfere with this process. The next section provides an overview of the organisation of the international economy as states sought to maximise the benefits of international trade and payments.

The organisation of the international economy

The way that the international economy was organised in the ‘long’ twentieth century from about 1880 to the present can be understood as a sequence of policy choices in reaction to the Mundell-Fleming Trilemma.² The Trilemma posits that there are three opposing goals for policy-makers in governments and central banks: stable exchange rates, open capital markets, sovereignty over domestic monetary policy. In the somewhat stylised world of economics, only two out of these three options are possible at any one time for relatively small, open economies. The largest economy at the anchor of the system will be the only one that can pursue policy autonomy in a context of free capital flows and fixed exchange rates. We can think of it using the following example. If a country sets a fixed value for its currency in terms of an anchor currency (sterling in the early part of the century or the US dollar after 1955) then it must follow the interest rate policy of the anchor. Otherwise, if interest rates rise abroad, for example, capital will flow out to get the higher returns overseas, demand for foreign currency will rise in the foreign exchange market and demand for domestic currency will fall so that there is pressure for the market rate to fall. A central bank might be able to protect the market price of its currency (the exchange rate) for a while by selling foreign currency and buying up domestic currency, but eventually the central bank will run out of reserves. To stop this happening and still retain the pegged exchange rate, either domestic interest rates must rise to stem the outflow, or residents must be prevented from buying foreign investments or currency. To have a pegged exchange rate either the government gives up its ability to set its own interest rate or imposes controls on international flows of capital. If it abandons the peg and allows the market to determine the exchange rate, then capital can flow freely and the central bank can set whatever interest rate it likes. In practice, of course, very few countries completely ignore their exchange rate in determining their economic policy since fluctuations can have a real impact on domestic incomes by changing the price of imports and exports (that is, currency appreciation makes foreign currency and foreign goods cheaper in terms of domestic currency and vice versa for depreciation). The trilemma is only a stylised tool of analysis, and compromises among the choices can also be found, such as limiting convertibility and free capital flows to a smaller group of countries or trading bloc in order to retain some degree of policy independence from a large economy outside the bloc – as happened with the inter-war Sterling Bloc. Nevertheless, the trilemma provides a useful framework in which to understand the evolution of international economic relations and the choices available to policy-makers.

Under the classic gold standard from about 1880, a fixed exchange rate system based on a defined value of each currency in terms of gold operated relatively smoothly with open international capital markets only because of the willingness of national governments to conform their interest rate policies to global levels led by the Bank of England. There were some currency and financial crises on the margins of the system, such as in South America, but for the most part the system functioned well and was associated with an era of globalised markets in labour, capital and trade and sustained economic growth, particularly for emerging market economies, such as Canada, the United States and Australia. After the disruptions of the First World War, the effort to restore this system foundered on the unwillingness of states to sacrifice their policy sovereignty in favour of stable exchange rates. For Britain in particular, the restraint on domestic economic policy required to sustain an overvalued sterling–US dollar exchange rate proved costly to economic prosperity through the later 1920s. In retrospect, the inability to pursue expansionary policies that might have mitigated the pain of the Great Depression was blamed on invidious free capital flows that allowed speculato...

Table of contents

• Cover
• Title
• Copyright
• Contents
• List of Figures
• List of Tables
• 1. Introduction and overview
• 2. Rebuilding the international economic system 1945–50
• 3. Years of growth 1950–73
• 4. Years of crisis 1973–85
• 5. The start of the second globalisation 1985–95
• 6. The acceleration of globalisation and renewed crises 1995–9
• 7. Lessons not learned
• 8. Conclusions
• Glossary
• Further reading
• Notes
• Index