Introduction to Globalisation
Globalisation concerns the opening up of trade, cross-border investment and inter-connected production and financing between countries, a process which underpinned much of the success of advanced countries in the post-war period. The world by the 1960s had essentially split into three: the OECD-integrated market (including Japan and West Germany); the centrally planned world led by Russia; and the developing countries that were not centrally planned like Russia, but which were significantly autarchic and did not rely on open market arrangements due to high tariffs, border controls on trade, high levels of state-ownership of industry, and controls on foreign exchange and capital flows. The way that globalisation unfolded in this latter group was to play a key role in the 2007–2008 crisis.1
The OECD Countries Open Up
Amongst the OECD countries, post-war reconstruction efforts were designed to encourage trade and greater integration. The Marshall Plan announced in 1947 engaged the USA in the European rebuilding process. It also oversaw the administration of the European Payments Union which facilitated the re-emergence of a multilateral trading system. From 1948, the Global Agreement on Tariffs and Trade (GATT) led to more trade liberalisation, mainly in the OECD area, with four ‘rounds’ of multilateral negotiations completed by 1956 and a fifth by 1961. With the retreat of European empires, successive GATT rounds became more global, with participation rising from 26 countries in the Dillon Round (1960–1961) to 62 in the Kennedy Round (starting in May 1964) and 123 in the Uruguay round (the last to be completed in 1994). Major expansions of trade followed in each case.
In Europe, the trend towards greater integration was even faster. The Treaty of Rome in 1957–1958 became the basic legal framework ultimately for the establishment of the European Union (EU) single market. European current account convertibility came into effect in 1958 and the process of import licensing ended. By 1968, a full customs union was established, with tariffs and quotas on internal trade being abolished and a common external tariff on third countries coming into effect. Capital account deregulation and the ending of financial repression of domestic financial markets were, on the other hand, notoriously much less rapid.2
Propping up fixed or managed exchange rate regimes was one primary reason for not promoting faster financial integration. Persistent dollar weakness from 1958 to 1973 (despite current account balance of payments surpluses) led to US controls such as: the Interest Equalisation Tax (IET) in 1963; the voluntary foreign credit restraint (VFCR) in 1965; foreign direct investment (FDI) limitations; and extensive diplomacy to support the dollar. At the same time, surplus countries (such as Germany and Switzerland) imposed capital account restrictions, in order to maintain domestic monetary control and a fixed exchange rate in the face of inflows. Capital flow management was driven by the direction of flows in the early 1970s: the USA, the UK, Denmark, France, Italy and Sweden imposed measures to control outflows, while Germany, Switzerland, Australia, Japan, Austria and Finland focused on measures to prevent inflows.
The fixed exchange rate system was eventually abandoned in 1973, leading to the floating of the major exchange rates. This coincided with a rapid rise in inflation nearly everywhere and the oil price shock in 1973–1974, with OPEC achieving a much greater share of the economic rent from its cheap production costs. Most developed countries found themselves wrestling with inflation, high unemployment, huge budget deficits and large external imbalances. Heavy use of eurocurrency markets to recycle oil surpluses followed, and there was strong official support for this, notably through the IMF.
With the end of the commitment to fixed exchange rates, the trend to financial repression and capital controls began to be reversed in the 1970s, a process which was accelerated in the 1980s by policy and structural changes that made regulations less effective. Central banks were formulating new approaches to monetary control, facilitated by separating their functions from the budget process and relying on market instruments. The extensive use of interest rate swaps, options, forwards and other derivatives separated the notion of exposure and capital flows across exchanges to which many controls applied. Institutional investors and international banks lobbied hard for deregulation to avail themselves of the increased range of products. Germany ended the repression of banks to prevent money from coming in by 1975 (see OECD 2002; Dooley and Isard 1980). The USA removed capital controls in 1974, and the Depository Deregulation Act followed in 1980 (which phased out interest rate ceilings). The UK abolished all capital controls and foreign exchange restrictions in 1979. In 1980, Japan formally ended its exchange controls in one move. By 1981–1982, all of the four major currency countries liberalised exchange controls and domestic financial markets. Other OECD countries soon followed.
From 1981 to 1983, the French under Francois Mitterrand tried independently to stimulate via fiscal and monetary policy during the Volcker squeeze and restrictive German policies. This was followed by capital flight and the imposition of strict controls on outflows to defend the franc. However, recurrent crises in France forced them to change gear after 1983, and France moved to liberalise from 1983–1984, completing the process by 1986.3 Jacques Delors left the French government around this time and went to the EU Commission to complete the single market project. The Single European Act was signed in 1986, committing countries to remove all controls on goods and capital by 1992. The Second Banking Directive came into effect in 1992—while recognising national regulatory approaches, countries could no longer restrict entry into their domestic market. Australia and New Zealand signed the Closer Economic Relations treaty in 1983, freeing up all trade and capital restrictions between them. The USA signed a free trade agreement with Canada in 1987 and the North American Free Trade Agreement (NAFTA) added Mexico in 1994. Much less progress in formal terms occurred in Asia.
The Case of Japan
Japan deserves some focus for two reasons: first, its spectacular growth prior to 1973 has to a large extent provided something of a model for how to achieve an ‘Asian miracle’; and second its cultural values, industrial structures and policies have been very different to those of other OECD countries, so that changing regulations and controls ‘on the books’ do not have the same implications for openness. For example, Japan has had the lowest FDI inflow of all OECD countries for many years, most likely due to the lack of a market for corporate control. Boards are reticent to allow hostile foreign takeovers via M&A activity, and legal teams to support such action are hard to find. Accountability in the corporate governance framework is unclear, and inflexible employment and termination rules and restrictions on the entry of foreign workers also serve as a barrier.4 Thus while foreign ownership was allowed on paper from 1970, and exchange controls and capital account restrictions were eased, in practice the potential benefits of regulatory openness were blunted.
As in China and the Asian Tigers subsequently, the state played the key role in accelerating Japanese growth in the early post-war period. The Ministry of International Trade and Industry (MITI) was perhaps the most important key actor in the planning process.5 Local industry was protected at the outset, and heavy investment in key industries through the Fiscal Investment and Loan Program (FILP) played a key role. The other parallels are striking too. As growth accelerated, poor social security and financial repression measures encouraged a sharp rise in saving. Relationships between large firms were strong, based on cross-shareholdings and the Kieretsu supply chain structure for intermediate inputs. The bulk of finance for new investments was provided by Japan’s development banks. As industrial policies succeeded, a bank-oriented financial system emerged in the form of the ‘mai...