Global Economy-The Crisis Years

8/6/2019 Global Economy-The Crisis Years

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1 | P a g e H W A C H O N G I N S T I T U T I O N ( C O L L E G E )

H I S T O R Y D E P A R T M E N T

HWA CHONG INSTITUTION (COLLEGE)

H1 HISTORY

INTERNATIONAL HISTORY: 1945-2000

THE DEVELOPMENT OF THE GLOBAL ECONOMY

LECTURE 2:

PROBLEMS OF THE GLOBAL ECONOMY

I. INTRODUCTIONTHIS LECTURE AIMS TO:

Highlight the problems that plagued the global economy during the Crisis Years(1974-1991)

Examine the actions taken to resolve these problems and evaluate the extent towhich they were successful

Explore the new developments in the third stage of the global economy: regionaland globalism (1991-2000)

II. AN OVERVIEW OF THE CRISIS YEARSWHAT ARE THE CRISIS YEARS?

The history of the twenty years after 1973 is that of a world which lost its bearings and slidinto instability and crisis...The global economy did not break down, even momentarily,

although the Golden Age ended in 1973-75 with something very like a classical cyclical


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slump...Economic growth in the developed capitalist world continued, though at a distinctly

slower pace than during the Golden Age.1

What transpired during the Crisis Years

The decline of the American hegemony

The collapse of the Bretton Woods System Two oil crises The rise of the European Economic Community (EEC) and Japan The emergence of the Newly Industrialised Countries (NICs) An increase in protectionism and reduction of international trade volume The debt crisis suffered by the Third World countries

What the Crisis Years were Not

The end of US dominance over the global economy the USA was no longer thegreatest economy by a wide margin, but remained the largest economy in the world

The end of international trade The end of economic growth - The NICs grew rapidly during the Crisis Years.

THE LINK BETWEEN THE GOLDENAGE AND THE CRISIS YEARS Ironically, it was the very successes of the Golden Age that led directly to the crises

experienced in the Crisis Years.

Spero and Hart note that the economic foundation of the global economy wasconfidence in the US dollar.

However, this system relied on the constant outflow of dollars from the US, causinga huge trade deficit and undermining the very confidence upon which the G.E. was

built.2

STATISTICS World inflation rose from 5.9% in 1971 to 9.6% in 1973 and finally 15% in 1974. Unemployment in Western Europe rose from an average of 1.5% in the 1960s to

4.2% in the 1970s.

International trade declined as the growth of real world fell to 3.2% per year, whichwas half its previous rate.

1Hobsbawm, Age of Extremes, p. 405

2Spero and Hart, The Politics of International Economic Relations, p. 13


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III. PROBLEMS OF THE CRISIS YEARS1.THE DECLINE OF THE USAS POSITION

PROBLEMS FACED BY THE USA

1. Budget deficits By the late 1960s, the USAs commitment to fighting the war in Vietnam, its other

political commitments abroad and the great increase in its direct overseas investment

resulted in a huge budget deficit.

Gilpin notes that with the acceleration of the Vietnam War and the simultaneousexpansion of the Great Society program3 by the Johnson Administration, American

dollars flooded world financial markets, and as such widening the US deficit.

The growing US deficit caused the real appreciation of the US dollar (this meant thatmore foreign currency was needed to buy US$1) which severely disadvantaged the USeconomy as its exports would be more expensive and thus less competitive.

Trying to maintain the fixed exchange rate further drained USAs economic vitality.

3The Great Society program was implemented as part of the War on Poverty to combat poverty in America.


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2. Depletion of gold reserves The USA tried to sell the dollar in exchange for gold which had greater intrinsic value,

but this was unsuccessful. This, coupled with the commitment of the US government to

stabilise exchange rates using its gold reserves, caused the USAs gold holdings to fall

from $24.4 billion at the end of 1948 to $19.5 billion at the end of 1959.4

3. Inflation The USA excessively printed money to finance its world position during the Golden Age

such as its military spending during the Vietnam War and Johnsons Great Society

programme.

This was because excessive printing inflated the USDs value, meaning that its valueappeared higher than its actual worth.

Moreover, the USAs inflation was spread to the rest of the world since American dollarsflooded the worlds financial markets, as all foreign currencies were pegged against the

USD, which caused inflation to be an international problem by the late 1960s.

This age of inflation distorted currency values and undermined economic stability.While the USA took measures to try and maintain the strength of the US dollar (which

was over-valued, as discussed in lecture 1), by mid-1971 the dollar had become

seriously out-of-line with the other major currencies due to the depletion of gold

reserves and inflation.

4Ibid., p.13


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Confidence in the dollar was rapidly eroding due to rampant speculation and causing

havoc in foreign exchange markets.5 This further weakened confidence and the value of

the USD.

The US government was under pressure to convert tens of billions of dollars into gold,and the international monetary system, managed by the IMF, was threatening to break

down.

ACTIONS TAKEN BY THE USA (INCORPORATE THE CONSEQUENCES)

Protectionism

1. The Nixon Devaluation Faced with a rapidly deteriorating situation, President Nixon took several drastic

measures to reverse Americas imminent economic decline, the most significant of

which was a substantial devaluation of the dollar in December 1971 in the SmithsonianAgreement. The US dollar was devalued by 10% against other currencies.

Devaluation of the USD would improve the USAs trade deficit by making its exportslook cheaper since less foreign currency could now be exchanged for US$1. Moreover,

by devaluing the USD, imports would be made more expensive. As such, the quantity of

exports will increase, while that of imports would decrease, reducing the size of the

USAs trade deficit.

This undermined economic growth as it took away investors confidence in the fallingvalue of the US dollar, causing them to withdraw capital investments from the US and

dump the USD.

Moreover, the USA imposed a surcharge of 10% on dutiable imports from Japan andWest Germany, thus limiting their access to the US markets.

This was done in an attempt to force both to revalue their currencies i.e. to allow theircurrencies to appreciate and thus reduce the US trade deficit with them as US imports

from these countries would seem more expensive. (For more on protectionism vs. Free

trade refer to problem 6.)

Speculators and investors dumped their USD in the wake of this shock, causing the USDto fall in value.

The Nixon Devaluation, coupled with the oil crisis of 1973, led to a global recession anda jump in inflation rates, finally resulting in stagflation where high unemployment

5Gilpin, The Political Economy of International Relations, p. 140


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coincides with high inflation. This resulted in economic stagnation in much of the

Western world.

2. Collapse of the Bretton Woods System6 Moreover, he suspended the convertibility of the dollar into gold, and thus destroyed

the central pillar of the Bretton Woods System by delinking the gold and the dollar. Thefixed exchange rate system was thus abandoned.

The Bretton Woods System collapsed in 1973, and the decision was made to letexchange rates float. The floating exchange rate system was more unstable,

unpredictable and uncertain, thus hampering international trade.

Inflation erupted, fueled by the USAs domestic inflation. The floating exchange rates system also contributed to the growth of protectionism

since different national rates of inflation created great instability, and increased

economies desire for greater isolation to avoid being affected by external inflation.

The collapse of the BWS also marked the end of the IMFs original regulatory role and itnow focused more on providing short and medium-term loans, as well as helping

countries repay debt by providing advice.

By its actions in the 1960s and 1970s, the United States had forfeited its role of monetary

leadership. With its adoption of inflationary policies and its stance of benign neglect, the

United States had in fact become part of the problem rather than the leader in the search for

a solution. In the mid-1980s, the relative decline of American power and Americas

unwillingness to manage the international monetary system stimulated proposals for

collective leadership, especially in the form of policy coordination and new rules to govern the

international monetary system.

- Robert Gilpin

3. Practised New Protectionism (will be discussed furtherunder problem 6)

USAs self-interest and self-preservation

Imposition of Reaganomics The Nixon Devaluation, the collapse of the BWS and the oil

crisis of 1973 led to the first real decline in industrial output

since the war. The recession was accompanied with high

inflation stemming from the large US deficit.

6Ibid.


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In the 1980s Reagan imposed Reaganomics which entailed a tight monetary policy(through increasing interest rates) to curb inflation while simultaneously raising

expenditures, especially for defence, and reduced taxes to stimulate growth.

Reaganomics did have its benefits inflation subsided, confidence grew, and the dollarturned from a weak to a strong currency. However, the tight monetary policy drove

both domestic and international interest rates to unprecedented high levels. As a

result, short-term capital flowed into the US to capitalise on the high interest rates,

stimulating economic growth.7

This led to massive capital outflows from West Germany and Japan into the US, whichcreated political tensions as West Germany and Japan saw Reagans actions as USA

unilateralism that the USA was trying to regain its dominance and exert control over

the global economy.

Subsequently, West Germany and Japan retaliated by increasing interest rates to avoidan outflow of capital to the US but dampening growth. They also closed their markets to

the USA and caused a fall in investment in the USA. The final result combined the worst of both worlds recession as well as capital

outflows. The repercussions for the developing third world countries were more

severe: exports declined and greater debt service costs (the cost of paying interest on a

countrys debt), contributing to the 1980s debt crisis.

Reaganomics also created serious consequences for the US as a strong dollar and worldrecession only served to weaken US exports and widen its already massive deficit. This

caused the US economy to retard instead of progress, which subsequently slowed down

the growth of the global economy which was linked closely to that of the US.

Although the impact of U.S. policies on the world economy was profound and often

disruptive, the United States carried out its abrupt shift and continued to conduct its policies,

not only without serious consultation, but also without taking into account their impact on

other countries.

- Spero and Hart

7Spero and Hart, p. 37


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2.CESSATION OF CONFLICT DTENTE

BACKGROUND

Dtente led to the slowdown of economic growth during the Crisis Years as previouslywith the threat of Soviet expansionism, the US and its allies submerged potential

economic conflict to maintain political security.

As such, the thawing of tensions during Dtente led to the increase in economiccompetition from Japan and Western Europe, further weakening the US and the global

economy together with it.

Moreover, the volume of trade in the sale of weapons also dropped significantly due toDtente, and as the ammunition industry comprised a large proportion of world trade,

this undermined economic growth.

CONSEQUENCES

As Western Europe and Japan became less dependent on the US, they also became moreassertive and nationalistic, opposing the continued and increasing US dominance in

economic and military matters. As such, where they were previously united in the face

of the Soviet threat, the period of dtente allowed them to challenge the US dominant

position by refusing to cooperate with it.

Prior to dtente, large economic growth was brought about the ever-expandingweapons trade, notably the selling of weapons by the US. Weapons trade is an

expensive business, and this coupled with the volatile international situation and fears

that war may break out, led to a vast volume of weapons trade and stocking up of

weapons.

However, during the period of dtente in the 1970s, the thawing of tensions paved theway for a more secure global arena, leading to a significant reduction in weapons trade

and an overall reduction of trade volume, thus undermining global economic growth.

Note: Bear in mind that dtente was the political backdrop for the global economicsituation during the Crisis Years, it is not a factor on its own.

3.TRADE IMBALANCES ECONOMIC DIVISION8 The Crisis Years also saw the emergence of the Third World Afro-Asian bloc, known

collectively as the Southern economies. Many of these were greatly dependent on trade

with the North (the developed first world economies), but believed that the global

8Ibid., p. 223


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economic system was not promoting their development, and felt excluded from the

trade system established by the North.

The South formed a united front to press the North for changes in the trade system.With its majority in the UN General Assembly, the South managed to press the North

into convening a United Nations Conference on Trade and Development (UNCTAD) in

1964. Despite opposition from the North, the South managed to obtain the

establishment of UNCTAD as a permanent organisation.

The economic in the late 1960s and early 70s led to a surge in Northern demand for rawmaterials from the South, allowing the South to use their commodity power to push the

North to restructure the pro-West economic order.

The South thus drew up a coordinated program for a New International EconomicOrder (NIEO) at the Third World Conference in 1974, which called particularly for the

reduction in Northern tariff barriers on a non-reciprocal basis and more financial

assistance from the North to reduce the cost of imports into the South.

The Souths leverage was sufficient to push the North into several rounds ofnegotiations on the issue of the NIEO. However, by the end of the 1970s, the NIEO came

to a dead end due to developments in the international market that reduced the Souths

bargaining power.

These included the recession in the mid-1970s that reduced Northern demand forcommodities and raw supplies, as well as the oil crisis which had a devastating impact

on the non-oil-exporting countries, thus weakening the Souths economic position.

IMPACT INCREASING INSTABILITY As the 1980s progressed, both the North and South experienced increasing frustration

with the existing trade regime. There was also a growing sense of alarm at the

proliferation of protectionist measures, especially the rise of new protectionism

(discussed under problem 6).

The US in particular was convinced that without significant reform of the existing tradesystem under GATT (discussed in lecture on International Financial Institutions), the

system would grow divorced from economic reality and collapse.

Moreover this led to greater economic disparity between the North-South divide,widening the gap between the haves and the have-nots (excluding the NICs). The huge

trade imbalances also played a role in contributing to the debt crisis of the 1980s

(discussed in problem 7) Growing antagonism towards the US and the first world countries hampered economic

growth during the Crisis Years as many third world countries from Africa and Asia

chose not to join the global capitalist system, thus straining trade relations and limiting


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a significant avenue for trade which was the main driving force of the global economy

during the Golden Age.

4.OIL CRISES

BACKGROUND

The Organisation of Petroleum Exporting Countries (OPEC) was formed in 1960 by thefive major petroleum-exporting countries of Iran, Iraq, Kuwait, Saudi Arabia and

Venezuela. OPEC was set up to protect the price of oil and the revenues of their

governments.

In its first decade, OPEC expanded to 13 members, accounting for 85% of the worlds oilexports.

The developed countries became more and more dependent on oil, especially oil fromthe Middle East and North Africa, since oil replaced coal as the primary source of energyand the US oil supplies diminished. By 1972, 80% of Western European and Japanese

oil imports came from the Middle East and North Africa, and even the US relied on these

countries for 15% of its oil imports.

THE 1973OIL CRISIS

October 1973 marked Israels victory against its neighbouring Arab states in the YomKippur War, which led OPEC cutting its oil production by 5% and the tripling of oil

prices from $3 a barrel to $12 a barrel.

It further announced an embargo on deliveries of oil to Western supporters of Israel. The world at this time was already suffering from rising inflation at approximately 8%.

As such, the impact of the oil-price inflation was catastrophic.9

Inflation in the North rose from 5.9% in 1971 to 15% in 1974, especially in the UK andItaly.

Scammell notes that the oil crisis resulted in the inflation problem manifesting itself inthe sharpest, greatest and most widespread price increase of the century.

The 1973 oil crisis, combined with the Nixon Devaluation and the collapse of theBretton Woods System, led to the 1974-75 recession. This, coupled with already rising

inflation rates that shot up due to the oil crisis, caused a period of stagflation in the1970s.

9W M Scammell, The International Economy since 1945, p. 196


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Hobsbawm notes that the fall of 1974 led to a substantial drop in the GNP of theadvanced industrial economies, something which had not happened since WW2.

THE 1979OIL CRISIS10 By the end of the 1970s, the demand for oil increased as the developed economies

moved out of the 1974-75 recession. This was matched with a decreasing supply of oil,however, and the international oil system was vulnerable to disruption.

In the wake of the 1979 Iranian Revolution, Iranian oil workers cut off all oil exports aspart of the successful attempt to depose the Shah. While the fall in supply from Iran was

largely offset by the other OPEC countries, the perceived shortage of oil led to escalating

prices and turbulence in the oil market.

This was exacerbated by the outbreak of the Iran-Iraq war in 1980 when Iraq launchedan attack on Irans oil-producing region, and Irans air force in turn attacked Iraqs oil

facilities.

This resulted in a halt of oil exports from both Iran and Iraq causing a reduction inworld oil supplies by roughly 10% (3.5 million barrels of oil a day). Oil prices shot up to

$33 a barrel.

This caused the second major recession in the world economy from 1981-82, and onlythe Asian tigers were left untouched. US industries saw a 10% decrease in output and

global trade nearly reached an all time low.

SIGNIFICANCE The oil crises played a major role in greatly exacerbating

the existing problems of the global economy by pushing

the global economy into two large recessions within aspace of a decade.

Moreover, the oil crises not only slowed growth for thedeveloped countries, it severely affected the growth of

the newly indenpedent developing countries. They played

a large part in bringing about the debt crisis of the 1980s

(discussed in problem 7).



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5.LACK OF ECONOMIC COOPERATION

BACKGROUND The Golden Age, particularly the period immediately following WW2, marked a period

of close cooperation between the economies of Western Europe, Japan and the USA,

thus providing the political foundation for the operation of the Bretton Woods System

and international stability.

It must be noted that from the late 1950s onwards, West Germany emerged as one ofthe strongest economies in the world, dominating Western Europe.

Together, Japan, West Germany and the USA accounted for nearly 2/3 of the industrialworlds output. Hence if these three economies cooperated, they could be a force for

international economic stability.

RISE OF WESTERN EUROPE The European Community rose to prominence after WW2 with the development of the

Common Market, which contributed significantly to the expansion of world trade, with

the total trade of the EEC countries growing from 24.5% of total world trade in 1960 to

41.5% in 1990.

In the Crisis Years, the relationship between Western Europe and the USA shifted as theUSAs economic dominance declined. The USA slipped from a $20 billion surplus in

1980 to a $15 billion deficit in 1984 with respect to Western Europe.

RISE OF JAPAN In the 1970s, competition from Japan intensified greatly due to its rapid technological

advance. This, coupled with the competition from the NICs (discussed later),significantly increased the number of manufacturing exporters.

Moreover, Japan and the NICs were combining modern technology with low-wages (thislowered the costs of production), producing goods that were far more competitive

(cheaper) than that of the USA, thus posing a direct threat to it.

By the 70s, Japanese exports numbered more than half of that of the US and were stillrapidly increasing. By 1985, $50 billion of the USAs $150 billion trade deficit was with

Japan.

Japans trade increased from 3% of worlds GNP to 15% in worlds GNP in 1992.

CONSEQUENCES The USAs relations with its major trading partners began to change in response to the

deteriorating trade situation.


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US share of world trade decreased from 26.1% in 1950 to 14.1% in 1994. Western Europe and Japan became economically strong over the Golden Age. Soon they

began competing with the USA by producing similar goods in the same industries more

efficiently. As such, their goods were cheaper and of a better quality, making them more

competitive than that of the USA.

American producers fought for protection against these new competitive imports. Thiscaused other countries to be resentful of US domination of economic and military

matters. This undermined economic cooperation and trust.

As both recovered, they became less reliant on the USA and more assertive. They beganchallenging the USAs dominance over political and economic issues. Moreover, Japan

and Western Europe resented the way the US used its dominant position to freely print

dollars to finance American political hegemony over Europe and the rest of the

world.11

When the USA extended aid to Western Europe and Japan after WW2, it expected themto recover to become engines of the economic growth. However both refused to share

the USAs burden of driving the global economy when they emerged as leading

economies in the world. (Refer to conferences discussed under bullet IV)

This can be seen in the various conferences and agreements discussed later, and also intheir refusal to remove protectionist policies (see problem 6).

RISE OF THE NICS (POINT TO NOTE) By the 1970s, the export-oriented industrialisation policies of some developing

countries (the Newly Industrialised Countries or NICs) began to bear fruit. Lower

labour costs in labour-intensive industries, coupled with production innovations

acquired from the North enabled these countries to compete successfully in Northern

markets.12

From 1970-1992, the share of manufactured goods in exports from these NICs nearlydoubled and by 1993, Southern manufactures formed 32% of world manufactured

exports.

The Asian Tigers comprising Singapore, Hong Kong, Taiwan and South Korea especiallybenefited from the change in the trade structure. They implemented export-led growth

policies by creating tax incentives, creating favourable terms for exporters and

maintaining under-valued exchange rates that made their exports look cheaper andthus more competitive.

11Gilpin, p. 136



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This led to a dramatic increase in exports the Tigers share of world trade rose from2% in 1960 to 9.3% in 1993.

The Asian Tigers posed a threat to the USA by competing with the USAs products andthus eroding its dominant position in the global economic order. Moreover, the Tigers

growth remained robust throughout the 1970s and 80s, and were untouched by the oil

crises.

This caused domestic unrest in the USA, since local producers were being sidelined forcheaper Asian imports and they began asking for protection. One such example was the

steel industry.

6.FREE TRADE VS.PROTECTIONISM

FREE TRADE

GATT GATT sought to promote free trade through the reduction and removal of trade

barriers, both monetary and non-monetary.

It sought to do so by the principles of reciprocity if one country makes tradeconcessions, the others must do likewise; non-discrimination treating all countries

equally and fairly; the most-favoured-nation principle any trade agreements made

between two countries applied to all members of GATT; and transparency

protectionism should be declared to other members and should take a visible form.

Carters Locomotive Theory From 1977 to 1981, the Carter (the then President of the USA)

administration emphasised collective management of

international economic relations.

This became known as Carters Locomotive Theory, whichcalled for coordinated national economic policies and for

countries with surpluses (Japan and West Germany) to follow

policies that encouraged growth, hence serving as engines of

growth for the international economy.

The main goal of this was to achieve international recoveryfrom the 1974-75 recession through the cooperation of the

major developed countries.


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REASONS FOR PROTECTIONISM Several key developments in the 1970s accounted for the slowing growth of trade and

the revival of protectionism. These included the collapse of the BWS and the shifting

nature of floating exchange rates, the oil crises, the intensification of competition from

Japan and the NICs and global stagflation.

Moreover, the USA was losing comparativeadvantage (its competitive edge) to Western

Europe, Japan and the NICs. While it still had the

highest absolute level of productivity, its business

sector had grown more slowly than that of other

industrialised countries since the 1960s.

Hence the USA resorted to new protectionism to

slow the influx of foreign imports. Japan and

Western Europe refused to co-operate with USA

and also resorted to protectionism to protectdomestic industries against competition from the

NICs. The USA thus had limited access to Japanese

and European markets and hence, could not earn from their considerable economic

strength.

DEFINITIONS Old protectionism, the practice of deterring the influx of imports through the means of

tariffs, existed from 1945-1970.

From the 1970s onwards, new protectionism emerged countries used non-tariffmethods to prevent imports from freely entering their markets.

New protectionism took place in the form of national policies such as subsidies and taxpreferences to help domestic industries, quotas, standards, regional trade blocs etc.

VOLUNTARYRESTRAINTAGREEMENTS (VRAS) Also known as Voluntary Export Restraints (VERs), these were meant to shield

industries that were threatened by foreign imports.

Under the VRA, low-cost exporters would voluntarily restricted sales to countrieswhere their goods were threatening industries and employment.

By the 1970s and 80s, VRAs had become an accepted mode of trade regulation andproliferated in sectors such as textiles, steel, automobiles, electronics and footwear.


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The USA negotiated various VRAs with Japan and many Third World countries betweenthe 1950s and 60s, such as the multilaterally negotiated Long-term Textile

Arrangement of 1962 and the Multi-Fiber Arrangement of 1974.

COMMONAGRICULTURAL POLICY(CAP) The European Economic Community (EEC) maintained the income of its farmers

through the imposition of a common, artificially high internal price by placing tariffs on

imports and purchasing surpluses.

However as production increased and world demand declined, the world commoditymarkets collapsed and agricultural producers in the first world experienced the worst

economic crisis since 1930. This resulted in an agricultural trade war.

The costs of the trade war were high that of CAP were estimated at $60 billion in1986, causing a budget crisis in the EU. That of the US rose sixfold from 1982-86 when

they surpassed $26 billion.

This led to an increase in agricultural conflicts.

IMPACT The increase in protectionism affected the structure of international trade. The primary

targets of New Protectionism were Japan and the Asian Tigers. Between 1980-83, the

share of their exports affected by such restrictions increased from 15% to over 30%.13

The increased protectionism also signalled the inability of GATT to reduce tradebarriers. Members simply side-stepped GATTs tariff regulations by implementing New

Protectionism. New Protectionism increased the overall extent of discrimination, shifting from trade

based on a non-discriminatory basis toward bilateralism, greatly intensifying the

politics of international trade. This marked the failure of GATT to uphold its Most-

Favoured-Nation principle.

The rise in protectionism served to highlight the failure of attempts to implementCarters Locomotive Theory, which emphasised economic cooperation. This was

increasingly difficult to achieve as relations between countries cooled due to

protectionism.

13Gilpin, p. 207


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7.DEBT CRISIS

BACKGROUND The debt crisis of the 1980s marked a period where the world debt problem reached a

magnitude that overwhelms the imagination.14 As the Time magazine described in

1984, never in history have so many nations owed so much money with so little

promise of repayment.

Total world debt soared from approximately $100 billion in the early 1970s to nearly$900 billion in the mid-1980s. The three largest debtors were Brazil ($99 billion),

Mexico ($97 billion) and Argentina ($48 billion).

REASONS The oil crisis, particularly the 1979 one, resulted in a massive increase in the price of

energy. This coupled with the increasingly protectionist tendencies of the developed

countries harmed the commodity export earnings of the third world.

Heightened interest rates (due to Reaganomics) also brought many nations to the brinkof bankruptcy. The ratio of debt to exports for Argentina and Brazil increased from

130% to 200% as a result.

IMPACT The debt crisis sparked fears that the default (inability to

repay debts) of a single major debtor could trigger a

financial panic that would cause the international

financial system to collapse.

It was a long-term economic and political problem thatthreatened both the development of the third world and

world economic recovery.

Moreover, since debt and trade were closely linked, thecrisis slowed the growth of international trade and only

served to encourage protectionism. Free trade was now

even harder to achieve, and the linkage between debt and

trade was a significant factor leading to the regionalism

seen in the third stage of the GE.

14Ibid., p. 317


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IV.ACTIONS TAKEN TO MITIGATE PROBLEMS

1.RAMBOUILLET CONFERENCE In November 1975, the six countries of France, the UK, West Germany, Italy, Japan and

the USA met at Rambouillet to work for greater stability in economic and monetaryconditions.

While some countries interpreted this greater stability as binding the US to deal withher fluctuating exchange rate, the USA had no intention of doing so. West Germany and

Japan also refused to revalue their currencies with respect to the USD. As such the issue

of exchange rates was not resolved and continued to breed instability in the

international monetary order.

The USA tried to promote the Locomotive Theory to get the other major industrialisedcountries to be engines of growth as well. Jimmy Carter had hoped that Western Europe

and Japan would co-operate to stimulate economic growth as the USA had done after

World War 2.

However, these refused to share the burden of sustaining the global economy.SIGNIFICANCE The Rambouillet Conference was the first unofficial summit that brought together the

Group of 6 (or G6). It set the precedent for

later similar summits held annually, such as

the G7 and G8 summits.

It also revealed the lack of economiccooperation and the refusal of West Germany

and Japan in particular to work in tandem

with the USA.

The USD continued to fall further and

Carter had no choice but to resort to

protectionist measures to protect the USA

steel industry from other competitive

Japanese steel industries.


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2.THE PLAZAACCORD15BACKGROUND In September 1985 at the Plaza Hotel in New York, a meeting was held involving the

USA, the UK, France, West Germany and Japan. After the negative experience with

Reaganomics, the USA agreed to cooperate more closely with the rest in monetary

management, particularly on the issue of intervention in exchange markets.

The US pledged to narrow its budget deficit by reducing government spending, whilethe others agreed to implement policies that would ease the economic imbalances (the

USA had a huge deficit while the other had great surpluses at the USAs expense).

This was followed by a coordinated exchange market intervention and a reduction ininterest rates, leading to a more reasonable exchange rate for the USD against the Yen

and the Deutsche Mark (recall that the USD was overvalued while the other currencies

were undervalued). The Plaza Accord marked the acceptance of Carters Locomotive Theory the beginning

of a new era in monetary management as the worlds monetary powers realised the

need to coordinate economic policy.

EVALUATION Limited steps were taken despite the agreements made in the Plaza Accord. While the

USA passed legislation to slow the growth of the US deficit in 1986, it failed to reduce

spending. Moreover, Germany and Japan only took limited steps to stimulate their

economies to offset the decline of the USAs economic growth. However an agreement

could not be made on the appropriate levels of budget cutting or growth stimulation. There were also disagreements on the appropriate exchange rate for the dollar, since

Japan and Germany feared that a decline of the US currency would damage their trade

and the value of their investments in the USA.

This resulted in the break down of cooperation with regards to exchange marketintervention and bred instability in the exchange markets.



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20 | P a g e H W A C H O N G I N S T I T U T I O N

( C O L L E G E )


3.LOUVREAGREEMENT16BACKGROUND In February 1987, the worlds monetary powers met at the Louvre to once more

attempt to stabilise the international monetary system.

It was decided that exchange rate had come into the proper relationship and henceleaders would cooperate to stabilise the exchange rates at the prevailing levels.

Again, the participants agreed to coordinate economic policies, with Germany and Japanagreeing to take steps to stimulate domestic demand while the USA renewed its

commitment to reduce its budget deficit.

EVALUATION The Louvre Agreement however failed to live up to its stated commitments to

coordinate policies. The German government was reluctant to pursue serious

stimulative policies due to the publics fear of inflation, and the US Congress and

administration were unable to agree on a significant deficit reduction package.

Cooperation disintegrated and private investors lost confidence in the dollar, whichbegan what seemed like a free fall in October, declining 15.6% against the Yen and

13.4% against the Deutsche Mark.

However, it must be noted that after the October crisis, the participants of the LouvreAgreement implemented massive coordinated action to stabilise the dollar, resulting in

the overall stabilisation of exchange rates.

The October crisis also led to the Gramm-Rudman-Hollings bill which was the firstbinding constraint on USA spending, aimed at reducing the USAs budget deficit.

IV. EVALUATION OF THE CRISIS YEARS It is important to note that the Crisis Years impacted the different countries in different

ways. The developed world was hit hard during these few decades, while the impact on

the developing countries was more severe, as seen in the 1980s debt crisis.

There were countries that were barely affected by the multiple crises occurring in theinternational economy such as the NICs, particularly the Asian Tigers.

Moreover, the Crisis Years marked the diminishing status of the USA while othercountries gained prominence, particularly Japan and China. Yet it must be noted thatthe USA still was the leader in the global economy.

16Ibid., p. 41


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It is also in the Crisis Years that we see the decline of the USSR, whose economicweaknesses eventually led to the end of the Cold War in 1991.

V. THIRD STAGE OF THE G.E.REGIONALISM AND GLOBALISM (1991-2000)

By the 1990s, the liberal international economy established at the end of WW2 hadbeen significantly transformed. The Bretton Woods principles of multi-lateralism were

replaced with bilateralism and discrimination, while the trend towards the

liberalisation of trade had been reversed.

There was a growing trend towards regionalisation due to the resistance of many firstworld economies to economic adjustment, as well as the threat posed by domestic

priorities to dissolve the unity of the liberal international economic order.

THE EUROPEAN UNION17

The EU added new members during the 1980s and 90s, namely Greece, Spain, Portugal,

Austria Sweden and Finland.

It also deepened its economic integration by planning a radical merger of their marketsto form a fully unified European market. This was formed in an attempt to rejuvenate

the European economy.

The Single European Act was approved by EU members in 1986. This eliminated theregulation of investment,

migration, product and

production standards,

professional licensing and many

other economic activities.

The economic and politicalmomentum of unifying their

markets pulled the EU towards

an even more radical proposal

the unification of all their

currencies.

The EU members adopted theMaastricht Treaty in 1991,which called for more

17Frieden, Global Capitalism, p. 384


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cooperation on various dimensions and set up a monetary union with the Euro as the

common currency.

As such the EU had all the economic hallmarks of a country: a single market, a singlecurrency and central bank, a common trade policy and common economic regulations.

This united European market would mark a new stage in economic co-operation wherecountries would work together for mutual economic benefit. However, the danger of an

even stronger Europe rising up against the USA was a grave fear of many.

NORTHAMERICAN FREE TRADEAGREEMENT (NAFTA) North American businesses also perceived regional integration as a means to improve

their competitive position. As such the USA created an initiative that gave countries in

and around the Carribean privileged access to the US markets. Canada and Mexico

joined and in 1994 the NAFTA came into effect.

As NAFTA removed virtually all trade barriers over the next ten years, a single NorthAmerican market began to take shape.

SOUTHERN COMMON MARKET (MERCOSUR) The worlds third largest trading-bloc was formed in South

America in 1994 between Brazil, Argentina, Uruguay and

Paraguay as full members, with Chile and Bolivia as

associates.

It drew together 250 million people with a combined outputof nearly two trillion dollars, fourth only to the EU, Japan and

NAFTA as a trading power. Mercosur hoped to attract more foreign investment since

global companies were often more interested in a larger

combined market than in any of the members alone.

RECOVERY OF THE USA After the crisises of the 1980s, the 1990s saw a positive

change in the global economy. Wth the end of the Cold War

and renewed global efforts at unity, the USA once again came to the fore of the political

scene. New markets opened up for reconstruction in the post Cold War era, thus

boosting the American economy. USA benefited immensely from the high technology, innovation heavy industries and

the dot.com booms.


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USA economy underwent rapid growth and expansion during this period. USAs GDPexpanded in the Clinton years by 38%.

By 1988, the USA had posted its first budget surplus in 30 years and by 2000, it had itslowest unemployment for 30 years. It also had a Gross National Income of US$9.7

trillion.

President Clintons main priority was to ensure eliminating the budget deficit,keeping interest rates low, and spurring private-sector investment.

a. Investing in people through education, training, science, and research.b. Opening foreign markets so American workers can compete abroad

Bill Clinton inherited from his predecessor, George H. W. Bush, a deficit of 4.7% of GDP.Clinton made the reduction a chief priority. Clinton cut federal spending and also raised

taxes of the rich to lower the deficit.

Clinton, unlike most other post-war Democrats, worked to keep the inflation rates low,and succeeded. The mean inflation rates of Bill Clinton were at 2.3%, which was rather

low when considering the fact that that is about half of the rates of past Republican

Presidents.

EVALUATION

Clinton managed to achieve lower unemployment rates by 14% in 1995. Some havecriticized him for causing loss of jobs because of his support

for free trade policies.

a. Even if Clinton did cost Americans some jobs because offree trade support, he allowed for more jobs to be

created, than were lost because the unemployment rateof his presidency, and especially his second term, were

the lowest they had been in thirty years.

Under the leadership of Bill Clinton, the USA drasticallyreduced military spending by 13% and raised taxes to reduced

the USAs budget deficit.

As such, the USA entered a period of peace-time economicexpansion, and managed to not only reduce the deficit but even

enjoy a budget surplus of $236 billion at the end of 2000. This

was the first time since before WWII that the USA was not in

the red.

Japan however, met with a prolonged recession that stagnated the countrys role inglobal economy. (Refer to later lectures for more information)


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VI. CONCLUSIONQUESTIONS TO CONSIDER: How great was the role of the USA in creating and/or exacerbating the problems

experienced by the global economy in the Crisis Years?

Did American economic dominance consistently lead to the growth of the internationaleconomy?

How important were roles of the rising Asian economies in promoting the growth of theglobal economy? Was their role exaggerated?

Global Economy-The Crisis Years

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