An earlier post commented on the calls that are intermittently made for a “New” Bretton Woods; as Boy Scouts say, “be prepared” for these calls to multiply and get louder as the year progresses.
Seventy years ago this July, representatives of the Allied and United Nations, then engaged in the final year of the Second World War, gathered at the Mount Washington Hotel, Bretton Woods, New Hampshire, to draft a truly remarkable document. The Bretton Woods agreement, which resulted from their labours, laid the foundations for post-war economic arrangements. The agreement was remarkable both because of the clarity of its vision and the underlying idealism that animated the document. (Lest readers accuse me of unalloyed naiveté, I am compelled to note that there was a healthy dose of economic and political self-interest of the principle parties embodied in the Bretton Woods agreement.)
The architects of the Bretton Woods agreement — Harry Dexter White representing the US Treasury and J.M. Keynes on behalf of the UK — set out to construct an international system in which access to markets and resources would be determined in transparent competitive markets; not through opaque state-to-state agreements. The lesson of the inter-war years was that the collapse of the open, liberal trade and payments system that had prevailed under the gold standard in the late 19th century had created a dysfunctional, asymmetric gold standard that imposed an intolerable adjustment burden: countries already in recession with balance of payments deficits were required to adopt austerity in order to drive prices down and restore international competitiveness. Of course, to get those lower prices, wages had to fall; and, with wages “sticky” downward, to get downward adjustment in wages, unemployment had to rise. (The same process, today euphemistically referred to as “internal devaluation,” explains the Great Depression levels of unemployment in some European countries). Eventually, however, widening social and political fissures forced countries to abandon the gold standard, and countries adopted a range of beggar-thy-neighbour policies designed to protect domestic employment at the cost of higher unemployment abroad. Currencies became inconvertible, prohibitive tariff barriers were erected, and international trade and payments collapsed.
In this environment, resources were increasingly allocated on the basis of a system in which governments sought to procure preferential access to natural resources and protected markets. With the outbreak of hostilities, this “Schachtian system” (after German Finance Minister Hjalmar Schacht) was strengthened by coercion in occupied territories. In this respect, the international system of trade and payments that Keynes and White set out to create was intended to offer a vision to which the peoples of the Allied and United Nations could aspire.
While not perfect, the international “architecture” that was painstakingly created over the next 70 years has, arguably, done a fairly good job of advancing that goal. Consider the remarkable integration of China and the decline in global poverty that has resulted from China’s re-emergence from economic, financial and political autarky. The challenge for the next 70 years will be to preserve the system in the face of major “transitions” that will stress the system. To succeed, the emerging powers will have to take on the responsibilities and obligations that go with their increased economic and financial power. All the institutions in the international financial architecture need to be aligned with this vision.
The question is: how relevant is the “system” to the challenges in the global economy of the early 21st century?
To address that question, it might be helpful to look at the challenges that the Bretton Woods architects confronted. As the Second World War drew to a close, four issues clouded the economic outlook.
- The threat of deflation hung over the negotiations at Bretton Woods, as participants worried that the switch from wartime production to peacetime pursuits, combined with demobilization, would lead to a return of the deflation and stagnation that prevailed in the 1930s. This was certainly true in the industrial countries of the “North” that were the principle combatants. It is less clear if such concerns were present in the developing countries of the “South,” though deflation in North America and Europe in the 1930s had a devastating impact on the commodity prices that dominated their terms of trade.
- The challenges of international adjustment — large imbalances in balance of payments — was, similarly, a preoccupation for all countries. The issue was especially urgent for the combatant countries of Europe and Japan, whose infrastructure was destroyed. But even non-combatants faced severe challenges as export markets were closed, while their ability to borrow in foreign capital markets was impaired by the severe debt problems they had experienced in the 1930s and their subsequent default.
- Public debt burdens, inflated by the enormous costs of waging total war, were also a major challenge to the industrialized countries of the North. The Bretton Woods system facilitated the slow, steady reduction of these debt burdens through a combination of financial repression (made possible by capital controls) and higher taxation. For the developing countries of the South, public debt problems were, arguably, less of a challenge because of earlier bouts of hyperinflation and/or the decision to default on foreign loans which reduced the burden of public debts.
- The final challenge confronting the participants to the Bretton Woods conference was the collapse of global trade flows that preceded the outbreak of hostilities in 1939. During the Great Depression, average tariff levels had risen to prohibitive levels. Creating an environment conducive to bringing those tariffs down and restoring trade flows to a moribund global economy were key objectives of Bretton Woods.
So, how does the current outlook compare to the situation prevailing 70 years ago? The table below attempts such a comparison. (Caveat lector: this assessment may reflect my personal biases as much as any analytical criteria; others will no doubt come to different conclusions.)
The first point to make concerns the threat of deflation. In contrast to the prevailing consensus at Bretton Woods, I suspect that most people today — in the North or South — don’t lose sleep over the potential for a deflationary stagnation to grip the global economy. But, whereas these concerns were misplaced 70 years ago, as officials misjudged the extent to which the purchasing power accumulated in wartime savings would fuel a post-war consumption boom as production lines switched from armaments to consumption goods, I worry that the threat today is underestimated. This is certainly true for the mature advanced economies of the North facing major demographic challenges. It is less clear that the rapidly-growing dynamic economies of the South have as much to fear.
The second observation is that, similar to the situation prevailing at Bretton Woods, both the North and the South have challenges with respect to external imbalances. The nature of these challenges differs; but both have a mutual interest in the timely, orderly unwinding of imbalances and the continuation of the international system of trade and payments.
The situation is rather different between North and South with respect to public debt burdens. Indeed, the past two decades have witnessed a remarkable reversal, with most industrial countries of the North with much higher public debt burdens relative to the dynamic, rapidly-growing economies of the South. As the post-war experience illustrated, a growing economy is probably the most effective way to bring debt burdens down over time. This underscores the need for both the North and South to work together to rebalance the global economy to provide such an enabling environment.
The final point to make is a happy note on which to end — in contrast to the situation at the end of the Second World War, the global trading system has remained remarkably robust despite the shock of the global financial crisis. That being said, a failure by the international community to effectively address the other three challenges could result in a situation in which countries “defect” from the cooperative equilibrium that the international architecture has supported and once again resort to policies that, in Keynes’ evocative language, are “destructive of national and international prosperity.” Such policies would not be beneficial to Keynes’ and White’s system in which access to markets and resources are determined in transparent competitive markets; not through opaque state-to-state agreements.
Adjustment Challenges