Welingkar Institute of Management Research and Development, Mumbai
Researched by
Mihir Naik
Saurabh Malhotra
Presented @ IBS, Hyd; Dec 08
“Mr Gorbhachav, tear down this wall”- June 12, 1987
Globality in all probability can be traced back to this these iconic words uttered by Ronald Reagan. This signified the beginning of the end of the eastern communism as the world had known it.
After World War II, the work of economist John Maynard Keynes came to be widely accepted in Western economies. Keynes believed in government regulation of the economy, and had great influence on governments. The political change of the 1980s ushered in a change of economic policy. The old trend changed when Margaret Thatcher became prime minister of the United Kingdom, and when Ronald Reagan was elected President of the United States. Both these leaders parted ways with Keynesian economics. Rather, they were more in the tradition of the work of Friedrich von Hayek, who opposed government regulation, tariffs, and other infringements on a pure free market, and Milton Friedman, who emphasized the futility of using inflationary monetary policies to influence rates of economic growth. While Thatcher, Reagan, and their successors made sweeping reforms, the current era of globalization finally began around 1991, with the collapse of the Soviet Union. Since then, they argue, countries embracing free markets have prospered on the whole, while those adhering to central planning have failed. Globality: An Introduction Globalization refers to "the compression of the world and the intensification of consciousness of the world as a whole" (R. Robertson, Globalization, in his 1992 book). In thought and action, it makes the world a single place. Globality is a term in both academic and business use that refers to the end-state of globalization - a state in which the process of globalization is complete or nearly so, barriers have fallen, and a new global reality emerges. This results in interdependence of economies. Globality has shown its face in the past, and it will in the future. After all, history repeats itself. Looking back at what happened in Russia in 1990 when the exchange parity between rouble and dollar stood at 4 Roubles to 1 US dollar. Rouble was considered strong, whilst USD was considered speculative. When Gorbachev introduced democracy in parts, there was revolt and counter revolt. Then Yeltsin came to power. But he had no clue of market economics. In communist Russia, prices of all commodities were determined by the Government. There was no inflation for decades. In short, there was no market economy in Russia. Yeltsin wanted to introduce capitalism and total democracy.
In Russia laws were changed by dictate of the President. He issued order and removed all regulations. Russia became more capitalist than USA. Market totally collapsed. Government had no money. Therefore Russia was forced to withdraw army from Afghanistan and Eastern Europe. Thousands of soldiers were retrenched as government had no money to pay. They became mafia who knew nothing else than to run guns. Through all these events started massive depreciation of rouble. From four roubles to a dollar - to eight roubles to a dollar, from eight to twenty and from twenty to hundred roubles to a dollar. Nobody knew what was happening. Yet no one outside Russia was concerned because the world did not use Russian rouble for international trade and western countries wanted Russia to fall. The exchange parity deteriorated so much that today it is almost 31,500 roubles to one US dollar. Russia has simply deleted three zeros from its currency. So 1,000 erstwhile roubles are now called one rouble. Current parity is 31.5 roubles to a dollar.
Economists were puzzled by this sudden change in, purchasing power parity, chart, fundamentals, technicals - nothing could justify depreciation of four roubles to a dollar to 31,500 roubles to a dollar. Russian economy was totally in shambles.
The long term effects were not evident yet. Western resources now started freely flowing into eastern block. The strong capitalist nations were free to explore uncharted territories. Mc Donalds Big Mac was available in the Red Square for 50 roubles.
Looking forward to 1997 Thailand accepted "Western advice" in full and lifted all controls. There was no foreign exchange control except that Thai Baht was linked to US dollar. So the value of the baht vis-a-vis dollar was fixed. There was no way of changing it. That encouraged people in Thailand and they felt that there was no exchange risk at all. Thailand, a developing country, had some scarcity of finance. Interest rates were around 20% p.a. If you borrow in Yen, interest rate was 1% p.a. Smart merchant bankers advised Thai businessmen to borrow in yen at interest rate of 1% p.a. There is no way one can convert yen into baht, so they converted yen into dollar and dollar into baht. The whole process would cost three to four per cent p.a. Borrowing at 4% p.a. and lending @ 20% p.a. in Thailand, there was a straight gain of 16% p.a. There was no exchange risk as dollar baht exchange rate was fixed and baht was considered as strong currency. Huge amount of foreign investments, FDI, FII, portfolio investments were freely flowing into Thailand. By the simple demand and supply rate baht used to go up. There being no perception for Baht to depreciate, nobody insured himself against exchange loss. So nobody did any hedging at all. Banks also went ahead, borrowed in Yen and lent in baht in Thailand.
Somewhere around June, 1997 Yen appreciated, say from 120 Y to 115 Y to one US dollar. It meant that those who had lent to the Thai investor, wanted some increase in margin money, say by 10 per cent. How do you increase margin because all your money was invested in either share market to real estate! Now the Japanese who were the main investors saw massive appreciation Yen against the US Dollar causing a shift in Thai investments. The only option left for Thailand was to delink its currency from the US Dollar and depreciate it by 20%. However, Thailand saw it as humiliation and did not yield.
Similar situation were taking place in other Tiger economies like Indonesia, Malaysia and South Korea. Foreign debt-to-GDP ratios rose from 100% to 167% in the four large ASEAN economies in 1993-96, and then shot up beyond 180% during the worst of the crisis. In Korea, the ratios rose from 13-21% and then as high as 40%, while the other Northern NICs (Newly Industrialized Countries) fared much better. Only in Thailand and Korea did debt service-to-exports ratios rise.
America had another financial weapon in its arsenal: Devaluation.
Devaluation is an exercise which nobody notices to be directly harmful. In fact, people believe (they are made to believe) that devaluation is good for them. A strong country like China does not take kindly to the arm twisting by U.S. It did not change its policies after the Tiananmen Square incident. The other countries silently withdrew their threats and boycotts. The U.S. threatened China with non-renewal of the Most Favoured Nation Clause (MFN). In June 1994, Clinton chew his own words and announced delinking of human rights from trade. China did not budge a single inch. So, like it or not, China is an independent country. However, when it came to devaluation, even China was fooled initially. It has devalued its currency many times. It appears, now China has realised the game behind devaluation. In 1997, the Chinese currency was attacked. China protected its value. Now it is reducing the weightage of U.S. $ in its currency reserve. It is also preparing for the use of Chinese currency - instead of U.S. $ in its international trade.
When the Middle East currencies are valued lower than the Purchasing Power Parity (PPP) rate, they get less for their crude petroleum and pay more for the imported products. However, in the Middle East which Government is independent of USA? Who can think in terms of economics in a manner deviating from USA? This subject itself can be a separate story. In short, why are the Arab terrorists so strongly against USA? They know that U.S. is exploiting them; and they could not do anything with their non-democratic governments. They have found their own way of retaliating.
Possible Aftermath of Globality
West believed globalization to be a tool it can use to manipulate and use eastern economies to strengthen its position. To their credit they have used the same for centuries effectively. But as the process of globalization is reaching its culmination, the west has started witnessing what the state of globality will mean for it. Thomas.L.Friedman says there are the two basic responses to globalization: Infosys and Al Qaeda.
Infosys said all the walls have been blown away in the world, so now we, an Indian software company, can use the Internet, fiber optic telecommunications and e-mail to get super-empowered and compete anywhere that our smarts and energy can take us. And we can be part of a global supply chain that produces profit for Indians, Americans and Asians.
Al Qaeda said all the walls have been blown away in the world, thereby threatening our Islamic culture and religious norms and humiliating some of our people, who feel left behind. But we can use the Internet, fiber optic telecommunications and e-mail to develop a global supply chain of angry people that will super-empower us and allow us to hit back at the Western civilization that's now right in our face.
Let us take some time to look at the causes of the same.
It is a well known fact that the west was low on resources but high on finances. On the other hand, the developing nations were rich in resources like manpower, oil etc but low in forex reserves. Once the Berlin wall fell, the western economies freely moved into these new territories, for ex: India after 1991, into China through Hong Kong in 1999 etc. This caused a void in manufacturing in western economies eg: GE outsourced making of toasters to China, Medical transcription was outsourced to India leading to unemployment in the western world. This was only made worse by the sub-prime crisis.
Though the west started this outflow of resources in 1990s, a major turning point in its relation vis-à-vis the east came around in 2001 Doha Round of WTO talks. Apart from inclusion of China, the biggest symbol of communism in WTO it had to give up on a lot of issues.
A failure at Doha would have undermined the American effort to build a coalition in the war against terrorism and the United States exerted an enormous effort to accommodate the less developed countries. The Doha guidelines, for example, water down patent protection for brand-name drugs by giving poor countries the right, in emergencies, to license inexpensive generic versions. That was a big concession to AIDS-ravaged Africa
Similarly, the antidumping rules that protected America's steel and lumber industries from lower-priced imports have become less protective.
Globalization is gradually slipping from the control of the United States and the other industrial nations. The developing countries are gaining ground in a few battles. The protests that started in Seattle in 1999, the third world poverty made worse by recession, the ravages of AIDS in Africa, the anti-American sentiment stirred up in the war against terrorism, the sudden pressure to turn critics into wartime allies -- all were felt in Doha, and the agreement that emerged was harder for Washington to savor.
Constant tariff reduction is only one aspect of globalization, which has come to mean not only the increasingly unrestricted flow of merchandise across borders, but also the free flow of money, people and all sorts of services. Bankers, lawyers, brokers, insurance companies and investment firms routinely operate from offices in a dozen countries. Merchandise trade, which once meant making a product in one country and exporting it to another, now means making a product in phases in several countries.
A Kodak instant camera sold today in France may have been assembled and packaged in that country, but the camera mechanism came from a Kodak factory in China, and its film from the United States. Cameras, and many other products, are no longer even made in America, which helps explain why Kodak and other powerful companies struggle to influence the rule-making that governs the globalization of their activities -- and to bring as many countries as possible into the World Trade Organization and thus commit them to the rules.
Owing to this there is a rise in unemployment in the US and UK, and is spreading to almost all the EU nations. Europe for example is already in the state of recession. Eastern countries, now rich in forex are poor in significant resources like land, which is important for building up infrastructure, agriculture etc. A steep rise in population in China and India and a reluctance to migrate by the younger generation means that there is a high population present in these countries who are of the working age causing enormous increase in prices of land, food, education etc. The west however has an aging population and a vast reserve of unused land and infrastructure. Government of the developing nations should encourage the corporations to build and transfer resources to the soon to be defunct western economies.
Conclusion
We conclude by saying that west now has lost the grip it had over the process of globalization and has started suffering the consequences. We propose that the next step in this era of globalization should be the transfer of money and resources from the developing economies to the western economies and that would be the only way the world as we know it will be able to survive.
