The Current Financial Crisis and Global Capitalism

The Current Financial Crisis and Global Capitalism


Perhaps it is best to step back a little in time to understand what has been going on. Certainly there would not be many individuals who would argue that the epicentre of the current crisis is centered on Wall Street and the massive (fraud some might say) issuance of Mortgage Backed Securities on the World Financial markets. This has led us into a major recession, possibly depression, and the possibility of a major setback in global growth and possibly global trade. The mispricing of MBS bonds and the massive housing boom created in America, and some other countries, is viewed as a typical free market over reaction, leading to normal boom and bust; events fairly common in the economic cycle. However, this is turning out to be nothing resembling a common recession. We are at a major turning point in the evolution of the global economy. In the 1930’s Capitalism itself was on trial, and many expected that its end was near. By taming it somewhat, putting in shock absorbers, and guiding it along, eventually revived capitalism; while communism or socialism, its supposed successors, have lost their shine and appear to have receded as alternatives to our current capitalist system. Today the questioning is not around Capitalism, as we have no rivals to replace it with; what we are questioning is global trade. Global trade which has been so positive in bringing millions of people out of poverty is on trial, due to the impact of competition on developed economies’ consumers.

We are therefore at a crossroads, just as in The Great Depression, we are questioning whether to kill the goose that laid the golden egg. Why have we become so disenchanted with global trade, and more specifically global capitalism? In total, global capitalism has benefited the world economy. When we look for specific winners and losers, we get a somewhat different view, or perception. We would all agree that Global Capitalism has benefited, the most, developing economies such as China, Brazil, Mexico, and India. We would also agree that OPEC countries and Russia have benefited from the rise in demand for oil. Resource rich countries have benefited from the demand for iron ore, copper, nickel, agricultural products, and livestock. The developed world has benefited from increased competition through lower consumer prices for manufactured goods. All in all, not a bad report card; however we must now also look at the losing side of the ledger.
On the losing side, the biggest losers have been the developed worlds’ current and former manufacturing workers whose jobs have been transferred to places such as China and Mexico, or whose salaries have been kept down by the pressure to compete against workers who are prepared to accept a lower standard of living. To these individuals, Global Capitalism is not quite viewed as a positive force. There are of course other consequences, such as greater amounts of pollution being produced by countries whose environmental standards are not comparable to the developed worlds’. Although prices have been kept down overall, the rise in demand for oil from emerging economies has had an impact on the price of gasoline worldwide.

The real problem that we are facing is that the adaptation to Global Capitalism is not reaching its end, but is only at the beginning. The modern corporation has learned to segment its business in such a way, that it produces in the least costly geographic entity, sells its wares in the geographic entity where it can get the highest price, and reports its profits in the geographic entity where it can minimize its taxes. Moreover, the modern corporation will play one government against another to obtain financial concessions to build or not close a given plant or facility. As all politics is local, politicians have not looked at the greater picture, but have focused on getting as much as they could to ensure local growth, or support for the local economy. This type of competition for investment dollars, after all, is nothing new, and not only international, but national as well. What is different is that on a national level, there are some rules to play by. On an International level, rules are vaguer and can more easily be gotten around.

Governments have been dealing with Global Capitalism for over 30 years at least and the developed world’s economies had been adapting rather well it seemed. There were two problems; politicians generally have been focusing on short term remedies, and the globalisation has moved well beyond manufacturing. Let’s look at these two individually.

Politicians, in the developed world, have been telling their citizens that the way to be more productive is to move up the production economic ladder. The theory being to let the developing economies produce the simple widgets, and gadgets, while the developed economies workers could focus on the higher end products, such as aerospace, automotive, healthcare, information systems, R& D, etc. This is certainly a valid strategy; however, these areas do not produce many additional jobs. The surplus labour has tended to be absorbed into the service economy. This has worked relatively well, as the service economy has the advantage of requiring local labour, or at least that was the thinking. The problem with the service economy is that it tends to produce lower paying jobs. This has had the effect of moving the average family from a single bread winner, to two bread winners, and thus maintaining their standard of living. This was not a big sacrifice, as house work has become highly automated as well as farmed out to the service economy (restaurants, dry cleaning, etc). Additionally, women were more than happy to leave the drudgery of the home, thus the two income family was welcomed, and the single income family was viewed as a relic.

Looking at the second problem, that is, that globalisation had moved well beyond manufacturing, we see the beginning of the need to address longer term globalisation issues. Globalisation no longer focuses solely on transferring blue collar jobs to developing economies. With the advent of the internet and instant communication, jobs as diverse as engineering, accounting, call centers, information processing, Research and Development scientists, and why not, middle level managers; could now be transferred to the developing economies such as India and China; economies that produced more University graduates in one year then the developed economies produced in a decade. Moreover, an engineer in India could be had for $10,000, while a similarly qualified engineer in the developed world could be had for ten times that. Companies such as IBM have been increasing their developing world staff significantly, while cutting their developed world staff. For corporations this was a no brainer, if we wish to remain competitive we have to reduce our labour cost. The way to reduce our labour cost is to transfer knowledge jobs, as well as service jobs to the developing world. For example, the Cruise ship industry is nothing more than packaging a developed world vacation into a developing world cost structure. Management of the Cruise Ship Company is handled out of New York or London, while ship staff is from Indonesia, Philippines, or Columbia. The design of the ships is done in California, while the actual ship building is done in the European or Asian nation that provides the greatest subsidy to the dry docks facilities. Cruising has become so successful that now there are plans to have medical ships that would actually dock in a third world country, local doctors would perform operations, and the ship would act as a convalescent hospital while transporting patients back to their home country. Another initiative is to create some type of retirement home, or convalescent home for the elderly. Why pay developed world salaries, when developing world labour is so abundant and inexpensive. Other creative approaches include moving a company to a Caribbean island for tax purposes, outsourcing accounting, IT, engineering, to a place such as India, while focusing on design, sales and marketing in a developed economy country. The permutations and combinations are endless.

The results of these trends have been to create a growing boom in the developing world, and strange enough a growing boom in the developed world. How is this possible? As the developing world produced greater products and services, they were mostly to satisfy the demand of the developed economies, as the local workers were paid wages that were so low that they could not afford to buy the products they produced. This created a trade surplus for the developing world, and a trade deficit for the developed world. The developing world wishing to stay competitive, not only with the developed economies, but more so with competing developing economies; undertook policies to keep the value of their currencies low. They did this by recycling their foreign reserves into the developed world economies currencies, such as the US dollar, the yen and the Euro. This money eventually found its way into Wall Street hands, and the US and other housing booms were underway. As the money could not be invested in productive endeavours in the developed world, it went into unproductive endeavours such as US government bonds and Mortgage Backed bonds. As the US $ was the International Reserve currency, it had the effect of keeping interest rates down and this lead to massive lending to the housing market. The US consumer being squeezed financially by suppressed wages due to the Globalization effect borrowed heavily hoping to make enough money for his retirement through investment and housing profits, and not through savings.

One other significant impact of Global Capitalism has been to dramatically alter the income distribution curve. This happened as the value of head office personnel rose, while the value of the middle manager and the industrial worker stagnated or fell. The top 5% of the population began amassing larger and larger portions of the income generated by the economy. The effect of this was to ultimately increase production capacity while at the same time lowering consumer demand. As income became concentrated, it generally went into investments all over the world. The greater the concentration of wealth, the greater the risk the investor is willing to take. This stands to reason, as a billionaire will be much more capable of absorbing a $100 million loss, then a simple millionaire will be capable of absorbing a $100,000 loss. The billionaire has much more room to manoeuvre and will consequently take greater risk. On the consumption side, consumers wanting to spend more could only do so by borrowing, as their income either stagnated or fell. They borrowed from their banks by mortgaging their houses to the hilt, by obtaining multiple credit cards and making only the minimum payment, by leasing their cars rather than buying them. For a while it looked that all was well. The rise in asset values whether in the stock market, or real estate, created a false sense of prosperity.
The hope was that at some point there would be a significant rise in demand from developing economies’ consumers, to offset the eventual reduction in demand from the developed economies’ consumers. Of course, this was not going to happen given the intense competition for jobs in the developing world, and the consequent low wages paid to the labour force.

Like in the great depression of 1929 capitalism has once again tilted dangerously towards concentration of capital, and an out of balance bargaining position between capital and labour. This has happened because in a world where capital and goods can move to anywhere in the world they choose, labour has remained stuck in the old Nationalist Ideology of the monolithic Nation State. Corporations have played one Nation State against another while at the same time reducing the power of labour. It was a great run for 30 years. We now see its consequences and the need to again place some rules around capitalism to tame its tendency towards extremes. Unfortunately, we do not have the international institutions in place to define, implement and manage these required changes. As long as we think nationally and not internationally we will not be able to adjust the economic eco-system that has sprung up, that is Global Capitalism.