Most Favoured Nation: Post Neoliberalism, The Baby, And The Bathwater

Guest post by Karthik Sankaran

Hi everyone, I’m very pleased to announce that Karthik Sankaran, has agreed to occasionally write for MFN on big macro issues that impact international trade and the global economy. Karthik has at various times been a modern historian, emerging markets journalist, and global macro portfolio manager and strategist. He is also an incorrigible and prolific source of terrible puns. My hope is that this provides an informative reprieve from all of my usual badgering on about niche technical issues and a more global context.

If you like what you read, please do sign up to Karthik’s Substack, which he promises to populate with more content soon. Meanwhile, he can also be found procrastinating on Twitter as @RajaKorman. 

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A chorus of recent hurrahs on both left and right, particularly in the US, has greeted the end of the neoliberal age and the dawn of post-neoliberalism. These celebrations have even breached the august walls of the salmon-colored newspaper I have heard described as “the house organ of the globalist nomenklatura” (the highest accolade, in my own book). See here and here, for example. 

While the word neoliberalism is often little more than an imprecise term of abuse, it does capture a political ambition in the early 1980s that —relative to the post-WW2 North Atlantic consensus — sought to shrink the role of the state relative to markets. The goal was a reduction in government provision of public goods, and a deregulation of the domestic and international activities of corporations.

But while this ambition did spread across much of the political spectrum in the 1990s, left-right divisions on austerity (and at whom it should be aimed) never went away; and there was an even wider spread between the GOP and Democrats on the desirable extent of domestic regulation. However, there was more agreement about deregulating the global activities of corporations—their decisions on sourcing goods, personnel, investments, and sales opportunities — both on the way up, and on the way down . While there were sceptics in both parties (Pat Buchanan and Richard Gephardt), there was a broadly shared view on the desirability of globalisation in the 1990s and early 2000s. This then turned by late 2015 (when Presidential candidate Hillary Clinton chose apostasy on the Trans-Pacific Partnership) into a bipartisan scepticism about globalisation that has only since hardened under Trump and then Biden. 

This consensus across the aisles owes to several concerns — maintaining US primacy in military technology amid a deepening rivalry with China; a quest for resilience in the aftermath of the pandemic supply-chain crisis; and a long-standing popular hostility to offshoring jobs in the fulcrum of American Presidential and Senatorial politics—the upper Midwest. And with intractable differences between the parties on how (or even whether) to fix the issues in America’s non-tradeable sector that most concern people —cost and access in healthcare, housing, and higher education — the one aspiration of post-neoliberalism most likely to stick is deglobalisation. I say aspiration because there will undoubtedly be resistance to such an agenda as well, particularly (but not exclusively) from corporate America, which is significantly less enthusiastic about decoupling from China or repatriating production to the US than are politicians. I have made such an argument here.

Even so, this is still a problem because the form of globalisation that seems most distasteful in this reading is the huge increase in the goods trade, but that increase is precisely what has been overwhelmingly positive for a big part of the world’s population, particularly in developing Asia. This is because it allows countries to engage with the global economy through steadily increasing participation in manufacturing supply chains, which in turn has allowed a gradual ascent up the ladder of technologically complex exports. And this has been a far superior integration model for developing countries than one based on commodity exports and static comparative advantage. 

This is obvious from a comparison of the growth trajectories of East and South Asia versus those of Latin America over the past two to three decades. There is a case that successful sustained development has come down to two policies—increasing the technological sophistication of a country’s export mix, and avoiding serial balance of payment crises. These two policies are also likely to be mutually reinforcing—a more sophisticated economy likely has a tradeable sector more responsive to shifts in the exchange rate, allowing a cyclically weaker currency to support domestic activity in a downturn. And welcoming foreign direct investment in greenfield plant not only leads to less flighty inflows that sit lower in the national capital structure than overseas debt, but it also transmits managerial, technological, and logistical skills. 

In a seminal article more than 25 years ago, trade economist Jagdish Bhagwati argued that while trade in “widgets” was beneficial, excessive openness to flighty flows of foreign portfolio capital increased balance of payments vulnerabilities. High integration in the trade in global manufacturing supply chains and lower capital market integration is the path that much of Asia followed after the 1997 crisis— the opposite of what South America has been doing for decades. A more piquant version of this observation is that any competent emerging market policymaker who understood The Volatility Machine (TVM), Michael Pettis’s masterly book that tied emerging markets’ financial structures and their propensity to crises, would take the steps that led to the world of Trade Wars are Class Wars (TWACW). The latter, Pettis’s most recent work coauthored with Matthew Klein, locates many of the most significant stresses in the international economy in the consumption-suppressing behaviour of the large trade surplus countries—Germany and China above all.  I have argued against one widely prevalent version of this view — dollar centrality as an “exorbitant burden” here.

The larger point is that the big difference between the world of TVM and the world of TWACW is that, in the first instance, the costs of bad policies and difficult coordination problems are borne almost entirely by developing countries. But in the second, “successful” (from the point of any single developing country) adaptations to such systems blowback to parts of the developed world as well. 

From a world-historical point of view, such adaptations have been enormously successful on a few fronts. The first is the massive increase in the productive capacity of East Asia, a region that now accounts for about half of global manufacturing value added. The second, of geopolitical importance, is that the centre of gravity of the global economy has moved decisively over four decades from the North Atlantic Basin to the North Pacific Basin. And the third, most profound, transformation is that for the first time in the 220 or so years since the Industrial Revolution, the ability to export technologically complex goods at scale does not depend solely on a country’s current level of aggregate per capita income. Income does indeed rise with increased economic complexity, but high incomes need not precede complexity. 

This last transformation is rooted in political, technological and logistical changes that allowed outbound investment by multinational companies targeting exports back into advanced economy, a process described by Richard Baldwin in his book the Great Convergence. It has been a far more potent mechanism for broad technological diffusion than anything else seen over the last 70 years. These changes have led to the distinguishing character of the second great age of globalisation identified by Branko Milanovic — the simultaneous fall in intercountry inequality alongside a rise in intracountry inequality, the obverse of what was observed in the first age of globalisation before 1914. One might say that GATT resurrected what Gatling destroyed. [Ed: **sigh**]

This has proven to be the real New International Economic Order, albeit one that has thus far mostly influenced only portions of Asia. Nevertheless, it is still more potent than the 1970s pipe dreams of ‘cartelising’ less critical commodity exports to give other developing countries the market power and prosperity OPEC members came to enjoy. One great way to see this process in action is to play the online game Tradle, hosted by the Observatory of Economic Complexity, and see how similar the export product mix in some poorer ASEAN members looks to that of somewhat richer central and eastern EU members (low percentage cheese, wine, and palm oil are useful differentiators). Conversely, the ease of recognising a South American or African country by the preponderance of primary commodities in its export mix is a (depressing) reminder of how unevenly distributed the process of trade-driven complexity enhancement has been. 

One issue is how the rhetoric around globalisation itself has changed under the post-neoliberal paradigm. The flip side of repeated accusations of a “race to the bottom” (a term often used by USTR Katherine Tai) by developed world corporations expanding production overseas is that countries experiencing successful catch-up growth through export diversification are in a race towards the top in terms of complexity. Similarly, charges that companies are choosing to move production overseas in response to higher domestic wages rather than increasing domestic investment seem to ignore that there is indeed capital deepening happening and is most likely happening precisely in countries that are more “capital-short.” 

There are undoubtedly more sound reasons for complaint, particularly in China, where the combination of hukou regulations and a paltry social safety net have sharply limited consumption possibilities for the mass of the population in a country that has been a massive beneficiary of these processes. But even if these changes did occur (and I sincerely hope they do, and fear that they will not happen fast enough), I doubt that these alone will restore labour-cost-parity with developed markets at many of the higher complexity levels that China is currently targeting. The changes described by Baldwin mean that in certain countries, linkages to markets at the technological frontier have made it possible for inbound (and increasingly endogenous) investment to create large archipelagos of complex tradeable industries that “outperform” the aggregate economic conditions of the country they are located in. And while that is a good thing in itself, it potentially creates an environment where those changes are diffused into the broader economy—an even better thing. 

Meanwhile, the real human problem on a global scale is less what happened in pockets of the developed world, and more the fate of those who were or will be locked out of their process of technological convergence. And current nostrums from those hostile to globalization sound uncomfortably like limited-market-access, lots of Peace-Corps style green technical assistance, and a ritual thaumaturgic invocation of Federal Reserve swap lines (a temporary liquidity expedient that does little to cure structural balance of payments problems).

My worry is that the politics of actually-existing post-neoliberalism will lead most naturally against globalisation of the goods trade in particular while leaving unfixed (or potentially worsening) intractable issues in the north Atlantic basin. These include horrific supply-side incentives in the US in markets for healthcare, housing and higher education; and those aspects of corporate globalisation associated with transfer-pricing tax arbitrage (as opposed to genuine outbound Greenfield plant and technology transfer). On the other side of the Atlantic, it could prove easier to build a consensus around threats from rising technological powers than to fix the architectural flaws that make it harder for the Eurozone to muster a combined fiscal capacity or the persistent inability to arrive on the consensus needed to build a banking and capital markets union.  

The risk, then is that on a global scale, despite its best intentions, post neoliberalism will not just throw out the baby, but may even end up keeping the bathwater.

Best,

Karthik