The case for structural financial deglobalization

The US Federal Reserve’s aggressive monetary tightening campaign has weighed on economies around the world, particularly in developing countries. With the dollar appreciating sharply against their currency, many emerging and developing economies have seen a rapid rise in borrowing costs and consumer prices, leaving local policymakers no choice but to raise rates. interest and jeopardize their fragile economic recovery.

Faced with soaring inflation, some low-income countries have pushed back against dollar hegemony. But instead of complaining, policymakers should consider insulating their economies from the greenback by erecting barriers to cross-border capital flows. To mitigate the effects of negative monetary policy spillovers, the world needs structural financial deglobalization.

When the Fed launched its quantitative easing program in the aftermath of the 2008 global financial crisis, it was accused of encouraging speculative capital flows to emerging and developing economies and fueling dangerous asset bubbles. . Now that he is raising interest rates to combat soaring prices at home, critics blame him for exporting inflation and financial instability by attracting capital to the United States. In both cases, the United States has been criticized for acting out of pure self-interest, even if it means forcing other countries to adopt beggar-thy-neighbour policies.

The Fed is therefore damned if it loosens its monetary policy and damned if it tightens it. But the uncomfortable truth is that countries around the world have chosen to open their economies to capital flows and expose themselves not only to US monetary policy, but also to fickle foreign finance and the institutions that control it. By ceding power, and often in the name of elite national interests, they have willfully made themselves vulnerable.

Attempting to downplay the costs of their Faustian bargain, policymakers in emerging economies have pinned their hopes on the international coordination of monetary policy. Some have pleaded with the United States to stop acting as a hegemon and consider the impact of its decisions on other countries, trying in vain to convince their American counterparts that it would be in America’s enlightened interest. .

But those hoping for monetary policy coordination seem to ignore the lessons of Covid-19. Even as scientists warned that the only way to end the pandemic was to ensure that most of the world’s population was vaccinated, the United States and other wealthy countries rejected global cooperation and instead accumulated doses. The result was vaccine apartheid and poorer countries had to scramble to get supplies.

Moreover, seeking global coordination seems like a wild ride at a time when the world is turning away from multilateralism. The international trading system has been under intense care for decades, not least because of U.S. trade barriers, while escalating Sino-U.S. rivalry could herald an era marked by economic fragmentation and geopolitical strife. At the same time, America’s domestic political polarization means that a new administration could overturn any American commitment.

So what is the alternative to dollar hegemony? Emerging market policymakers must resist the lure of financial globalization. Several studies, including one by Harvard’s Dani Rodrik and myself, have shown that cross-border flows of private financial capital do not promote sustained economic growth. The substantial benefits of financial globalization, if any, are too few to outweigh the costs of sudden shocks, capital flight and loss of political control. As bad as China’s policies have become under President Xi Jinping, China is one of the few countries still able to use domestic politics to cushion the current financial turmoil.

Emerging and developing economies need to let go of their narrative of victimhood and shed their illusions about global cooperation. Instead, policymakers should reclaim agency and control by returning to the relatively limited mobility of capital that characterized the Bretton Woods era.

This would require going beyond the timid measures proposed by the International Monetary Fund to mitigate the risks of temporary capital inflows. Developing and emerging countries should impose constraints on cross-border flows of certain forms of capital, especially volatile portfolio flows. Only “good capital”—for example, foreign direct investment that has a long-term interest in the recipient country and brings it technology, skills and ideas—should be allowed to cross borders.

The usual response to such proposals is that the genius of international finance cannot be re-bottled. But emerging economies can, in fact, restrict capital flows (albeit imperfectly and impermanently). It is up to local policymakers to decide, while cooperation to minimize the impact of dollar hegemony is controlled by the United States. It is hypocritical to embrace financial globalization and oppose it when it is not working for you.

More broadly, the world seems to have forgotten that excessive financialization is responsible for some of the worst economic crises of the past four decades. Capitalism must be saved from its financial rentiers, and financial de-globalization is a good starting point. As British economist and architect of Bretton Woods John Maynard Keynes once said, while ideas, knowledge and science are international by definition, finance should be “primarily domestic”. It’s time we listened to his advice.

The writer, Senior Fellow at Brown University, is a Distinguished Nonresident Scholar at the Center for Global Development and the author of Of Counsel: The Challenges of the Modi-Jaitley Economy (India Viking, 2018) © Syndicate Project, 2022

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