Welcome back! This month’s episode covers a lot of ground. What is “free trade”? What does Mary Poppins have to do with John Hobson? What do most people miss about Ricardo’s theory of comparative advantage? How can poorer countries make the global financial system work better for them? How should people outside the U.S. think of the Inflation Reduction Act? And more!

The first 20 minutes are free for all, but the full conversation—and full transcript—are for paying listeners. Please consider subscribing to get the full experience!

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Related Links:

Whither Globalization? And What Would that Even Mean, Anyway? (Matthew Klein)

Fighting Global Protection: Why the Economist is Mistaken (Michael Pettis)

Britain can learn from Singapore on savings (Martin Wolf)

CFR Global Imbalances tracker (Benn Steil)

The peak globalisation myth (Richard Baldwin)

Mary Poppins bank scene

Thanks again to White+ for the music and to George Drake Jr. for producing!

The full transcript is below, lightly edited for clarity.

Matthew Klein: Hello, and welcome back to UN/BALANCED, a listener-supported podcast about the global economy and financial system. I’m Matt Klein.

Michael Pettis: And I’m Michael Pettis. Today we’re going to discuss globalization—what it is, how it’s doing, and something that’s come up a lot recently: whether or not the U.S. government is endangering it via green subsidies and “Buy American” provisions.

Matthew Klein: Let’s ask the big question, which I think a lot of people don’t necessarily ask when we try to grapple with this topic, which is: what is globalization? How should we think about that? And then maybe from there, we can question of whether it’s good or bad or not.

Michael Pettis: I think globalization is one of those words that’s both extremely useful, but also fairly useless, in the sense that I don’t really think it makes sense to talk about one “globalization”. I think there are lots of different kinds of globalization.

You know, Keynes famously discussed these various types of globalizations—and I’m paraphrasing him, of course, because he never used the word “globalization”. But he talked about the globalization of ideas, which he was all in favor of, by which he meant the free flow of information and ideas around the world. He talked about the globalization of trade, in which he was largely in favor. He talked about the free flow of goods and services around the world, but he did recognize that there were limits, or he believed that there were limits to the optimal amount of free trade around the world.

I’m sorry: before trade, he talked about the globalization of migration—the free flow of people back and forth, which he was also very strongly in favor. He recognized there were limits, but he was very strongly in favor of that. And then finally he talked about the globalization of capital, which of course is the free flow of capital around the world. And he was very skeptical about that.

So in his hierarchy: totally free trade in ideas; pretty much free trade in the flow of people around the world; constraints on the free trade of goods and services around the world, but generally a good idea; and significant constraints on the free flow of capital around the world. And we can talk a little bit about particularly what those last two things mean.

The other thing I would add to this issue of globalization is something that you and I have discussed and have written about, and that is that the free flow of goods around the world can occur in many forms.

One of the things that I think we try to distinguish in in our book—and it’s certainly something I’ve been speaking about a lot recently—is that there is a trading system in which countries compete by increasing productivity, and there is a very different trading system, which is the trading system I think we actually live in, in which countries compete primarily by putting downward pressure, directly or indirectly, on wages.

As we explained in our book, the latter form of free trade is exactly the free trade we don’t want, because it’s the kind of free trade that puts downward pressure on global demand and global growth, whereas the former kind puts upward pressure on global demand and global growth.

So let me stop there and just say that what we really should be talking about is not globalization, but kinds of globalization and the globalizations that we want.

Matthew Klein: That of course leads to the question of why we ended up with the globalization that we did. If we’re looking at historical context, you mentioned Keynes, who’s always a very good guide for understanding any kind of big question.

Someone I also think about—someone who I think is often misinterpreted—is Ricardo. He wrote one of the original arguments that people often use for free trade, which is now called “comparative advantage”. I remember reading the original source when we were working on our book, and I was very struck by the way that he phrased the argument. There were all of these caveats involved, in particular regarding the free movement of capital.

In fact, he basically said that the arguments that he put forward for free trade in goods only made sense, in his view, if you had very, very high barriers to foreign investment.

Otherwise, what he thought would happen was, if you have a situation where, in his hypothetical example, you could produce more at lower wages—both more wine and more cloth in Portugal—then instead of having a system where people in England would produce the cloth, which is what was supposed to be their comparative advantage, and people in Portugal would produce the wine, which was supposed to be their comparative advantage, that instead you’d have capital, and possibly labor, but definitely capital, move from England to Portugal. And then everything would get made in Portugal and nothing would get made in England.

He thought that that was a bad thing! And he said, well, the good news is people are going to be afraid of foreign investment because it’s too risky and difficult with the communications technologies and the political turmoil and the threats of war that we have. And what’s interesting, of course, is that in the 200 years since he wrote that, a lot of that has changed. It’s interesting how that caveat—whether or not it’s right—has been forgotten by the people who cite comparative advantage as an argument for free trade in goods.

Keynes does bring up that link and I think it relates to this question of: why is it that we ended up with the globalization over the past few decades that we did? Why did we end up with a globalization based very much on this idea of “competitiveness”, not by increasing output per hour in the context of rising wages and rising consumer power, but rather in the context of just squeezing workers and having a lower and lower share of output going to workers?

It doesn’t seem like it had to have happened that way. I don’t think it always was that way. People talk about the trentes glorieuses—those three decades after the end of World War II when you saw, at least within the non-communist or Western alliance bloc, a big increase or rebound in global trade. Back then, globalization wasn’t about wage suppression. What do you think changed that put us in the situation that we’re in now, or have been in recently?

Michael Pettis: It’s an interesting question because a lot of things have changed, and a lot of these are sort of self-reinforcing processes. But one of the things that I think we don’t think about when we think about economics is that when a lot of our economics was produced, particularly in the 19th century in the time of Ricardo, et cetera, there were significant frictional costs on the movement of everything across borders. Information flows were quite expensive. Migration flows were even more expensive. There were significant frictional costs on capital flows and on trade flows.

And because these costs have impeded growth, there’s been the sense that what we really need to do is reduce frictional costs across the board.

And I would say that maybe there’s a limit to that, that certainly you want to reduce frictional costs up to some point, but it’s not clear that frictional costs should be driven down to zero.

And of course, I’m thinking primarily about the cost of capital. It was quite difficult for developing countries in the 19th century and for much of the beginning of the 20th century to access the savings they needed to fund investment.

And so much of what happened in the 1960s, 1970s, and 1980s from a developmental point of view was focusing on ways to improve the flow of capital into developing countries by lowering frictional costs. And I would argue that frictional costs are so extremely low that we've sort of come on the other side of that where capital flows now become a problem, perhaps because frictional costs are so low.

The other really big change I would argue is that economics was developed… You know, I remember when I was studying economics, one of the definitions of economics was the management of scarcity. And that idea of scarcity is really implicit in a lot of our economic thinking, particularly the scarcity of capital. So Martin Wolf recently came out with an article in the Financial Times, in which he said that investment in the United Kingdom was extremely low, which is of course correct. But according to him, what England needed to do to address that was to take pages out of Singapore’s book and take steps to boost savings.

I disagree with that very strongly, but I think there is almost automatic sense that if you don’t have as much investment as you like, it is probably because you are unable to access savings. And this is really an unstated assumption because the moment you state it, it becomes sort of hard to believe it.

Matthew Klein: It’s worth just stepping in very briefly and say that “savings”, macroeconomically, is literally just GDP—in other words, the value of everything that you produce in your country—minus whatever it is you consume. And so in practice, the only way to increase savings is either you find a way to produce more, which is obviously preferable, or you force people to consume less. There’s no other way to do it. And in practice, if you do force people to consume less, then the question becomes: what happens? How do businesses respond? And what are the ramifications, the second and third order ramifications, of that?

Michael Pettis: I’m glad you said that because that’s the key point. Globally, if you reduce consumption to boost savings, then either investment goes up or investment doesn’t go up, in which case production goes down, and clearly you want to avoid the ladder. So the question then becomes: what drives investment? And I would argue that a hundred years ago, what drove investment was the almost infinite backlog of unmet investment needs, and what constrained investment was the lack of savings.

Today we don’t have that problem. What seems to constrain investment, at least in advanced economies like the U.K., is the lack of demand.

The great irony is that if you implement policies that shift income away from consumption and towards savings, rather than boost investment, you may actually reduce investment, and then you have to respond either with rapid growth in debt, or a contraction in the economy.

We may be moving a little bit away from our original discussion about globalization. But I think the important point is that much of the discussion about the benefits of trade and capital flows started from a very different set of assumptions, particularly the assumption that we simply don’t have enough savings, so anything that increases savings, or increases the flow of savings, must be a good thing. That is why I would say the globalization that we’ve sort of ended up with is really a globalization driven by the globalization of capital.

Matthew Klein: So, I would just want to say that I think this was not a digression. I think it actually was very relevant for exactly the reason you said. And you know, you’ve reminded me of something, which is, for reasons due to my personal life, I’ve been watching the movie Mary Poppins many, many, many times. One thing that’s striking—I don't know if you remember the movie, but this movie is set in 1910, which is interesting because it’s very much in the period of John Hobson’s Imperialism, which was an inspiration for our book.

There’s a scene in the movie where the children are going with their father to go to the bank, and the boy has with him two pennies, two pence, “tuppence”. And he wanted to use it to feed the birds. And his father [we recorded this early in the morning SF time, George Banks didn’t say this, it was Dawes Sr., sorry] goes, “Feed the birds? If you do that, all you get is fat birds. No, you should deposit the money in the bank.” And the boy goes, “well, why?” And the response is, “well, if you deposit the money in the bank, then we can finance all these investments.” And all the investments are all abroad: they’re plantations of tea, or canals, I presume something like the Suez Canal, there are railways in Africa, and “fleets of ocean greyhounds.”

It’s really striking listening to the song. Of course, it’s funny in context, but this actually is very relevant commentary about what globalization was like back then. There was this choice, essentially. You have some extra money and you can spend it on consumer goods, and maybe in the case of the birds that might create more demand for bird seed or something. Who knows if that’s the best use of that money, but alternatively, even in the U.K. at that point in time, over a hundred years ago, the sense was that the best investment opportunities were outside of the country. I’ve really developed an appreciation for that scene the more I watch it. I think it relates very much to your point about how the way we think about globalization now is shaped by the constraints on globalization from, you know, 100, 200 years ago.

Michael Pettis: I haven’t seen Mary Poppins in an awfully long time. I mostly remember Dick Van Dyke’s accent, but I think in 1910, it probably was almost true by definition, that if you invested your tuppence, you would end up with more bird seed than if you had bought bird seed. The question is whether that continues to be true today. Today, I think that’s no longer true.

If you invested in developing countries, then probably you will end up with more bird seed, because developing countries do have—not all of them, China doesn’t—but many developing countries do have significant investment needs that are constrained by the lack of domestic savings and the unwillingness of foreigners to invest savings.

I think what really matters today for business investment is demand.

The irony is that if you invest your tuppence rather than buy the bird seed, you might end up with less bird seed. I think that’s the big change that’s taken place.

Matthew Klein: That leads to a really interesting question. Why were so many investment flows going the “wrong way”? Places that already had the most physical and intellectual capital per person, at least as measured in national statistics, were getting the most investment inflows, whereas the places that seemed like they might have benefited more from foreign investment were suffering from a lack of investment. Obviously, we’re not the first people to notice this. This was a commentary people were making at least 20 years ago, I think.

Michael Pettis: For those who are interested, Benn Steil at CFR, the Council of Foreign Relations, has a really good page in which he identifies all of the flows from and to in the form of the current account surplus. The flows, of course, are just the obverse of the current account surplus. What he shows, completely contrary to all economic theory, is that rather than capital flowing from rich countries to developing countries, it flows from a group of rich and developing countries, and around 70 to 80% of it ends up in the Anglophone economies, mostly the U.S. and the U.K., which I think is what you’re referring to.

Matthew Klein: Yes, that’s right. This is not a new phenomenon either. It’s striking because, for all the faults we can talk about with Edwardian capital markets, at least in principle, it would make sense for savers in an advanced economy, if they were looking for the highest return investment opportunities, to be looking at places that were underdeveloped and lacking infrastructure.

Building a new railway in Africa in 1910, to use the Mary Poppins example, would theoretically—you could imagine why it might have a higher return than building another railway somewhere in England, which already had built out its railways over the previous 50-60 years. That kind of globalization would’ve made sense if we’re thinking about the benefits of reducing constraints on the flow of capital and finance, and yet it’s mostly not what we’ve seen. And that’s what I'm curious about.

There are plenty of places in the world we can identify that would benefit from more investment that really have to face the difficult tradeoffs between consumption and investment because “savings are scarce”. They just aren’t producing enough to meet all their material needs.

They would benefit from being able to import more, but they can’t, or they’re not, that’s not where the investment is going. It’s not where the financial flows are going to support additional consumption or additional spending.

I’m curious what your view is on this. You wrote the Volatility Machine, which talks some about these questions, and I think arguably a lot of this stuff has just gotten worse since then. So I’m really curious: looking back, why is that the world we ended up with?

Michael Pettis: That’s a question that I often ask my students, those who are going into PhD programs. It’s something worth thinking about. In the 19th century, and up until the Second World War, money flowed into developing countries. It was risky, but it still made sense. The profits generally more than made up for the losses from time to time. Even in the best developing countries, such as the United States, we had crises pretty regularly, most famously in 1837. The British lost so much money in their investments in the U.S. that they were absolutely furious. But that happened quite regularly, and yet they never abandoned the U.S., because basically it was still profitable to invest in the U.S. They invested in other countries too.

Now, one cynical view is they invested in their colonies, so they never worried about debt repayment because they could always send in the Navy. It turns out that that’s one of those stories everybody knows, but it’s very hard to find real examples of that. Certainly, for investments in countries like the United States, they weren’t able to send in the Navy and collect. Nonetheless it was considered quite profitable.

And then something changed around the 1970s. It seems that investing in developing countries became much riskier. I don’t really have an answer as to why, but I suspect it may have to do with the nature of the flows.

UN/BALANCED

UN/BALANCED Episode 3: Globalization, Mary…

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