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July-August 2007
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< previous | 1 | 2 | 3 | 4 “Rising housing prices have a substantial follow-on effect,” Frieden explains, “when middle-class Americans, whose principal asset is their home, realize that their wealth has increased and they can therefore increase consumption.” This is not just a psychological thing, he points out. Houses increased in value, so people borrowed more, stopped saving as much, and cashed out the equity in their homes when they refinanced. When a house that cost $200,000 in 1999 swelled in value to $450,000 in 2005, lenders extended credit of up to 100 percent of the equity in that home. The sums involved are enormous. In a 2006 article in Foreign Affairs, Baker professor of economics Martin Feldstein wrote that “the increase in consumer spending as a result of increased wealth has been reinforced by the process of mortgage refinancing.... In the past five years, the value of U.S. home mortgage debt has increased by nearly $3 trillion. In 2004 alone, it increased by almost $1 trillion. Net mortgage borrowing not used for the purchase of new homes that year amounted to nearly $600 billion, or almost 7 percent of disposable personal income.” Says Frieden, “Rising home prices have led to feelings of well-being and an expansion of consumer credit, and, therefore, consumption.” So have rising equities, as people have watched their retirement portfolios double in value and concluded that they don’t need to save as much. The Loser’s PerspectiveBut momentary feelings of well-being are not the whole story. Virtually any economist will tell you that globalization is good, but that it creates winners and losers. The benefits of global trade accrue from what economists call “comparative advantage,” the theory that a country gains from specializing in production activities at which it is relatively better (even if it is not the absolute best at producing anything). All of the countries that do this are better off than they would be without international trade. But even though it is possible to prove mathematically that this is true for nations, it is not true for every group of people within nations. These, Frieden says, are globalization’s losers: firms that will be driven out of business; workers whose wages will go down or whose jobs will be displaced by foreign competition; mortgage holders who will be foreclosed upon by foreigners; corporations that will be bought by foreigners and, like Chrysler, discarded. When a country runs a large current-account deficit, as the United States does now, foreign manufacturers and holders of dollar debt come into focus as their factories supply American stores and their financiers buy more iconic American assets. 
Photograph by Stu Rosner Rawi Abdelal “Part of the reason people are spending beyond their means,” says Rawi Abdelal, an associate professor of business administration at HBS, “is because they are—in a way—witnessing the end of the American dream.” Between 2000 and 2005, even as the U.S. economy grew 14 percent in real terms, and worker productivity increased a remarkable 16.6 percent, workers’ average hourly wages were stagnant. The median family income fell 2.9 percent. Though these trends—which signal rising income inequality—concern economists, few people are complaining at the moment. “When money is flowing into an economy,” as it is into the United States now, “people feel pretty good about the way things are going,” notes Frieden. Homeowners can easily establish home-equity lines of credit that, for the time being, let them use their residences like an ATM. Some people have refinanced their mortgages three or four times to buy cars, swimming pools, and other luxuries. “It seems like we are borrowing to have a party,” says Abdelal. Brazil, Mexico, Argentina, Taiwan, Korea, Indonesia—all these developing countries have gone through this stage, says Frieden, and no one really complained about the borrowing while it was happening because it was making more capital available for investment and consumption. “But if you borrow,” says Abdelal, “you have to have a theory about why it is sensible. It is not obvious that the U.S. government has a theory about why it is sensible to borrow, and I feel very nervous that the American public does not have a good theory about why they are borrowing so much money, either. We are not taking all this money and investing it.” Less than 30 years ago, the interest rate on home mortgages ran to 13 percent or more. Inflation was in the double digits, and the prime rate that credit cards use to set interest charges rose above 15 percent. If that happened again, investment would plummet and there could be huge social costs. Says Frieden, “It is one thing to say there was a big decline in the price of mansions in Silicon Valley, but if a million middle- and working-class families are forced out of their homes, that is a real social cost. What will happen to our relationship with the rest of the world when the constraints start to bind?” he asks. “What will happen when they go from allowing us to run these deficits to forcing us to tighten our belts?” A resurgence of protectionism is one concern. Says Abdelal, “I think the public’s view has been turning away from the idea that we actually benefit from these cheap Chinese imports. Of course, economists always say, ‘Look, we can do the cost-benefit analysis and when you buy your cheap stuff at Wal-Mart, that is good for [American consumers]’…. So we can talk about ‘comparative advantage,’ but what is important…is whether or not the commitment to open markets is politically sustainable.” He sees warning signs that it may not be: “drumbeating about China”; “the rising riskiness of middle-class life in the United States, for which people, rightly or wrongly, blame the globalization of goods markets”; the debate about how big the wall should be between the United States and Mexico, not whether we should have one; the Dubai ports episode; the scuttling of a Chinese company’s offer to buy American oil company Unocal. “Here we are with the biggest current account deficit ever—we require foreign capital—but if it is Arab or Chinese foreign capital going into a sector that we might be worried about, we tell them, ‘No, no, no, we only want you to buy Treasuries.’ What would happen to the American commitment to openness,” Abdelal wonders, “if we had a real recession or a real crisis?” Absent protection for globalization’s losers, history suggests that they will become the core of opposition movements. “There is a commonality to their demands,” Frieden says. “They typically argue in favor of protecting [those] people who are doing poorly in international competition from the ravages of the global economy.” Pat Buchanan is an American example of a convinced protectionist. “He says, ‘Let’s protect the workers in North Carolina and farmers in Kansas and to hell with Wall Street and Silicon Valley,’” says Frieden—“a very popular message outside Wall Street and Silicon Valley.” Sometimes we do protect the losers: price supports for domestically produced sugar cause Americans to pay two to three times the world market price. Without the supports, Americans as a whole might be better off, but “several thousand sugar producers and maybe a hundred thousand farm workers would go out of business. Even if we could all agree that globalization is good for the economy as a whole and good for the majority of Americans,” says Frieden, “there will still be a non-trivial minority for whom it is not good.” He wonders, “Is any political system up to the task of compensating losers in order to generate benefits for society as a whole?” Protectionism is a legitimate concern stemming from global financial imbalances, agrees the Kennedy School’s Jeffrey Frankel. “That is what happened in 1971 and 1985 when Americans became worried about trade deficits that were indeed alarming, but drew some incorrect conclusions. We economists always explain that the deficit is the result of macroeconomic forces, and that we need to cut the federal budget and depreciate the dollar, but to your average congressman and your average man in the street, that doesn’t seem very tangible. There is a temptation for scapegoating,” he explains. “It was Japan in the 1980s and now it is China and, on outsourcing, India.” Adds former U.S. Treasury Secretary Lawrence H. Summers, the Eliot University Professor, “I think there are enormous potential losses—in terms of consumer well-being and the real incomes of workers, and ultimately, in terms of the ability to maintain a stable global system—that come from the threat of protectionism, and so I think containing that threat is enormously important.” The Foreign DimensionOur own openness to international flows of goods and capital is only half the equation. On the other side of American borrowing is lending by foreign agencies, banks, and governments, which continue to accumulate massive reserves of U.S. currency, frequently in the form of low-yielding government bonds. (China holds more than $1 trillion in currency reserves, mostly denominated in dollars; Japan is a close second.) This flow of funds from emerging economies to the developed world (the United Kingdom and Australia run current account deficits, too) is a startling reversal of the usual pattern, in which developed nations have loaned money through institutions such as the IMF and the World Bank to emerging economies that need investment in their own nascent growth. Furthermore, as Summers points out, the real returns on these reserve investments, measured in those countries’ local currency and after adjusting for inflation, are close to zero. Why these countries are sending us their money—while choosing investments with returns so low that they could easily turn negative if the dollar were to depreciate significantly—is, he says, “a very profound question, in my judgment.” How these lenders to the industrialized world decide to act in the future has large implications for whether the imbalances sort out gradually or violently. Although their desire to lend and export is aligned for the moment with our consumerism, we cannot expect that they will want to keep accumulating dollar-denominated debt forever. 1 | 2 | 3 | 4 | continued >  
 
 
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