Problems for the growth of the Global Economy:

1. Oil Crises
2. Rise of Protectionism, especially in the 1970s and economic slowdown
3. Trade imbalances
4. Debt Crisis of the 1980s.

Introduction

Bretton Woods and its constituent countries tried to achieve free trade, but by the 1970s there was a threat to this belief that free trade represented the best way of achieving economic prosperity.

1. Oil
i) The 1973 oil crisis (October 17, 1973). Members of Organization of Arab Petroleum Exporting Countries (OAPEC, consisting of the Arab members of OPEC plus Egypt and Syria) announced, as a group that they would no longer ship petroleum to nations that had supported Israel.
- The Arab-Israeli conflict triggered a crisis already in the making. The West could not continue to increase its energy use 5% annually, pay low oil prices, yet sell inflation-priced goods to the petroleum producers in the Third World. This was stressed by the Shah of Iran, whose nation was the world's second-largest exporter of oil and the closest ally of the United States in the Middle East at the time. The Shah:
"Of course [the world price of oil] is going to rise. Certainly! And how...; You [Western nations] increased the price of wheat you sell us by 300%, and the same for sugar and cement...; You buy our crude oil and sell it back to us, refined as petrochemicals, at a hundred times the price you've paid to us...; It's only fair that, from now on, you should pay more for oil. Let's say ten times more."
- Impositions placed on West and Israel; demanding withdrawal and the stopping of support.
- A world financial system already under pressure from the breakdown of the Bretton Woods agreement, would be set on a path of a series of recessions and high inflation that would persist until the early 1980's, and elevated oil prices that would persist until 1986.
- The effects of the embargo were immediate. OPEC forced the oil companies to increase payments drastically. The price of oil quadrupled by 1974 to nearly US$12 per US gallon barrel (75 US$/m³).
- Meanwhile, the shock produced chaos in the West. In the United States, the retail price of a gallon of gasoline rose from a national average of 38.5 cents in May 1973 to 55.1 cents in June 1974. Meanwhile, New York Stock Exchange shares lost $97 billion in value in six weeks.
- With the onset of the embargo, U.S. imports of oil from the Arab countries dropped from 1.2 million barrels (190,000 m³) a day to a mere 19,000 barrels (3,000 m³). Daily consumption dropped by 6.1% from September to February, and by the summer of 1974, by 7% as the United States suffered its first fuel shortage since the Second World War.
- Underscoring the interdependence of the world societies and economies, oil-importing nations in the noncommunist industrial world saw sudden inflation and economic recession. The embargo was not uniform across Europe. Of the nine members of the European Economic Community, the Dutch faced a complete embargo (having voiced support for and supplied arms to Israel and allowed the Americans to use Dutch airfields for supply runs to Israel), the United Kingdom and France received almost uninterrupted supplies (having refused to allow America to use their airfields and embargoed arms and supplies to both the Arabs and the Israelis), whilst the other six faced only partial cutbacks.
- Despite being a target of the embargo as well, Japan fared particularly well in the aftermath of the world energy crisis of the 1970s compared to other oil-importing developed nations. Japanese automakers led the way in an ensuing revolution in car manufacturing. The large automobiles of the 1950s and 1960s were replaced by far more compact and energy efficient models. (Japan, moreover, had cities with a relatively high population density and a relatively high level of transit ridership.)
- A few months later, the crisis eased. The embargo was lifted in March 1974 after negotiations at the Washington Oil Summit, but the effects of the energy crisis lingered on throughout the 1970s. The price of energy continued increasing in the following year, amid the weakening competitive position of the dollar in world markets; and no single factor did more to produce the soaring price inflation of the 1970s in the United States.
- The energy crisis led to greater interest in renewable energy.
- The Soviet Union was also a net oil exporter and the increase in the price of oil had an immediate effect on that country. The Soviet economy had stagnated for several years and the increase in the price of oil had a beneficial effect. Some historians believe the windfall in oil revenues during this period kept the Soviet Union in existence for a considerably longer period of time than would otherwise have occurred.
ii) The 1979 (or second) oil crisis after the Iranian Revolution. The protests shattered the Iranian oil sector. While the new regime resumed oil exports, it was inconsistent and at a lower volume, forcing up prices. Saudi Arabia and other OPEC nations increased production to offset the decline, and the overall loss in production was about 4%. Panic increased the price even further.
- President Jimmy Carter made symbolic efforts to encourage energy conservation, such as urging citizens in a famous July 15, 1979, 'malaise' speech to turn down their thermostats. He also installed solar power panels on the roof of the White House and a wood-burning stove in the living quarters.
- However, his successor Ronald Reagan, ordered the solar panels removed and the wood stove dismantled.
- In 1980, following the Iraqi invasion of Iran, oil production in Iran nearly stopped, and Iraq's oil production was severely cut as well. In that instance, oil lines only reappeared in the United States in a few isolated incidents.
iii) The 1990 (or third) energy crisis was milder and more brief. It lasted only six months and occurred as a result of the first Gulf War. Oil hit a then-record $40.42 per barrel during this crisis due to retreating forces destroying oil fields.

2. Rise of Protectionism

- We have seen, that in the 1970s, as a result of decolonisation, protectionist measures took place to protect the new economies.

- The was a slowdown in total world economy. These changes or problems were not uniform.
- Compared with the performance of many other emerging market economies, and especially those in Asia, growth performance in Latin America has been less successful. There were successes, of course The Brazilian economy, due to its change from import substitution to export orientation. grew by 9.8 percent a year on average between 1970 and 1974. Mexico also grew rapidly—averaging 6.5 percent between 1960 and 1979 and more than 5 percent annually between 1996 and 2000.
- But in general, periods of rapid growth in the region have tended to be followed by sharp slowdowns. For much of the 1980s, for example, Brazil grew by less than 1 percent a year. Mexico's growth rate also dropped sharply after 1981 until the mid-1990s. Significantly, both countries had reintroduced trade restrictions at about the time their growth performance deteriorated: Latin American countries have tended to be more closed to trade than rapidly-growing regions such as Asia. And for decades, inflation rates in most countries in Latin America were even more volatile than growth performance.
- Such uneven economic performance had its roots in policies that have since been discredited. High tariffs and import substitution policies—along with heavily regulated labour markets, credit rationing, and other measures—helped stunt the development of countries rich in potential.
- An exception: Trade liberalization was an integral part of Chile's reforms. Tariffs in Chile have been progressively lowered over the years. Since the late 1980s, Chile has experienced strong, crisis-free growth and at a much higher average rate of GDP growth than its neighbours.
- There were also trade imbalances between the developed countries. E.g. Between USA and Japan / Germany.

- USA no longer able or willing to continue to be in charge of the push towards a truly global economy.


3. Trade Imbalances
- In the 1970s the US began to lose its economic steam, and started failing in its mision to be the key leader in the economic sphere.
- From1982 to 1986 US imports rose 48%, US$248 billion to US$368 billion.
- We have already seen the increased in protection, and deficits. The US dollar also increased in value, so its imports increased while its exports stagnated. The unexpected overvaluation of the US dollar led to protectionism as well.
- There needed to be some intervention to control the situation.
- The first great depreciation of the dollar started in August 1971, when President Nixon undermined the old Bretton-Woods system of fixed exchange rates. He imposed a tariff on all imported manufactures, and refused to remove it until other industrial countries appreciated by changing their dollar pegs—which they had done by December of 1971. The fixed rate system broke down altogether in early 1973.


- This drove the dollar down, but inflation went up. Not until 1979, when Paul Volker became chairman of the Fed and imposed very tight money with extremely high interest rates in the early 1980s, was inflation painfully squeezed out of the American economy. But an incidental side effect was that the dollar shot upwards in the foreign exchanges by more than 50 percent because foreign capital inflows were attracted by the high U.S. interest rates.
- There wer other measures to control the US dollar as well. The Plaza Accord (in the Plaza Hotel in New York) was an agreement signed on September 22, 1985 by 5 nations - France, West Germany, Japan, the United States and the United Kingdom. The five agreed to, amongst others, depreciate the US dollar in relation to the Japanese yen and German Deutsche Mark by intervening in currency markets.
- The exchange rate value of the dollar versus the yen declined 51% over the two years after this agreement took place. Most of this devaluation was due to the $10 billion spent by the participating central banks. Currency speculation caused the dollar to continue its fall after the end of coordinated interventions.
- Unlike some similar financial crises of the 1990s (such as the Mexican crisis in 1994), this devaluation was planned, done in an orderly manner with pre-announcement, and did not lead to financial panic in the world markets.
- The reason for the dollar's devaluation was twofold:
a) to reduce the US current account deficit, which had reached 3.5% of the GDP
b) help the US economy to emerge from a serious recession that began in the early 1980s.
- The U.S. Federal Reserve System under Paul Volcker had overvalued the dollar enough to make industry in the US (particularly the automobile industry) less competitive in the global market. Devaluing the dollar made US exports cheaper to its trading partners, which in turn meant that other countries bought more American-made goods and services.
- The Plaza Accord was successful in reducing the US trade deficit with Western European nations but largely failed to fulfill its primary objective of alleviating the trade deficit with Japan due to the fact that this deficit was due to structural rather than monetary conditions.
- The Louvre Accord was signed in 1987 to halt the continuing decline of the US Dollar.
- The signing of the Plaza Accords was significant in that it reflected Japan's emergence as a real player in managing the international monetary system.
- Both these accords also showed that in order to promote the rise of a global economy the big players must work together to coordinate efforts.
- However, In Europe, the sharp appreciations slowed economic growth causing what was then called “eurosclerosis”. Japan had appreciated the most, with additional American pressure creating the expectation of further yen appreciations. This thoroughly destabilized Japan’s financial system with gigantic stock and land markets bubbles in the late 1980s that crashed in 1991—and severe deflation from the overvalued yen throughout its “lost decade” of the 1990s.


4. Increasing debt of developing countries in 1980s
- By the 1970s and 80s the world was suffering from a recession, and oil prices skyrocketed, it created a breaking point for most countries in theregion. Developing countries also found themselves in a desperate liquidity crunch. Petroleum exporting countries – flush with cash after the oil price increases of 1973-74 – invested their money with international banks, which 'recycled' a major portion of the capital as loans to Latin American governments.
- This was known as Petrodollar recycling: the phenomenon of major oil-producing states mainly from OPEC earning more money from the export of oil than they could usefully invest in their own economies. It was a phenomenon of the late 1970s and early 1980s with the peak years for petrodollar surpluses.
- During this period, states such as Saudi Arabia, Kuwait and Qatar amassed large surpluses of petrodollars which they could not invest in their own countries. This was due to small populations or being at early stages of industrialisation. These petrodollar surpluses can be defined as net US dollars earned.
- Take the following example: Japan needs to import oil for domestic use. To do so it must first acquire dollars, as the dollar is the main currency in which oil is traded. To acquire these dollars, Japan must sell goods and services to the U.S. economy. The Japanese build a Honda to sell to the U.S. The U.S. federal reserve prints a certain amount of dollars and gives these to the Japanese in exchange for the Honda. The Japanese buy oil from Saudi Arabia using these dollars. The Saudis take the dollars and reinvest them in the Federal Reserve Bank of the U.S., and from then on they will only be used as a reserve currency. Therefore, all the U.S. had to do to acquire a Honda, was to print dollars. In essence, it has its very own money tree. The result of this is that the total debt of the United States is somewhere in the region of $8.4 trillion and increasing by $80 million per hour.
- These surpluses could be profitably invested in other nations. Alternatively, the world economy would have contracted if that money was withdrawn from the world economy while the exporting nations needed to be able to profitably invest to preserve their wealth for the future.
- While recycling petrodollars reduced the recessionary impact of the oil crisis, it caused problems for nations especially oil importing nations who were paying much greater prices for oil and incurring debts. The International Monetary Fund (IMF) estimates that the foreign debts of 100 developing countries increased by 150% between 1973 and 1977. Johannes Witteveen, the Managing Director of the IMF, said in 1974 the international monetary system is facing its most difficult period since the 1930s.
- From 1974 to the end of 1981, total current account surpluses for all members of OPEC amounted to $450.5 billion. Ninety percent of this surplus was accumulated by the Arab gulf countries and Libya with Iran also accumulating oil surpluses prior to the revolution in 1979.
- Arab oil exporting nations also used their surpluses to fund foreign aid programs with Arab nations being one of the largest donors of foreign aid since 1973. The IMF also introduced a new lending facility during this period called the Oil Facility. This facility was funded by oil exporting nations and other lenders and was available to nations suffering problems with their balance of trade due to the rise in oil prices
- In USA, late 1979, Mr. Paul Volcker was appointed as a new chairman of the US Federal Reserve Board (i.e., American central bank). Immediately, he initiated an anti-inflation campaign. From 1979 to 1980, the Fed tightened money supply. As a result, dollar interest rates shot up sharply, even to 20% per year or above. Although this caused serious economic slowdown in the US and the rest of the world, in the long run Mr. Volcker succeeded in stopping the global inflation of the 1970s. But this process caused enormous strain for highly indebted developing countries.
- The tightening of American monetary policy impacted indebted countries in three ways:
--As dollar interest rates rose, debt service payments also rose sharply.
--Due to global recession, the quantitative demand for their exports fell.
--As commodity prices declined, they faced lower "terms of trade" (= export price/import price)
- As interest rates increased in the United States of America and in Europe in 1979, debt payments also increased making it harder for borrowing countries to pay back their debts. This led to a DEBT CRISIS;
- This occurred in August of 1982 when Mexico's Finance Minister, Jesus Silva-Herzog declared that Mexico would no longer be able to service its debt. Mexico was the first to make aware that third world nations might have problem repaying their debts. In the wake of Mexico's default, most commercial banks reduced significantly or halted new lending to Latin America. As much of Latin America's loans were short-term, a crisis ensued when their refinancing was refused. Billions of dollars of loans that previously would have been refinanced, were now due immediately.
- To counter this, macroeconomic tightening and "structural adjustment" (liberalization and privatization) were administered, often through the conditionality of the IMF and the World Bank. The governments of developing countries were unable to repay the debt, so financial rescue operations became necessary.
- In response to the crisis most nations abandoned their Import Substitution Industrialization models of economy and adopted an export-oriented industrialization strategy, usually the neoliberal strategy encouraged by the IMF, though there are exceptions such as Chile and Costa Rica.
- A massive process of capital outflow, particularly to the United States, served to depreciate the exchange rates, thereby raising the interest rates. Real GDP growth rate for the region was only 2.3 percent between 1980 and 1985, but in per capita terms Latin America experienced negative growth of almost 9 percent.
- Since the 1980s several countries in the region have experienced a surge in economic development and have initiated debt management programs in addition to debt relief and debt rescheduling programs agreed to by their international creditors
- The 1990s: optimism and new crises
- With debt rescheduling and reduction, which were combined with neoclassical policy conditionality, the debt crisis in many countries, including those in Latin America and East Asia, were successfully contained. It took about ten years, but by the early 1990s, Latin America declared graduation from the "Lost Decade" and hoped for renewed growth. Inflation was still a bit too high in Latin America, but their economies had been liberalized and opened up externally thanks to the IMF and World Bank conditionalities, and foreign investment began to return.
- The developing and transition economies which open up their financial sectors to invite foreigners to lend and invest in them are called emerging market economies. In the early to mid 1990s, this mode of attracting foreign funds became very fashionable. Many countries rushed to liberalize capital accounts (for capital mobility) as well as current accounts (for free trade) to absorb as much foreign savings as possible.
- But this led to another great risk. Emerging market economies simply borrowed too much, and foreigners lent and invested too much, without much thinking and beyond sound limits. The financial sectors of these countries were still primitive. Moreover, their governments were not monitoring private-sector behaviour properly. The domestic economy first enjoyed a strong investment boom and an asset market bubble, especially in land, property and stock markets. Then, the crash came. Suddenly, foreign investors and lenders pulled out in droves and the macro economy and the domestic currency collapsed, with the banking sector paralyzed. Enterprises were faced with bankruptcies and people suffered unemployment. Multilateral and bilateral donors had to come to the rescue after private investors left. This was the basic nature of the Asian crisis 1997-98.
Conclusion
These problems must be looked at with previous readings and notes, show that the movement to a truly global economy was not easy.
Not everyone believed that the best way to economic progress was free trade. The Bretton-Woods states had to convince them of this.