The gated globe

October 12th 2013

S P E C I A L R E P O R T

W O R L D E C O N O M Y

The gated globe

World Economy.indd 1 27/09/2013 14:36

1

FIVE YEARS AGO George W. Bush gathered the leaders of the largest richand developing countries in Washington for the �rst summit of the G20.In the face of the worst �nancial crisis since the Great Depression, theleaders promised not to repeat that era’s descent into economic isolation-ism, proclaiming their commitment to an open global economy and therejection of protectionism.

They succeeded only in part. Although they did not retreat into theextreme protectionism of the 1930s, the world economy has certainly be-

come less open. After two de-cades in which people, capitaland goods were moving evermore freely across borders, wallshave been going up, albeit oneswith gates. Governments increas-ingly pick and choose whomthey trade with, what sort of capi-tal they welcome and how muchfreedom they allow for doingbusiness abroad.

Virtually all countries stillembrace the principles of inter-national trade and investment.They want to enjoy the bene�tsof globalisation, but as much aspossible they now also want toinsulate themselves from itsdownsides, be they volatile capi-tal �ows or surging imports.

Globalisation has clearlypaused. A simple measure oftrade intensity, world exports as ashare of world GDP, rose steadily

from 1986 to 2008 but has been �at since. Global capital �ows, which in2007 topped $11trillion, amounted to barely a third of that �gure last year.Cross-border direct investment is also well down on its 2007 peak.

Much of this is cyclical. The recent crises and recessions in the richworld have subdued the animal spirits that drive international invest-ment. But much of it is a matter of deliberate policy. In �nance, for in-stance, where the ease of cross-border lending had made it possible forplaces like America and some southern European countries to run upever larger current-account de�cits, banks now face growing pressure tobolster domestic lending, raise capital and ring-fence foreign units.

World leaders congratulate themselves on having avoided protec-tionism since the crisis, and on conventional measures they are right: ac-cording to the World Trade Organisation (WTO), explicit restrictions onimports have had hardly any impact on trade since 2008. But hidden pro-tectionism is �ourishing, often under the guise of export promotion or in-dustrial policy. India, for example, imposes local-content requirementson government purchases of information and communications technol-ogy and solar-power equipment. Brazil, which a decade ago compelledits state-controlled oil giant, Petrobras, to buy more of its equipment fromlocal companies, has been tightening restrictions steadily since. Andboth America and Europe imposed, or threatened to impose, tari�s onChinese solar panels, alleging widespread government support. At thesame time, though, Western countries themselves o�er hefty subsidies

The gated globe

The forward march of globalisation has paused since the �nancial

crisis, giving way to a more conditional, interventionist and

nationalist model. Greg Ip examines the consequences.

A C K N O W L E D G M E N T S

CONTENT S

Many people generously gave of

their time and knowledge for the

preparation of this report. Apart

from those mentioned in the text,

the author would particularly like to

thank Mansueto Almeida, Welber

Barral, Andrew Batson, Ajith Nivard

Cabraal, Paulo Cardamone, Sage

Chandler, Ilan Goldfajn, Davis

Hodge, Doug Irwin, Daisy King,

Susan Lund, Antonio Megale, Mei

Jianping, Neelkanth Mishra, Kevin

Nealer, Michael Pettis, Matthew

Slaughter, Madeleine Sumption and

ShangJin Wei.

A list of sources is at

Economist.com/specialreports

An audio interview with

the author is at

Economist.com/audiovideo/specialreports

3 The history of globalisationRailroads and hegemons

4 Financial fragmentationToo much of a good thing

6 CapitalJust in case

8 TradeIn my backyard

10 ProtectionismThe hidden persuaders

12 Political pressuresA question of trust

14 The outlookWhat kind of capitalism?

SPECIAL REPORT

WORLD ECONOMY

The Economist October 12th 2013 1

2 The Economist October 12th 2013

WORLD ECONOMY

SPECIAL REPORT

2

1

for green energy at home.Capital controls, which were long viewed as a relic of a

more regulated era, have regained respectability as a tool forstemming unwelcome in�ows and out�ows of hot money.When Brazil imposed a tax on in�ows in 2009-10, it was carefulto emphasise that not all foreign investment was unwelcome.�Nobody here is rejecting people that want to invest in our portsor our roads,� says Luiz Awazu Pereira, a deputy governor at thecentral bank. �But if you are here just because you are running anaggressive hedge fund and noticed that our Treasuries pay 10%while US Treasuries pay zero, this is a less desirable outcome.�

The world has not given up on trade liberalisation, but ithas shifted its focus from the multilateral WTO to regional andbilateral pacts. Months before Lehman Brothers failed in 2008,the WTO’s Doha trade talks collapsed in Geneva largely becauseIndia and China wanted bigger safeguards against agriculturalimports than America felt able to accept. Shortly afterwardsAmerica joined talks to form what is now called the Trans-Paci�cPartnership, which also includes Australia, Brunei, Canada,Chile, Japan, Malaysia, Mexico, New Zealand, Peru, Singaporeand Vietnam. Barack Obama has held up the TPP as the sort ofagreement China should aspire to join.

The trend in foreign direct investment, too, is still towardsliberalisation, but a tally by the UN Commission for Trade andDevelopment shows that restrictions are increasing. Last Decem-ber Canada allowed a Chinese state-owned enterprise to buy aCanadian oil-sands company, but suggested it would be the last.�When we say that Canada is open for business, we do not meanthat Canada is for sale to foreign governments,� explained Ste-phen Harper, the prime minister.

The �ow of people between countries is also being man-aged more carefully than before the crisis. Borders have not beenclosed to immigrants, but admission criteria have been tight-ened. At the same time, however, many countries have made en-try easier for scarce highly skilled workers and for entrepreneurs.

Mr Obama sees globalisation not as something to bestopped but to be shaped in pursuit of broader goals. He wantsother countries to raise their standards of labour, environmentaland intellectual-property protection so that American compa-nies will be able to compete on a level playing �eld and, perhaps,pay decent middle-class wages once again. When a clothing fac-tory collapsed in Bangladesh in April, killing more than 1,000people, Mr Obama suspended America’s preferential tari�s onmany imports from Bangladesh until it improves workers’ rights.

A clear pattern is beginning to emerge: more state interven-tion in the �ow of money and goods, more regionalisation oftrade as countries gravitate towards like-minded neighbours,and more friction as national self-interest wins out over interna-tional co-operation. Together, all this amounts to a new, gatedkind of globalisation.

A state of imperfection

The appeal of gated globalisation is closely tied to state cap-italism, which allowed China and the other big emerging mar-kets�India, Brazil and Russia�to come through the crisis in muchbetter shape than the rich world. They proudly proclaimed theirbrand of state capitalism as superior to the �Washington consen-sus� of open markets and minimal government that had pre-vailed before 2008. But the system also covered up structural�aws that are now becoming more obvious. In China, state-owned enterprises and state-directed lending have siphonedcredit from the private sector and fuelled a property bubble. InIndia and Brazil, inadequate investment in infrastructure has re-sulted in rising in�ation and sharply slowing growth.

The globalisation in the West before 2008 certainly had its�aws. The belief that markets were self-regulating allowed stag-gering volumes of highly levered and opaque cross-border expo-sures to build up. When the crisis hit, �rst in America, then in Eu-rope, the absence of barriers allowed it to spread instantly.Voters, who had never been keen on wide-open borders, took

15

20

25

30

35

1980 85 90 95 2000 05 10 13*Sources: IMF; McKinsey GlobalInstitute; The Economist *Forecast

World exportsas % of GDP

Capital inflows% change 2007-12

0 to 49

0 to -49

-50 to -99

-100 to -149

Below -150

No data

50 to 99

100 to 149

Above 150

AFRICA

66.0

128.7

%

$bn

Regionalcapital inflows2012

% change2007-12

ASIA

-28.9

1135.9

MIDDLEEAST

-66.5

42.2

EASTERNEUROPE

-60.3

229.7

WESTERNEUROPE

-86.1

954.2

AMERICAS

-65.5

909.3


SPECIAL REPORTWORLD ECONOMY

2 this badly, and support for anti-globalisation parties grew.A few constraints on global �nance are not necessarily a

bad thing. Limiting banks’ foreign-currency borrowing, as SouthKorea has done, makes them less likely to fail if the exchange ratefalls. But gated globalisation also carries hidden costs. Policy-makers routinely overestimate their ability to distinguish be-tween good and bad capital, and between nurturing exports andinnovation and rewarding entrenched interests. The opening upbefore the crisis had done wonders for channelling capital to the

best investment opportunities, lowering prices for consumersand promoting competition. Interfering with this process re-duces a country’s growth potential.

This special report will seek to answer two big questions. Isgated globalisation merely a pause on the path to more open-ness, or is it here to stay? And is it, on balance, a good or a badthing? The report will look at �nance, capital controls, interna-tional trade and protectionism in turn to see how gated globali-sation a�ects them for good or ill. Start with �nance. 7

HISTORICALLY, TECHNOLOGY HAS been thesingle most important force for opening upborders. In the 1800s it was the spread ofthe steamship and refrigeration, the expan-sion of railroads and the invention of thetelegraph that gave a push to globalisation.In the 1980s and 1990s it was the shippingcontainer, and more recently it has been theinternet, allowing information and servicesto be exchanged in the blink of an eye.

But technology is not enough; global-isation also needs political patronage.Writing in 1973, Charles Kindleberger point-ed to the importance of an economic hege-mon who would act as an importer of lastresort and �nancier of the world’s monetarysystem. From the mid-1800s until 1914 thathegemon was Britain. In 1846 it unilaterallyreduced import tari�s by repealing the CornLaws and in 1860 it signed a free-tradeagreement with France, starting a virtuouscycle of falling tari�s worldwide. As guaran-tor of the gold standard, Britain made

possible a system of �xed exchange rates,�nancing the de�cits of some countrieswhile absorbing the surpluses of others.

In 1910 Norman Angell, a Britishjournalist, concluded in his book �The GreatIllusion� that Europe had become so eco-nomically interdependent that war would befutile. Ten years and one world war later,John Maynard Keynes wrote: �What anextraordinary episode in the economicprogress of man that age was which came toan end in August 1914! ðThe inhabitant ofLondon could order by telephone, sippinghis morning tea in bed, the various productsof the whole Earth, in such quantity as hemight see �t, and reasonably expect theirearly delivery upon his doorstep.�

Keynes worried, correctly, that thevindictive Treaty of Versailles would furtherfragment the damaged global economicsystem. It tumbled into abyss a decade laterbecause, Kindleberger wrote, �Britain couldnot act as a stabiliser, and the United States

would not: every country turned to protectits national private interest, the worldpublic interest went down the drain, andwith it the private interests of all.�

In 1945 America took up the mantle ofbenevolent hegemon. �Our foreign rela-tions, political and economic, are indivis-ible,� said Harry Truman in 1947; and thepursuit of international peace and freedomwas �bound up completely with a thirdobjective: re-establishment of world trade.�America underwrote the InternationalMonetary Fund and the Bretton Woodssystem of �xed exchange rates to endbeggar-thy-neighbour currency devalua-tions, and the General Agreement on Tari�sand Trade to end trade disputes.

The breakdown of Bretton Woods, twooil-price shocks and the Latin Americandebt crisis severely tested globalisation inthe 1970s and 1980s. Fearful of Japan’sgrowing economic clout, America turnedprotectionist. Free trade gave way to man-aged trade. But in 1989 the Berlin Wall felland in 1990 Japan’s bubble economy burst.America became the �hyperpower� andpresided over an unprecedented expansionof globalisation.

These days America is acting less like ahegemon. Americans have grown leerier offoreign entanglements and more self-interested on economic matters. Americawalked away from the Doha trade talks in2008 when it concluded it was getting toolittle in return for its own sacri�ces, andCongress has refused to expand the Interna-tional Monetary Fund’s resources. ManyAmericans think that China is violating thespirit of free trade.

Others also see America as less of aleader. In a poll earlier this year the PewResearch Centre found that in 23 of 39countries the largest groups of respondentsthought that China had already replaced, orwould replace, America as the main su-perpower. But China is not yet ready to takethe hegemon’s mantle.

Railroads and hegemons

Globalisation depends on technology and politics

1Open and shut

Source: McKinsey Global Institute *Seven countries in 1825, expanding to 79 in 1990

Global foreign investment assets as % of sample* GDP

1914-18:First world war

1939-45:Second world war

0

30

60

90

120

150

180

1900 10 20 30 40 50 60 70 80 90 2000 12

1926: Britain returnsto gold standard

1929-39:Great Depression

2008:Lehmanfails

1957: Treaty of Rome signed,creating the European Economic Community

1971:America

closes goldwindow,Bretton

Woodscollapses

1981: Japan agreesto limit car exports

to America

1989: Berlin Wall falls

2001: China joinsWorld Trade

Organisation


WORLD ECONOMY

SPECIAL REPORT

1

IN 2005 ITALY’S UniCredit bought HVB, Germany’s sec-ond-largest lender, in what at the time was the continent’s

biggest cross-border bank merger. At a stroke this gave UniCredita commanding presence in Germany, Austria and Poland. It waswidely hailed as a foretaste of deals to come thanks to Europe’ssingle currency. �We will become the �rst truly European bank,’’declared Alessandro Profumo, Unicredit’s chief at the time. So itwas something of a shock when in 2011Germany’s bank regula-tor, BaFin, sought to limit the amount of cash UniCredit couldtransfer to its Italian parent, fearing that the German unit’s �nan-cial health might be compromised. This seemed to violate thespirit of free capital movement within Europe, and o�cials inBrussels complained.

Finance, the sector that globalised the most in the yearsleading up to the crisis, is threatening to go into reverse. Between1990 and 2007 cross-border bank �ows increased about tenfold,to around $5 trillion, according to the McKinsey Global Institute,the consultancy’s research arm. Last year the �gure was less thana third of that. The decline extended across all regions, thoughEurope su�ered most.

This has happened for two reasons. The �rst is the banks’own e�orts to deleverage, either to shed money-losing opera-tions and assets or to meet sti�er capital requirements. The sec-ond is the realisation that cross-border banks were an importantchannel for transmitting the mortgage crisis in America and thesovereign-debt crisis in peripheral Europe to other countries. Tolimit such spillovers and save taxpayers having to bail banks outof their foreign misadventures, regulators around the world areseeking to ring-fence their banking systems.

The case for integration

Before the crisis, the logic of �nancial globalisation seemedimpeccable. Businesses were increasingly operating across bor-ders and needed banks that could travel with them. Americaand Britain, which excelled at �nance, were anxious to markettheir expertise abroad. A more integrated global economy alsoneeded a �nancial system to funnel capital from countries with asurplus of savings to those with a surplus of investment oppor-tunities. Banks had long played that role within countries, takingin deposits in one market and deploying them in another. Itmade sense to do the same thing across borders.

Recipients of such �ows bene�ted in other ways, too. Moree�cient foreign banks could force local ones to raise their game.That was why China, for example, listed its state-owned bankson stock exchanges and permitted foreigners to hold minoritystakes. In short order Goldman Sachs, Bank of America, UBS andRoyal Bank of Scotland took up the o�er, though some of themhave since sold stakes.

In Europe the logic was especially powerful. The bene�ts ofa single currency strongly suggested that there should be a singlebanking market as well, so that the interest rates which business-es and households paid were determined by the European Cen-tral Bank (ECB), not the relative health of their local banks.

Financial globalisation did just what it was meant to, per-haps a little too well. Cross-border bank �ows expanded enor-

mously between 2000 and 2007, with 80% of the increase com-ing from Europe, according to McKinsey. Those �ows enableddebtor countries such as America, Spain and Greece to �nancehousing booms and government de�cits without paying puni-tive interest rates. But a large part of those �ows re�ected banks’own leverage as they both borrowed and lent heavily abroad.

Tellingly, the event that touched o� the crisis in the summerof 2007 was an announcement by France’s BNP Paribas that itwas suspending redemptions to an investment fund heavily in-vested in American mortgage securities. Eventually a number ofbanks across Europe needed government bailouts because oflosses sustained on mortgages in America and elsewhere.

The cost of bailing domestic banks out of foreign misad-ventures exposed one risk of �nancial globalisation; the lossessustained by domestic creditors and savers when foreign bankswent bust showed up another. In 2008, when Landsbanki, anIcelandic bank, went bust, British and Dutch depositors had tobe bailed out by their own governments because Iceland wouldguarantee only Icelandic deposits. Sir Mervyn King, the formergovernor of the Bank of England, famously commented that�global banks are international in life but national in death.�

Regulators around the world, working through the Finan-cial Stability Board, an international committee of central bank-ers, regulators and �nance ministers, have since tried to reducethe threat of a big bank collapse and the need for a bailout, butmany of these e�orts have undermined banks’ incentive andability to do business across borders. For example, domestic reg-ulators used to allow foreign banks to rely on the capital, liquid-ity and regulatory oversight of the foreign parent. Now many ofthem are pressing units of foreign banks, and foreign units of do-mestic banks, to maintain su�cient liquidity and capital inde-pendent of the parent, sometimes by organising themselves assubsidiaries rather than branches.

In America the Federal Reserve will soon require foreignbanks above a certain size to collect all their local units into a sin-gle, separately capitalised holding company that meets the samecapital and liquidity requirements as American banks do. Untilnow the Fed has relied on foreign regulators to ensure that theparent bank can support its units in America. The proposal hasprompted a �urry of opposition.

Nor is it just banks that have to abide by tighter rules. Amer-ica’s Commodity Futures Trading Commission (CFTC) has ruledthat anyone trading swaps with an American bank’s foreign unitmust generally go through a central clearing house. Gary Gens

Financial fragmentation

Too much of a goodthingSince 2008 global �nancial integration has gone into

reverse



2

1

ler, the CFTC’s chairman, rattles o� a litany of �nancial disastersinvolving o�shore a�liates: AIG had run its derivatives out ofLondon; Lehman’s London a�liate had 130,000 outstandingswaps contracts, many guaranteed by its American parent; Citi-group had set up many o�-balance-sheet vehicles in the Cay-man Islands; and JPMorgan Chase earlier this year su�ered hugelosses on trades in London. �Riskðcomes crashing back to ourshores from overseas when a run starts in any part of a modern,global �nancial institution,� says Mr Gensler.

The CFTC has agreed to exempt foreign swaps customersthat operate under similar rules abroad, and the Fed has yet to is-sue its �nal foreign banking rule. But for the most part Americanregulators, like their counterparts overseas, have stuck to theirguns. �We will not let the pursuit of international consistencyforce us to lower our standards,� said Jack Lew, the Treasury Sec-retary, in July.

Even when regulatory initiatives are not explicitly discrim-inatory, they make cross-border banking harder. Benoît Coeuré,a member of the ECB’s governing board, notes that Basel 3, a setof new international capital and liquidity standards for banks, isbeing implemented di�erently across countries: capital is mea-sured di�erently under American and international accountingrules, and even within Europe, Britain, France and Germanyhave proposed di�erent bank holding-company structures. �Ifyou have an idiosyncratic local legal environment, then marketparticipants will �nd it safer just to play on their home turf be-cause of the legal uncertainty that goes with international activ-ities, and we’ll lose the bene�t of international �nancial integra-tion,� he says.

Such changes have undermined the case for global banks.Huw van Steenis at Morgan Stanley comments that �if I’m a Ger-man bank, one of my edges is I have really cheap funding in Ger-many because I have more deposits than loans. If that advantagegoes away, one of their unique selling points goes, too.� MorganStanley estimates that banks’ cross-border claims within theeuro zone have fallen from nearly $4 trillion in mid-2008 toabout half that amount now.

And regulation is only one factor at work. Another is theneed to deleverage in order to shore up capital and meet highercapital requirements. Again, this is most apparent in Europe,where banks have been shedding loans and bonds in troubledperipheral economies. Non-residents have gone from holding43% of Spain’s and Italy’s sovereign debt in 2010 to 35% now.American money-market funds have cut their exposure in Eu-

rope by 60% since 2010. In some countries regulators have quietly pressed banks to

increase domestic lending to boost their economies, at the ex-pense of foreign operations. In others they have been more ex-plicit. Britain’s Funding for Lending scheme, launched in 2012, of-fers banks cheap central-bank �nancing for increasing lending toBritish households. America’s Volcker rule would exempt thatcountry’s debt, but not that of other sovereigns, from restrictionson banks’ proprietary trading.

In retrospect, much of the rise in cross-border lending wasfoolish. It made both European and American banks more vul-nerable to a sudden drop in asset prices and increased the risk ofa credit crunch. McKinsey’s work shows that cross-border banklending is far more volatile than other capital �ows such asbonds, equities and direct investment. Research by the Bank ofEngland shows that over the past decade lending by foreignbanks was far more cyclical than by domestic banks.

Less �nancial globalisation should also reduce the risk thatcontagion from one country’s banking problems will cause eco-nomic damage elsewhere. That is the lesson of the Asian bank-ing crisis of 1997-98. In many countries loans in 1997 exceeded de-posits by 20%, says Mr van Steenis, with the gap made up bywholesale funding, often from abroad. When that funding dis-appeared, many banks teetered on the verge of collapse, prompt-ing the authorities in the countries concerned to put a cap on theuse of such funding. This had the positive e�ect that Asian bankssu�ered very little contagion from either the American mortgagecrisis or the European sovereign-debt crisis.

The penalties of self-reliance

But reduced cross-border links come at a price. If a countrysu�ers a domestic shock, it will have to bear more of the conse-quences itself. Although regulators fret over shocks to a bank’sforeign parent or withdrawal of that parent’s support, PeterSands, the boss of Standard Chartered, a British bank, observesthat �there are lots of examples of shocks in the market when thesupport of the parent is needed.� International banks providedvital funding to South Korea during its crisis in 1997 and to Dubaiin 2009 when a state-owned developer almost defaulted. �Inter-national �ows of funds in the banking system can be a source ofcontagion but also of resilience,� says Mr Sands.

Financial fragmentation also challenges one of the greatpromises of globalisation: that savings-poor countries will beable to �nd the wherewithal to �nance essential investment byborrowing abroad. In theory, if capital is free to seek the highestpotential return, domestic saving and investment should not becorrelated. In 1980 Martin Feldstein and Charles Horioka docu-mented that in fact they are, suggesting that national borders

2Getting back to normal

Source: European Central Bank

Correlation between saving and investment1.00=perfect correlation

0.50

0.25

0

0.25

0.50

0.75

1.00

+

–

1995 96 97 98 992000 01 02 03 04 05 06 07 08 09 10 11 12 13

Non-euro-area OECD

Euro area


WORLD ECONOMY

SPECIAL REPORT

2

1

were impeding the free �ow of capital. Over the years that corre-lation diminished, particularly within Europe, but Mr Coeurépoints out that it has now returned.

The result is starkest in Europe, where Spanish and Italianbusinesses are obliged to pay 80-160 basis points more than Ger-man ones to borrow. This is because of the higher rates on sover-eign debt in those countries and fewer deposits from healthiercountries. A more balkanised �nancial market makes it less like-ly that German savers will �nance dodgy Spanish loans. But italso makes it more likely that they will �nance low-yielding Ger-man loans, sending high-yielding Spanish businesses awayempty-handed.

In addition, �nancial fragmentation means less competi-tion for often cosseted domestic banks from nimbler foreign ri-vals. Studies of foreign banks entering Australia, Indonesia, thePhilippines and Colombia found that they reduced interest-ratespreads and made domestic banks more e�cient (althoughsometimes also more likely to make bad loans).

The best way to maintain �nancial globalisation withoutfear of shoddy regulation spilling over from one country to an-other would be increased co-operation among regulators. This isbeginning to happen at the Financial Stability Board, which istrying to ensure uniform implementation of new capital and li-quidity standards across most countries and has been pushingfor a European banking union.

Unfortunately this process has exposed divisions. Ameri-ca’s biggest banks, for instance, will have to maintain a higher le-verage ratio (a type of capital requirement) than stipulated by Ba-sel 3. And although a single European supervisor will replacenational regulators for the euro zone’s biggest banks next year,prospects for a common deposit insurance and resolution re-gime remain uncertain, for much the same reason that has madethe entire crisis so intractable: creditor nations such as Germany,Finland and the Netherlands are deeply reluctant to make theirtaxpayers foot the bill for bank failures in debtor countries.

It seems unlikely, then, that banks will return to the highlyglobalised state of 2007 soon. But if cross-border lending re-mains subdued, that will put added pressure on capital marketsto make up the di�erence�and they, too, are feeling the pinch. 7

IT WAS AS if the Vatican had given its blessing to birth con-trol. The International Monetary Fund, which has long

been the ideological guardian of borders open to capital, de-clared last November that under certain circumstances capitalcontrols were a good thing.

The IMF’s conversion re�ected some rethinking within theorganisation, but it was also an acknowledgment of what mem-ber countries were doing anyway. In 2008 Iceland became the�rst industrial country in decades to impose capital controls, tolimit a �ight of capital from its busted banks. Between 2009 and2011 Brazil, South Korea, Thailand, Indonesia, among others, in-troduced controls to discourage in�ows of hot money that theyfeared would drive their currencies to uncompetitive levels. Andwithin the past few months India has reimposed controls to

slow an exodus of capital. These moves have reversed a de-cades-long trend towards greater openness to foreign capital andmade the intellectual climate more hostile to it.

�Capital controls� is a loosely de�ned term. In the post-warperiod such controls usually took the form of outright prohibi-tion or quotas on the amount of money that could be moved inor out of a country. Some countries, notably China, still employsuch controls, and others have reimposed them to deal with theaftermath of crisis, among them Iceland and Cyprus. But thosepost-crisis controls are explicitly temporary, and even China hastaken some important steps towards relaxing controls in recentyears, for example by making the renminbi more easily conver-tible. The sort of controls now in favour are lighter-touch, mar-ket-based ones such as taxes on certain types of �ows, changesto withholding taxes and di�erential reserve and liquidity re-quirements for foreign funds. They amount to a selective em-brace of globalisation, not a rejection.

A quali�ed welcome

No country exempli�es this better than Brazil. In 2008, asthe �rst waves of the crisis washed over it, the Brazilian centralbank lowered bank reserve requirements to ease credit and of-fered foreign-exchange swaps to Brazilian companies trying toroll over foreign-currency debt. In late 2009, as Brazil raced out ofrecession and money began to pour in, the authorities switcheddirection, initially imposing a �nancial-transactions tax of 2% onforeign purchases of stocks and bonds. In 2010 the tax wasbroadened and raised to 6%.

Brazil’s central bank has made it clear that foreign invest-ment is still welcome. The goal, says Mr Pereira, the deputy go-vernor, was to smooth exchange-rate �uctuations and make hiscountry’s banks less vulnerable to a sudden out�ow of capital.The measures were not intended as a substitute for monetaryand �scal policy.

The Brazilian government put it rather di�erently. GuidoMantega, the �nance minister, spoke of the need to act on the ex-change rate and help Brazilian industry survive what he called�currency wars� triggered by easy American monetary policy.Brazilian industry had pushed for the controls, complainingabout the high exchange rate.

This summer capital abruptly started to pour out of Brazil.As Brazil’s currency, the real, plummeted, the country suspendedits �nancial-transactions tax, then intervened in foreign-ex-change markets and again o�ered swaps to Brazilian companiesin need of dollars. O�cials argue that the reversal would havebeen far worse had capital controls not tempered the in�ows inthe �rst place. �We knew this was going to come, and we pre-pared ourselves,� says Mr Pereira.

Capital

Just in case

Capital controls are back as part of many countries’

�nancial armoury

3What goes up too much must come down

Source: McKinsey Global Institute *2012 exchange rates, 173 countries

Cross-border capital flows, $trn*

0

2

4

6

8

10

12

1980 85 90 95 2000 05 10 12



2

1

The consensus in favour of capital mobility has alwaysbeen less clear-cut than that in favour of free trade, for two mainreasons. First, capital �ows can push a currency far above its in-trinsic value, widening the trade de�cit and hollowing out do-mestic manufacturing. Second, they can fuel borrowing booms,especially in countries with underdeveloped �nancial systems,leading to devastating busts when the money �ows out. Hencethe IMF’s original charter prohibited controls on cross-bordertrade, interest payments and pro�ts but allowed them on capital.

Right move, wrong time

But over time a di�erent argument emerged: that removingcapital controls would speed up the �ow of badly needed fundsto savings-poor, opportunity-rich countries, deepen their �nan-cial sectors, encourage a more e�cient allocation of credit andreduce dependence on the IMF. On this view, the way to discour-age hot-money in�ows was to cut government borrowing ratherthan maintain capital controls. In September 1997 the IMF for-mally proposed amending its charter to promote capital-accountliberalisation, calling it �an essential element of an e�cient inter-national monetary system in this age of globalisation�.

The timing was dreadful. The Asian �nancial crisis had justbegun, and opinion soon started to shift against wide-open capi-tal markets. Michael Klein of Tufts University has shown that theuse of capital controls began to rise a few years later. From 2008 itbecame widespread, propelled by the �nancial crisis and thenby quantitative easing (QE), the practice of buying bonds withnewly created money. Rich countries, desperate to rekindle

growth, made their monetary policy ever more expansive. In2010, when the Fed started its second round of QE, in�ows intoemerging-market bonds surged and their currencies climbed.Last summer, when emerging markets had started to slow, theFed hinted that QE would stop�and money �owed in the oppo-site direction. In September, when the Fed failed to stop, �owspromptly changed direction again.

QE has thus helped to make capital controls intellectuallyrespectable again. In a paper presented at the Kansas City Fed’sJackson Hole conference in August, Hélène Rey of the LondonBusiness School argues that the volume and volatility of capital�ows rules out an independent monetary policy, even with a

�exible exchange rate, in theabsence of capital controls.The IMF has not gone that far,but has laid out conditions inwhich such controls would beappropriate.

Even so, nobody is seri-ously suggesting a return tothe more draconian prohibi-tions on capital movements ofthe 1950s and 1960s. Eswar Pra-sad of the Brookings Institu-tion, a think-tank, notes thatboth China and India havesteadily liberalised their capi-tal account in recent decades,but neither seems to want to

go as far as America towards unfettered markets. Joseph Yam, aformer head of the Hong Kong Monetary Authority, argued in2011that China may want �full� but not �free� convertibility. �Fullconvertibility does not necessarily and should not mean totalfreedom to convert without, for example, the need to seek ap-proval from any authority or to report.�

Essentially, he suggested that China would relax its capitalcontrols but retain the option of reimposing them as needed�the very essence of gated globalisation. Other countries have al-ready adopted this approach. Brazil turned to the �nancial-trans-actions tax to slow capital in�ows because it already had it in re-

serve, where it remains, though the ratehas since dropped to zero.

Such o�-on controls do not alwayswork as intended. India responded to therecent fall in the rupee by resurrecting agrab-bag of controls, including a cut in the

amount of money residents can take out of the country withoutspecial approval from $200,000 to $75,000 a year; a reduction inthe foreign acquisitions a domestic company can make, from400% to 100% of its net worth; and higher import taxes on gold,silver and �at-panel televisions. A government o�cial was re-ported as insisting that these were not capital controls, but that�non-essential out�ows have been moved from the automaticroute to the approval route.� Foreigners were not convinced, andthe rupee plunged even farther. India is not about to undo twodecades of liberalisation, but wants to retain the option to inter-vene, just as China does.

Do controls work? Countries that have them certainly seemto think so. A study by Brazil’s central bank claims its measuresslowed down excessive growth in certain types of credit such ascar loans; forced foreign-currency borrowers to lengthen theirterms, leaving them less vulnerable to the �ckleness of short-term lenders; and reduced banks’ derivatives exposure. A studyby Valentina Bruno of American University in Washington andHyun Song Shin, a Princeton professor who advised South Koreaon its capital controls (mainly in the form of a tax on certain for-eign-currency deposits), says they made the country �less sensi-tive to global factors�. Many investors agree. �They do exactlywhat they are intended to do: put sand in the market,� says Mo-hamed El-Erian, chief executive of PIMCO, the world’s largestbond-fund manager. �We think twice, or three times.�

Others are more sceptical. Mr Klein notes that after Braziland South Korea imposed controls, their currencies continued torise at about the same rate as that of Chile, which did not. TheIMF has mixed feelings. It acknowledges that the jury is out onwhether controls reduce in�ows or exchange-rate appreciation,but reckons that they may strengthen a �nancial system by shift-

5Can’t be too careful

Source: IMF

World foreign-exchange reservesas % of world exports

0

10

20

30

40

50

60

1995 2000 05 10 13

4Still a way to go

Source: European Central Bank*20 countries based on an index developed by Menzie Chinn and Hiro Ito, which

tracks restrictions on cross-border financial transactions

Capital-account openness in emerging markets*, 1=most open

1.00

0.75

0.50

0.25

0

0.25

0.50

+

–

1984 86 88 90 92 94 96 98 2000 02 04 06 08 10 11

The consensus in favour of capital mobility has alwaysbeen less clearcut than that in favour of free trade


WORLD ECONOMY

2

1

ing more of the in�ows into direct investment. In its most recentWorld Economic Outlook, it found that the current accounts ofChile, the Czech Republic and Malaysia held up fairly well tocapital in�ows not because of controls but because of better �s-cal and monetary policy and more investment abroad.

Leaving aside their macroeconomic consequences, suchcontrols do have serious microeconomic e�ects. They are ad-ministratively burdensome, requiring the government to dis-criminate between di�erent types of credit, encouraging eva-sion, lobbying and rent-seeking. Much of the recent enthusiasmfor controls is based on Chile’s experience in 1991-2001, when for-eigners had to leave part of their investment on deposit with thecentral bank where it earned no interest. But research by KristinForbes of MIT found that those controls in Chile made it harderfor small companies to raise funds. Companies also respondedby delaying tax payments, borrowing from suppliers and some-times disguising loans as direct investment, giving rise to a cat-and-mouse game with o�cials. Brazil’s ban on currency out-�ows in the 1980s created a black market in hard currency and �aculture of transgression�, says Arminio Fraga, a former chief ofthe country’s central bank and now an investment manager. Heworries that even the milder controls in use recently could shiftactivity o�shore and damage transparency and liquidity.

Do it yourself

The increased deployment of capital controls, despite theirdisadvantages, is in part a response to a broader problem: thegaping absence of global monetary co-operation. This has beencausing concern at least since the collapse of the Bretton Woodssystem in the early 1970s, but the worries have increased in re-cent years. Another part of the response has been more interven-tion in foreign-exchange markets. This �rst surfaced in the late1990s when Asian countries, led by China, used intervention tohold down their currencies, both to promote exports and to�self-insure� against future �nancial crises. Since 2000 the globalvolume of reserves has risen from $2 trillion to $11 trillion andfrom 25% to 49% of annual exports (see chart 5, previous page).

Foreign-exchange intervention is a zero-sum game. A coun-try that keeps down its currency can improve its trade balanceonly by making someone else’s worse. For many poor countries,holding bucketloads of low-yielding foreign government bondsis a bad investment. By arti�cially depressing interest rates in therecipient country, it also encourages excessive borrowing andbubbles there. The IMF sought to discourage sovereign self-in-surance in 2009 by o�ering ��exible credit lines�, loans on easyterms and with few conditions attached to countries with re-sponsible macroeconomic policies. But only Poland, Mexico andColombia took up such loans. Others, including South Korea,have painful memories of the punitive interest rates and forcedrestructuring of banks and industrial companies imposed dur-ing the East Asian crisis. Many countries in need of dollars wentnot to the IMF but to America’s Federal Reserve, which openedmassive swap lines with hardly any conditions.

Recent events have only reinforced the perceived bene�tsof self-insurance. The crisis, says Mr Prasad, was �a game-chang-er: every emerging-market central bank now sees more reservesas a good thing.� The IMF sought to boost its lending power witha quota increase, but that has been blocked by Republicans inAmerica’s Congress who regard giving the IMF more resourcesas an invitation to more bailouts. Even the Fed’s use of swaplines has been attacked as a gift to foreign banks. It is no surprise,then, that individual countries put less faith in multilateral insti-tutions and more in their own resources.

A similar rejection of multilateralism is under way in worldtrade, as the next article will show. 7

UKRAINE, LONG PULLED back and forth between eastand west, is feeling the tug again, this time between rival

trade blocks. Next month it hopes to sign a free-trade agreementwith the European Union. But Russia wants Ukraine for its owncustoms union, which already includes two other former Sovietrepublics. So earlier this year, in a clumsy e�ort to change itsneighbour’s mind, the Kremlin banned Ukrainian sweets be-cause they allegedly contained carcinogens, then imposed long,intrusive customs checks that slowed Ukrainian exports of steel,machinery and chemicals to a crawl.

The ti� has geopolitical undertones: Russia does not wantUkraine, with which it has deep cultural and political ties, to driftinto the West’s sphere of in�uence. But it also points to a changein the world trading system. Russia joined the World Trade Orga-nisation in 2012, but it is less interested in strengthening the mul-tilateral trading system than in building its own regional tradeblock. Fyodor Lukyanov, editor of Russia in Global A�airs, a for-eign-policy journal, notes that with America trying to concludesweeping trade agreements with its neighbours in the Paci�cRim and with Europe, �the whole structure of world trade ischanging towards a more fragmented system. That’s why Russiais trying to build something of its own.�

Free-traders in the West worry that the proliferation of re-gional trade agreements (RTAs) is gutting the multilateral tradingsystem. Arvind Subramanian of the Peterson Institute for Inter-national Economics calls the rise of ever larger RTAs an �existen-tial threat� and gives warning that �multilateral trade as we haveknown it will progressively become history.�

The debate about whether RTAs help or hurt the multilater-

Trade

In my backyard

Multilateral trade pacts are increasingly giving way to

regional ones

SPECIAL REPORT


2

1

al trading system has gone on for decades. Supporters arguedthat wherever two countries entered into an RTA, they wouldcreate incentives for others to join or to negotiate their own RTA.Trade barriers around the world would fall, one by one, and po-litical support for multilateral deals would increase. Detractorsclaimed that once inside an RTA, countries would discriminateagainst outsiders and lose interest in multilateral liberalisation,undermining the authority of the WTO. They would divert asmuch trade as they created and introduce big distortions.

For most of the post-war period, the optimistic view pre-vailed as regional and multilateral liberalisation proceeded intandem, albeit unevenly. The forerunner of the European Unionwas established in 1957, even as members of the General Agree-ment on Tari�s and Trade, the WTO’s predecessor, continued tocut tari�s. In the 1990s Bill Clinton signed the North AmericanFree-Trade Agreement just as the Uruguay round of trade liberal-isation was completed. In the early 2000s China joined the WTOand the EU expanded into eastern Europe.

In the past decade, though, RTAs have increasingly lookedlike an alternative, not a complement, to multilateralism. TheDoha �development� round, which began in 2001, immediatelyran into trouble as emerging markets chafed at the central bar-gain: big cuts in their industrial tari�s in exchange for more ac-cess to rich-world agricultural markets. Talks faltered in Cancunin 2003 and �nally collapsed in Geneva in 2008. One negotiatorrecalls going to dinner that night convinced that a deal had beenstruck, only to learn the next day that it had failed.

As Doha began to founder, the appeal of RTAs grew. Thenumber concluded rose from 104 in 1958-2001 to 154 since then.Many of these are tiddlers, but the Trans-Paci�c Partnership(TPP) and the Transatlantic Trade and Investment Partnership(TTIP) have the potential to become mega-RTAs accounting for ahuge share of global trade. TPP �wasn’t initially seen as the big al-ternative to WTO,� says Gary Hufbauer of the Peterson Institute,�butðthe US position is, ‘If emerging market countries don’twant to play ball in the WTO, we have alternatives’.�

In need of protection?

The biggest obstacle to more multilateral trade deals is thechanging balance of global economic power. Brazil, Russia, Indiaand China (the BRICs) see themselves as countries still poorenough to need protection for their industries while the richones lower their own barriers, especially to agriculture. But therich world increasingly views the BRICs as full-�edged eco-nomic competitors whose state capitalism is incompatible witha free and open global economy.

�For too long, much of the economic force and sacri�ce inGeneva to produce global trade agreements has come at the ex-pense of the US and EU,� says Ron Kirk, who was Mr Obama’s�rst trade negotiator. �We have been lectured over and over byour colleagues from the emerging markets that they have the eco-nomic heft and prestige to demand a seat at the table. And weagree.� But that, he says, means they too need to make sacri�cesby opening up further to America and Europe.

These divisions became clear in the race to elect a newWTO director-general this year. The contest between HerminioBlanco, Mexico’s former trade minister, and Roberto Azevedo,Brazil’s ambassador to the WTO, became a referendum on Mexi-co’s liberal preferences versus Brazil’s protectionist stance. Richcountries backed Mr Blanco while emerging markets plumpedfor Mr Azevedo, the eventual victor. Mr Azevedo has stressedthat he represents the interests of all members.

The emerging markets are not monolithic. They often wantprotection not just from rich countries but from each other, par-ticularly China. Roberto Giannetti da Fonseca, an o�cial with

FIESP, Brazil’s largest industrial association, ran a trading com-pany in the 1980s that sold Brazilian manufactured products toChina. He struggled to �nd anything worth buying from China,often settling for arts and crafts. �I could not imagine that 20years later they’d be invading Brazil with hundreds of productsand we’d be crying that we cannot compete.� His organisation isa vocal critic of China’s mercantilist practices and has urged theBrazilian government to negotiate free-trade agreements withNorth America and Europe.

Trade liberalisation is now proceeding along two di�erenttracks. One, preferred by America, goes �behind the border�, fo-cusing on things such as harmonising safety, health and techni-cal standards, currencies, national treatment of foreign investors,the protection of intellectual property, services such as telecom-munications, and enforcement of labour and environmentalprotection. The other, preferred by China, concentrates on reduc-ing tari�s�outside sensitive sectors.

America started on its track in 2007 when Democrats inCongress struck a deal with President George W. Bush that in fu-ture trade agreements, signatories’ adherence to environmentaland labour standards would be subject to the same dispute-set-tlement rules as commercial disputes. Sandy Levin, a Democrat-ic congressman who helped negotiate that deal, notes that peo-ple like himself who were intent on correcting market failures athome were also keen to use trade policy to do the same abroad.Their goal, he said, is �to shift the equation that has dominateddiscussions of trade as ‘free trade’ versus ‘protectionism’ to oneof ‘free trade’ versus ‘free and fair trade’.�

In practice, this means America is most likely to strike dealswith countries at a similar stage of economic development, suchas the European Union and Japan, or with developing countrieswilling to meet rich-world standards in exchange for market ac-cess, such as Mexico and Chile. America’s comprehensive free-trade deal with South Korea is the model for the TPP.

China, by contrast, has pursued a variety of bilateral dealswith its neighbours, mostly in the hope of persuading them �thatit sought a peaceful rise as an emerging superpower�, says ChinLeng Lim, a trade-law expert at Hong Kong University. China’sfree-trade agreements are numerous but shallow, often leavingout sensitive sectors and subjects. Its agreement with the Associ-ation of South-East Asian Nations, for example, allows signato-ries to classify 400-500 tari� categories as sensitive and thus eli-gible for slower tari� reduction.

Regional trade liberalisation is better than no liberalisationat all, yet it interferes with globalisation in several damagingways. By excluding sensitive sectors or imposing onerous rulesof origin, it complicates life for multinational companies whose

6Strength in numbers

Sources: Arvind Subramanian; Martin Kessler; World Trade Organisation

*Includes joint customs union and partial-scope agreements†Covering only certain products

Newly signed preferential trade agreementsNumber, by type of agreement

0

5

10

15

20

25

1958 65 70 75 80 85 90 95 2000 05 10 13

Customs union

Economic integration*

Free trade

Free trade and economic integration

Partial scope†



WORLD ECONOMY

SPECIAL REPORT

2

1

LAST SUMMER FRED HOCHBERG, head of America’s gov-ernment-backed Export-Import Bank, joined the chief of

Westinghouse on a sales trip in the Czech Republic. A Czech o�-cial, he recalls, told him they would not even consider Westing-house’s bid to expand a nuclear power plant without �nancefrom his bank. Russia’s state-owned nuclear-energy company,Rosatom, had already o�ered to fund half the project. Mr Hoch-berg promised to do the same if Westinghouse, an Americanunit of Japan’s Toshiba, won the bid.

�It’s time to drop the fantasy that a purely free market existsin the world of global trade,� Mr Hochberg told an American au-dience shortly after returning from Prague. �In the real world ourprivate enterprises are pitted against an array of competitors that

are often government-owned, government-protected, govern-ment-subsidised, government-sponsored or all of the above.�Russia was particularly active, pledging $38 billion to �nance Ro-satom’s global ambitions.

The rival loans from America and Russia to win the CzechRepublic’s business do not �t the usual de�nition of protection-ism. Indeed, conventional protectionism of the tari� and quotakind has been remarkably, and blessedly, quiescent in recentyears. In the past decade the number of incidents when coun-tries have punished dumping (selling below a �fair� price) byslapping tari�s on imports from the o�ending trade partner hasbeen running at about 200 a year, fewer than in the late 1990s.

One reason for the decline in traditional protectionism isthat countries hit by recession are able to let their exchange ratesfall. In the 1930s countries on the gold standard did not have thatoption, so they resorted to tari�s instead to ward o� imports. TheWTO can also take some credit. Since its creation in 1995 big trad-ing countries have regularly brought cases to it, and have respect-ed its rulings when they have lost.

Beyond tari�s and quotas

But another reason why there is less overt protectionism isthat the practice has crept back in other guises, often to avoidrunning foul of WTO rules. The WTO concentrates on measuresdesigned to keep out imports. Global Trade Alert (GTA), a mon-itoring service operated by the London-based Centre for Eco-nomic Policy Research, de�nes protectionism more broadly asanything that hurts another country’s commercial interests. Itthus includes government bailouts of domestic companies,wage subsidies, export and VAT rebates, export credits and �-nancing from state-owned banks. For example, it classi�esFrance’s loan guarantee to the �nancing arm of PSA Peugeot Ci-troën, a carmaker, as protectionist because, by helping sales ofthe company’s cars, it hurts their competitors’ sales. It reckonsthat at least 400 such �beggar-thy-neighbour� policies have beenput in place each year since 2009, and that the trend is on the rise.

GTA’s Simon Evenett, who is also a business professor atSwitzerland’s University of St. Gallen, thinks the WTO under-counts protectionist activity, both because of its narrow de�ni-tion and because many countries do not complain about covertprotectionism because they are guilty of it themselves: �The re-action of many trading partners to illegal subsidies is to havesubsidies of their own.�

GTA’s data start only in 2009, making it hard to prove thatsuch protectionism is on the rise, and some experts are scepticalof Mr Evenett’s alarmist take. Researchers at the European Cen-tral Bank point out that a small number of countries, accountingfor only 13% of G20 imports�Argentina, Brazil, India, Indonesia,Russia, South Africa and Turkey�were responsible for 60% of themeasures recorded by GTA since 2009. But GTA’s data do make itclear that countries have found ways other than traditional pro-tectionism to help domestic industry, keep out imports andboost exports, often under the guise of industrial policy.

Brazil has perfected the art. Last year, looking for a way toreduce car imports, it introduced a new programme to encourage

Protectionism

The hidden persuaders

Protectionism can take many forms, not all of them

obvious

supply chains cross multiple borders. And even global agreements have their limitations. One of

the most successful global trade pacts has been the Information-Technology Agreement (ITA), signed in 1996 under the WTO’sauspices to liberalise international trade in technology products.But it is becoming less useful as technological developmentcreates new products that are not covered by it. For example, it in-cludes computer monitors and gaming software but not televi-sions and game consoles. As �at-panel televisions increasinglydouble as computer monitors for users to go online, and as videogames migrate from consoles and personal computers to hand-held devices, the ITA’s scope is narrowing. WTO members hadbeen negotiating for a year to update the pact to include 256 extraproducts, many of which did not exist in 1996. But in July Chinaasked for more than 100 of these products to be taken o� the ta-ble, including audio and video products. In e�ect, that put a stopto progress on a new ITA.

The WTO is in part a victim of its own success. Thanks toearlier rounds of tari� reductions, further liberalisation o�ersprogressively less economic bene�t. Mr Hufbauer, Je�rey Schottand Woan Foong Wong reckon that a comprehensive (and im-probable) Doha deal would lift participants’ output by a mere0.5%. The Uruguay round in the 1990s is thought to have pro-duced a gain of 0.5-1.3%. Even the TPP will boost participants’ out-put by only 0.5%, much the same as Doha would, reckons onestudy by Peter Petri of Brandeis University and Michael Plum-mer of Johns Hopkins.

In theory, a successful TPP or TTIP could become a magnetfor other countries, eventually achieving multilateral trade liber-alisation by default. In practice that seems unlikely. China’s andRussia’s interventionism and attachment to state capitalism aredi�cult to reconcile with the �behind-the-border� liberalisationAmerica and Europe are seeking. And having had no say in de-signing the pacts, China and Russia may be reluctant to join later.

The decline of multilateralism may not make much di�er-ence to big countries able to negotiate regional agreements ontheir own terms. Small countries without such leverage may beharder hit. But the marginalisation of the WTO as a deterrent toprotectionism would hurt everyone. And increasingly such pro-tectionism is taking on new forms that are hard to deal with. 7



2

1

innovation, Inovar-Auto. Designed to stay within WTO rules,this requires Brazilian car manufacturers (all foreign-owned) toinvest in local innovation and engineering and to meet certainfuel-e�ciency standards by 2017, or else face higher excise taxesand import tari�s on domestic sales. This has boosted domesticinvestment in engineering and fuel-saving technology.

Brazil has also used state-controlled companies and banksto encourage domestic innovation and industry. Over the pastdecade it has required Petrobras, the state-controlled oil com-pany, to meet ever tougher domestic-content requirements.BNDES, the state-owned development bank, has expanded itslending and equity investment since 2007 by 140%. Recepta, abiotech company, has received a grant, a low-interest loan and,last year, a direct equity investment by BNDES worth about $15m.José Fernando Perez, who founded Recepta in 2006, does not likethe Brazilian government’s propensity to meddle in markets, buthe makes an exception for innovation policy, noting that Austra-lia, Britain and America all subsidise basic biotech research. �Icould not have survived if I’d paid commercial interest rates.�Even so, he complains about the thickets of red tape that make ithard for his company to develop and test its new drug.

It is no surprise that the BRIC countries �gure prominentlyin GTA’s record of covert protectionism. Thanks to their embraceof state capitalism, the line between industrial policy and exportsubsidy is blurred or non-existent. China has long used compul-sory joint ventures, technology transfer and access to cheap landand loans from state-owned banks to boost companies in strate-gic sectors. In the mid-2000s it invited foreign manufacturers, in-cluding Germany’s Siemens and Japan’s Kawasaki, to supply lo-comotives for its high-speed rail network. Later it switched toChinese companies, which now compete with Siemens and Ka-wasaki in foreign markets.

A similar story unfolded in wind power. A decade ago for-eign companies such as Spain’s Gamesa had a signi�cant shareof China’s market for wind-power turbines, but now Chinesecompanies, many using skills acquired as partners or subcon-tractors to Western suppliers, along with subsidised land andcredit, dominate the Chinese market and compete �ercely withthose original Western suppliers.

Let the sunshine in

When the same thing started to happen in solar power, Chi-na’s competitors hit back. In 2012 America, embarrassed by thebankruptcy of Solyndra, which had received federal loan guar-antees, slapped tari�s on Chinese solar-panel exporters for o�er-ing illegal subsidies and dumping. Karel De Gucht, the EU’s tradecommissioner, has linked China’s illegal exports to its pervasiveindustrial policy, pointing out that to discover which industriesare dumping, �you read the last �ve-year plan.� In June the Com-mission threatened to impose tari�s of up to 47.6% on Chinesesolar panels. But China said it would retaliate and had its handstrengthened when Germany questioned the Commission’scase. Eventually the two sides reached a settlement stipulating aminimum price for Chinese solar panels.

The tangle illustrated how di�cult it is to identify and pun-

ish protectionism in an industry where industrial policy is therule, not the exception. �Solar energy is subsidised in almost allcountries,� says He Weiwen, of the China Association of Inter-national Trade, a Beijing think-tank. �The important thing is notwhether we have subsidies but whether they are illegal,� andthat question is best determined by negotiation.

Whereas the solar-panel dispute was carried out in theopen, the battle over cheap export loans has been fought behindthe scenes. For decades rich countries have �nanced exportswithin guidelines laid out by the OECD, but in recent years muchmore business has been conducted outside those guidelines.They do not cover non-OECD countries such as Russia, Braziland, of greatest concern to the rich world, China, which has usedexport �nance to turn its construction-equipment manufactur-ers into world leaders. But OECD countries, too, have found waysto o�er loans that are not covered by the guidelines, such as �oat-ing-rate loans. The ExIm bank reckons that last year export creditregulated by the OECD guidelines amounted to $120 billion, un-regulated credit by OECD countries to $110 billion and lending byRussia, Brazil, India and China to $70 billion.

America has been no slouch itself. The ExIm bank madenew loans of $31 billion last year, up from $8 billion in 2007, andhas been focusing on key industries: oil and gas; mining and agri-culture equipment; agribusiness; renewable energy; medicaltechnology; construction; aircraft; and power generation.

Although export promotion and industrial policy are lesslikely to trigger retaliatory action and trade wars than importsuppression, that does not make these subtler methods less dis-tortionary or damaging, says GTA’s Mr Evenett. If country A’s ex-ports to country B bene�t from generous export credit, country Bcan complain. But he notes the real damage is being done to theexports of other countries that are being hit indirectly.

And just like import tari�s, export subsidies cause manydistortions. Delta Air Lines, for example, has complained it washurt by ExIm Bank’s �nancing of the purchase of Boeing jets byAir India, which competes with Delta on certain routes. Andshould a loan go bad, taxpayers would have to foot the bill.

Industrial policy also often has unexpected consequences.In 2010 India required central-government solar-power projectsthat used crystalline modules and, later, cells to source them lo-cally. Since India has a limited capacity for producing such tech-nology, many developers imported American-made thin-�lmtransistor technology instead, taking advantage of low-interestloans from ExIm bank.

Brazil’s industrial policy, too, is riddled with problems. Buy-local requirements have hampered Petrobras’s ability to exploitnew deep-sea oil deposits because the country’s capacity forproducing oil�eld equipment is limited. Idiosyncratic fuel stan-dards mean the new engines spurred by Inovar-Auto have re-stricted export potential. Brazilian businesses appreciate thehelp they get from the government but would prefer moregrowth-friendly policies on taxes, investment and pay.

Earlier this year Romi, a manufacturer of machine tools,plastic processing machinery and castings near São Paulo, got alow-interest loan of 27m real from the Brazilian government to


WORLD ECONOMY

SPECIAL REPORT

2

1

invest in innovation and process design. R&D is integral to thecompany’s success. Its senior managers say it spends 4% of itssales on this, gesturing to the ranks of designers and engineerssitting behind glass walls above a spotless factory �oor. But, theyadd, that R&D would proceed even without the loan. What Romireally needs is stronger investment growth, but the governmenthas put most of its e�orts into boosting consumption.

Hidden protectionism and industrial policy may boost spe-ci�c industries or exports, but that does a country no good if oth-er policies sti�e private enterprise and cause underinvestment inhuman and physical capital. Brazil and India have been heldback because their governments funnelled state resources to pre-ferred sectors and constituencies instead of boosting their econ-omies’ underlying potential, slowing down their growth.

In China, covert protectionism helped domestic manufac-turers achieve formidable market share at home and abroad, butexcessive lending by state-owned banks to state-owned enter-prises and local government caused investment and propertybubbles. The country’s leaders say they want to reinvigorate therole of private enterprise, but whether that extends to foreigncompanies remains to be seen. 7

LAST APRIL A retooled assembly line complete with 120new robots at Ford’s sprawling factory on the outskirts of

São Paulo started churning out sporty redesigned Fiesta hatch-backs. By July Ford’s Brazilian output was 30% up on a year earli-er, thanks in part to the Fiesta’s popularity and in part to an unex-pected protectionist move by Brazil.

Companies such as Ford had been importing cars into Bra-zil from Mexico at a lower tari� under an agreement betweenMexico and Mercosur, a Latin American trade block. But inMarch 2012 Brazil, fretting over a surge of imports, negotiated aquota on purchases from Mexico. Ford’s Brazilian production isup partly because planned imports from Mexico are down.

�The trade-agreement change with Mexico happened veryquickly and the timing caught us by surprise,� says Steven Arm-strong, president of Ford Brazil. Later in the year the governmentintroduced the Inovar-Auto programme under which importedcars attract higher taxes unless the manufacturer meets local-content requirements for innovation and engineering as well asfuel-e�ciency targets. Ford, which has a design centre in Brazil,expects to hit those targets. Nonetheless, it must now spend con-siderable time and e�ort tracking the local content throughout itsoperations to satisfy government audits.

Multinational enterprises have always been subject to thepolitical idiosyncrasies of their host countries, and have learnedto live with them. The restrictions that have appeared in the past�ve years have not made them any less multinational, but haveforced them to respond more rapidly. For Mr Armstrong, that isthe price of doing business in a dynamic market such as Brazil’s.�Exchange rates move rapidly and governments tend to negoti-ate regularly and quickly around trade agreements. That’s part ofmy job, and my team’s job: to �gure out ways to be nimble and�exible, to adjust to that.�

Ford can cope. Back in 2006 it had begun to consolidate itsrange of models (many of which were speci�c to particular mar-kets) into a few global platforms, which meant assembling andselling the same cars in Europe, the Americas and Asia. That al-lows it to shift production more easily from one market to anoth-er if quotas, tari�s or other rules change.

Small is problematic

But whereas large companies have the resources to re-spond to shifting requirements, smaller companies �nd it muchharder to adjust. MiTek, for instance, a manufacturer of audioequipment based mainly in Arizona, with a sta� of 500, doesnot enjoy tari�-free treatment for its output, but it often �nds it-self competing with products that do (under under the Informa-tion Technology Agreement). Currently it sells a small portableBluetooth speaker for $49 in America, but in China the price tagwould be $100 because of tari�s and other costs, and customerswould not pay that much for an accessory to a $400 tablet, saysJohn Ivey, MiTek’s vice-president of sales and marketing. Onlypremium brands can command such mark-ups.

The company could make the speaker in China, but thatwould double development, certi�cation and marketing costs,which for a small production run would be prohibitive. �If wecould just sell our traditional American product there, none ofthat would be necessary,� says Mr Ivey. But unless and until Chi-na agrees to include audio products in a new Information Tech-nology Agreement, that solution is probably out of reach.

Few markets present foreign companies with as many chal-lenges as China does. When the country lowered barriers to im-ports and investment around the time of its accession to theWTO in 2001, virtually every big multinational that was not al-ready in China started to pile in, but since then many have hadsecond thoughts. In a recent survey of its members, the US-Chi-na Business Council found that only 39% were optimistic aboutbusiness in China over the next �ve years, down from 58% in2011. Some of this disenchantment is due to the slowdown in theeconomy, but most of it stems from political barriers to growth.

Starting around 2008, the pace of reform in China stallednoticeably and Western companies often found their plans frus-trated by rules that seemed designed to give Chinese competi-tors a head start. In critical sectors Western companies were lim-ited to working with joint-venture partners with which theyoften found themselves competing later on. Forced technologytransfer, intellectual-property theft and cybercrime have all re-duced the allure of the Chinese market.

Financial services have been a particular disappointment.Foreign insurance companies had hoped for a sizable chunk ofChina’s business, but last year their share of the life-insurance

Political pressures

A question of trust

For companies doing business across borders, the

politics of globalisation can be a serious obstacle

7Proceed with caution

Sources: UNCTAD; IMF; The Economist

World foreign direct investment flows as % of world GDP

0

1

2

3

4

5

1980 85 90 95 2000 05 10 12



2 market was under 5%, lower than in 2007, according to PWC, aconsultancy.

China classi�es foreign investment as encouraged, restrict-ed or prohibited, depending on the sector. In the past �ve yearsthe list of prohibited and restricted sectors has changed but notshrunk much. Many of the fastest-growing technology sectors,such as internet businesses and cloud-computing services, areon the restricted list, requiring joint ventures. This poses pro-blems not only for foreign companies but for their customerstoo. More than 70% of companies surveyed by the AmericanChamber of Commerce in China said they would not store theirdata on a server owned by a Chinese company.

In July China and America agreed to restart long-dormantnegotiations on a bilateral investment treaty. Importantly, Chinaagreed to do so without conditions, meaning it would consideraccording national treatment to foreign investors at the �pre-es-tablishment� phase, before they had entered China. Rather thanspecifying which sectors foreign investors can enter, Chinawould create a less restrictive �negative list� of sectors fromwhich they are barred. Last month Li Keqiang, the Chinese pre-mier, said a negative list may also be used in the soon-to-openShanghai Free Trade Zone.

Yet against those encouraging signs from on high, a darkerreality has unfolded at ground level. Chinese regulators and me-dia have launched a number of high-pro�le investigations ofWestern companies: GlaxoSmithKline for allegedly bribing doc-tors to use its medicines; Mead Johnson, Danone and Nestlé forallegedly �xing the price of baby formula; Yum! Brands (the par-ent of KFC, a purveyor of fried chicken) for the use of antibiotics

in its meat. Even for companies that are never charged, mere in-vestigations or allegations can devastate sales.

According to Gregory Gilligan, the American Chamber’schairman, �companies should not approach these things as acommercial issue.� They often re�ect political priorities ratherthan impartial enforcement of consumer-protection or competi-tion laws. It is not clear whether the Chinese government is sin-gling out Western companies as a covert form of support for do-mestic �rms. Many Chinese companies have also been targeted,but they are smaller and attract less attention.

It works both ways

Chinese companies, for their part, complain of problemsthey encounter in Western markets, many of them to do with na-tional-security concerns. Huawei was blocked from buyingAmerica’s 3Com in 2008; from acquiring assets of 3Leaf Systems,a defunct internet company, in 2011; and from bidding for a sharein Australia’s national broadband network earlier this year. Alsothis year, America’s Congress prohibited the federal governmentfrom buying information-technology gear �produced, manufac-tured or assembled� by entities �owned, directed or subsidisedby the People’s Republic of China�.

When Shanghui International, a Chinese food company,bid for America’s Smith�eld Foods, senators urged the adminis-tration’s foreign-acquisitions watchdog, the Committee on For-eign Investment in the United States (CFIUS), to treat the foodsupply as �critical infrastructure� in considering the security im-plications of the takeover. That, in turn, raised nationalist hack-les in China.

Ultimately CFIUS didapprove the Smith�eld take-over. Yu Qiao, an economist atTsinghua University in Beij-ing, notes that America hasalso permitted several take-overs in the energy sector.Chinese companies, he says,need to learn that doing busi-ness in the United States is notthe same as in Africa and Lat-in America, where large dealsare often done government-to-government. �Maybe tele-communications isn’t sensi-tive in Africa, but it is in ma-ture countries,� he says. JohnFrisbie, head of the US-China

Business Council, reckons that as Chinese companies investmore abroad, foreign companies’ rights in China might bestrengthened.

Security concerns are not con�ned to Chinese companies:other countries, too, often suspect American technology compa-nies of acting as electronic conduits for America’s spy agencies.That is particularly true for companies o�ering cloud computingservices which host customers’ data so that they are easily acces-sible from anywhere. Some foreign customers worry that the Pa-triot act, passed in 2001 and renewed in 2011, could compel dataproviders based in America to hand over information on foreign

customers to American security services.Those concerns have grown since revela-tions by a former federal contractor, Ed-ward Snowden, that America’s spy agen-cy was eavesdropping on electronicconversations in other countries on a mas-sive scale.

France has invested in two domestic cloud computing com-panies, Cloudwatt and Numergy, with the express purpose ofenabling its companies and its government to keep their data inFrench hands on French soil. Fleur Pellerin, France’s minister forsmall business and innovation, said the Snowden revelationsraised the importance of having data centres on French territoryto ensure the security of national data.

Such sensitivities mean that aspiring foreign cloud-serviceproviders need to tread carefully. Nnamdi Orakwue, head ofcloud computing at Dell, says that although having a single datacentre in America might be the most e�cient way for his com-pany to provide services around the world, it might run counterto local �mores, cultures inside industries, customer preferenceor industry standards�. So when Dell markets its public cloud-computing equipment and services abroad, it works with localpartners who know their way around such contentious issues.In France its partner is Quadria, an information-technology con-sultancy. French customers �want Dell equipment, they wantDell’s stamp of approval,� says Mr Orakwue. But Quadria dealswith the local authorities and anything else that raises Frenchsensitivities. �We don’t get in the middle of that. They view themas a French company.�

Navigating such foreign sensitivities will be part of multi-national executives’ job description and a source of income to lo-cal lawyers, consultants, �xers and lobbyists for years to come.Ultimately, though, companies are at the mercy of other coun-tries’ policy priorities. The fate of globalisation rests on whetherAmerica, China and the rest of the world see open borders as be-ing in their national interest. 7

8More gates

Source: UNCTAD *January-April

New national investment policiesthat are restrictive% of total

0

10

20

30

40

2000 02 04 06 08 10 13*

The fate of globalisation rests on whether America,China and the rest of the world see open borders asbeing in their national interest

tensions between America andChina tend to reinforce each oth-er. America’s prohibitions ongovernment purchases of Chi-nese-made telecommunicationsgear are prompted by fears thatthey would expose criticalAmerican infrastructure to Chi-nese attack. China, for its part,has until recently treated the nas-cent Trans-Paci�c Partnership asthe economic counterpart toAmerica’s military �pivot� toAsia: an attempt to �encircle�China and contain its rise.

Given such political head-winds, the surprise is not thatglobalisation has struggled, butthat it has not struggled more.One reason is that the lessons ofthe 1930s have been taken onboard. Central banks in thecountries hit hardest by the �-nancial crisis have pursued un-precedented monetary expan-sion. That drove down theirexchange rates, triggering prot-ests and some protectionist reac-tion, but far less than in the 1930s.

The anti-globalisers lack anideological focus. �In the 1930sthere were very powerful alternative ideologies�communismand fascism,� says Harold James, an economic historian atPrinceton University. Now �we have anti-globalisation, with noset of beliefs that would really sustain anti-globalisation.� Oth-ers may envy the way China’s communist party has transformedthe economy, but few wish to embrace its political ideology.

Certainly in recent years state capitalism has emerged as acompetitor to liberal capitalism, causing a shift towards gatedglobalisation. But so far the state capitalists are sticking to therules of the global system. Russia has joined the WTO and is hop-ing to join the OECD. And state capitalism itself is less able to de-liver sustainable growth, one reason why India, Brazil and Indo-nesia su�ered runs on their currencies this past summer.

John Ikenberry, a political scientist at Princeton, notes thateven as America’s hegemony has eroded, more of the rest of theworld is now democratic and at least nominally committed tofree-market capitalism than in the 1980s, when globalisation lastpaused. That, he thinks, should help its institutions survive.

So the chances are that globalisation will not go into re-verse. The power of technology to erase distance is too strong,and the economic bene�ts of international trade and foreign in-vestment are too widely accepted. But nor will globalisation re-gain the broad and often unquestioned support it had before2008. The risk is not that the gates to globalisation will beslammed shut altogether, but that governments will make themtoo e�ective: that export promotion will shade into protection-ism and wasteful industrial policy, that the crackdown on banksand capital �ows will deprive deserving countries and business-es of capital, and that the proliferation of rules and regulationswill breed costly bureaucracy and rent-seeking. Political leaders,most of all in America and China, must not lose sight of the hugebene�ts that a freer �ow of people, trade and capital has broughtover the decades, even if such �ows occasionally go awry. Gatesmust remain the exception, and openness the rule. 7

Offer to readers

Reprints of this special report are available. A minimum order of five copies is required.Please contact: Jill Kaletha at Foster Printing Tel +00(1) 219 879 9144e-mail: [email protected]

Corporate offer

Corporate orders of 100 copies or more are available. We also offer a customisation service. Please contact us to discuss your requirements.Tel +44 (0)20 7576 8148e-mail: [email protected]

For more information on how to order special reports, reprints or any copyright queries you may have, please contact:

The Rights and Syndication Department20 Cabot SquareLondon E14 4QWTel +44 (0)20 7576 8148Fax +44 (0)20 7576 8492e-mail: [email protected]/rights

Future special reports

Previous special reports and a list of forthcoming ones can be found online: economist.com/specialreports

The Koreas October 28thBritain November 9thAmerica’s foreign policy November 23rd

The future of museums December 21st


GLOBALISATION’S OBITUARY HAS been written manytimes. In the 1970s and 1980s the multilateral trade system

was regarded as moribund or even dead. In 1999 and 2000 inter-national summits were besieged by anti-globalisation protes-ters. In 2002 the war on terrorism and the economic slumpprompted this newspaper to ask, �Is globalisation at risk?�

The worldwide �nancial crisis �ve years ago dealt it anoth-er blow. It survived but, as this special report has shown, it haschanged: policymakers and the public are more doubtful aboutallowing it to develop without constraints and more anxious toshape the �ows of trade, capital and people. From America toEgypt, the fruits of globalisation went mostly to those at the top,causing growing resentment among the middle and workingclass and undermining political support for open borders.

Is this just a pause in the spread of globalisation, much as inthe 1970s and 1980s, or, more ominously, could it signal a movetowards greater isolationism and growing international eco-nomic friction?

As this special report has noted, historically globalisationhas needed a hegemon. America seems to be retreating from thatrole and China is not yet ready for it. So far it has opened itself toforeigners only when it sees a clear bene�t to itself. As one for-eign executive who has spent decades in China puts it, �the de-�ning ideology in China is the ideology of nationalism. Its viewis, ‘foreign capital should be here as long as it is useful to us’. It’snot an intellectual commitment to open markets and a levelplaying �eld.�

In the 1980s the strategic military alliance between Ameri-ca and Japan ensured that economic tensions were never al-lowed to get out of hand. By contrast, economic and geopolitical

The outlook

What kind ofcapitalism?

The liberal sort may rebound as economies revive


The gated globe

Documents

Transcript of The gated globe