Ken Reinert, co-editor, with Ramkishen Rajan, of the authoritative new reference THE PRINCETON ENCYCLOPEDIA OF THE WORLD ECONOMY, has penned a fantastic piece about how to teach the world economy during one of the worst financial collapses since the Great Depression.  Hopefully, Ken’s piece can help our international economics teachers help their students understand the problems–and prevent it from happening again.  Enjoy!

Teaching the World Economy in Crisis

Kenneth A. Reinert

School of Public Policy

George Mason University

I have been teaching students and professionals about the world economy for two decades now. Along with the rest of my international economist colleagues, I explain the factors that have shaped economic globalization: advances in transportation, information, and communications technologies, a global consensus that market-friendly policies are a means of rapid and sustained economic growth, and the push toward global economic liberalization by global economic institutions. But what to say when the entire globalization process is disrupted in a crisis and the threads of the world economy begin to unravel?

In the current crisis, international trade, international finance, and international production are all in retreat. Economic globalization is, for the moment, moving in reverse. The International Monetary Fund suggests that the world economy will barely grow in 2009. Statistics recently released by the World Trade Organization indicate that trade in 2009 will fall by nearly 10 percent. UNCTAD suggests that foreign direct investment will fall by a similar magnitude. Risk aversion and the continuing global credit squeeze are shrinking portfolio investment, while the World Bank expects the remittances of migrants to fall in 2009.

            Even before the current crisis, much of our understanding of the world economy was in flux. For example, around 1980, our understanding of international trade—the exchange of merchandise and services among the countries of the world—began to change in response to emerging patterns of trade within (rather than between) manufacturing and service sectors. At the same time, trade policy agendas expanded into new areas such as trade in services, intellectual property, a new generation of preferential trade agreements, and dispute settlement mechanisms. Trade economists and trade lawyers became acquainted. Unforeseen issues emerged out of or alongside of trade negotiations such as trade and the environment, trade and labor, and trade and public health.

            Changes in the realm of international finance have been even more dramatic than in international trade. The liberalization and integration of global financial markets began in the 1980s, but accelerated significantly in the 1990s. Data from the Bank of International Settlements indicates that global foreign exchange turnover increased from US$620 billion in 1990 to US$3.2 billion in 2007. Such changes have potential benefits, including improved resource allocation and competition in the financial sector, and increased portfolio diversification and market discipline.  

But repeated episodes of significant financial turbulence also have significant costs. In 1992-93, Europe was faced with the very real possibility of a complete collapse of the European Exchange Rate Mechanism (ERM). In 1994-95, the Mexican currency crisis saw a steep devaluation of the peso and brought Mexico to the brink of default, with spillover effects on Argentina and Brazil. In 1997-1998, the world experienced the effects of the East Asian crisis, which started somewhat innocuously with a run on the Thai baht, but spread swiftly to a number of other regional currencies. Other large emerging economies such as Russia and Brazil also experienced periods of significant market weakness and required the assistance of the IMF.

         Another striking change has been the reversal of capital flows from developed to developing countries. Due in large part to the emergence of a significant current account deficit in the United States and involving the official transactions of central banks, the developing world is now an exporter of capital to the developed world rather than an importer. In fact, the flow of international capital from developing countries to developed countries is now one of the key paradoxes of the global economy.

         In international production, a key change has been in the structures of production of goods and services, as multinational enterprises engage in varieties of foreign direct investment. Economists have incorporated MNEs and FDI into the theory and practice of international economics. At the same time, political interest in this area has increased as such issues as outsourcing and offshoring have attracted public attention.

         Due to the huge disparities in standard of living around the globe and the effects of increased global integration, the ideas and policies that shape economic development have been the subjects of highly charged debates. The impacts of trade, finance, and international production on growth and development are hotly contested as are the roles of influential development institutions such as the World Bank. Although often naively considered in terms of the “Washington Consensus” or “neoliberalism,” these debates have gained new relevance in the midst of the current crisis.

The Crisis and the Classroom

What does this emerging crisis mean for our teaching in the classroom? The mood has definitely changed. From “rah-rah” globalization, we now have unemployment, bankruptcy, and home mortgages under water. If our students don’t have direct experience with this, they know someone who has, and we cannot pretend differently. Rather, an honest assessment is in order. So are some shifts of emphasis. For example, in the area of trade, we need to pay much more attention to the role of trade finance which supports nearly all of global trade. My colleague Delio Gianturco, an expert on this subject, recently told The Economist saying that the providers of trade finance, the Export Credit Agencies are “the unsung giants of international trade and finance.” These unsung giants are currently going through a shortfall of hundreds of millions of dollars, and this has contributed to the collapse of trade. Our students need us to be more honest about the fact that trade in not some automatic process, but one that requires economic agents to engage in trade-related services that have real costs. This is but one example of what international economists refer to as “border effects” and appears in the classic example of the Canadian inter-provincial trade being more significant than its trade with the United States despite the presence of the most open border in the world. 

            In the realm of international finance, we must carefully lay out the balance between financial-sector liberalization and regulation and discuss participants’ tendencies to take outsized risks. If there is one key result in recent microeconomic theory, it is that imperfect information matters, especially in financial markets. The theory of this phenomenon is now decades old, but is easy to ignore when there is money to be made. Self-policing is a distraction from reality in the realm of global finance, and we must admit this to our students. We also need to draw attention to the imperfect assessment of “tail risk” or “black swan” events built into risk modeling in financial institutions. This imperfect art has been likened to having an automobile air bag that works perfectly except in the case of an accident.

Now is an excellent time to revisit the issue of national, regional and global financial coordination and what role, if any, the International Monetary Fund (IMF) in particular should play in this and future crises. As in the previous Asian crisis, proposals range from the utopian (the IMF as global central bank managing a global currency) to the more mundane (increased contributions my members). But these are perennial issues taking on urgent importance. Why? Consider the words of Ian Goldin, Director of the James Martin 21^st Century School at Oxford University as recently reported in the British Telegraph newspaper: “I’d be very surprised if more than a handful of the individuals tasked with supervising the system at the national or global level really understood key aspects of what’s been going on in recent years, what’s happening in their financial kitchen…. The regulators couldn’t and didn’t predict the financial meltdown. Their research and expertise wasn’t up to it.” That is sobering thought, one that requires humility as we teach the world economy in financial crisis.

In the classroom, we debate whether the WTO’s Doha Round is dead or just in suspended animation. The difference here is important because, despite the distraction of the financial crisis, the real economy—the actual production of goods and services—still matters. The financial crisis and the crisis of the real economy are reinforcing each other in negative ways. Consequently, an increased focus on and understanding of the Doha Round is more important than ever. This is a teaching moment in the global political economy of trade policy, and standard WTO-bashing won’t do the issue justice.

In the current crisis, we cannot neglect the poor in our classrooms. Countless studies of past economic crises have shown that the bulk of adjustment burdens in the form of reduced incomes are placed on the shoulders of the poor, those that can least afford it. We must admit that the Washington Consensus was a promise that the poor would ultimately benefit from the globalization processes, a promise that now rings somewhat hollow. More specifically, the Washington Consensus emphasized a causal chain from globalization and market liberalization to economic growth and then to poverty reduction. It is time to revisit the subtleties of each of these causal connections and hold them up to the light of the current crisis. This is where the central issues of economic globalization are to be found and where they impinge most strongly on humanity.

The current financial headlines hint at recovery, and this is a real prospect, particularly in Asia. The discussion of what shape this recovery will take, however, should not detract from the fact that many of the causes and consequences of the crisis will remain for some time: imbalances of global savings, deflated asset prices, lack of financial sector oversight, and a checkered history of market liberalization, to name a few. If we use the recovery to revert to the slogans and rigidities of the past, that will have done our students (and ourselves) a great disservice.

Kenneth A. Reinert teaches in the International Commerce and Policy Program of the School of Public Policy at George Mason University. He was lead editor-in-chief of the recently-published Princeton Encyclopedia of the World Economy.

The other four chats are scheduled for December 1, 8, 15 and 22. Subjects could include:

‘What is dark matter?’

‘What defines a planet?’

‘Why isn’t Richard Carrington better remembered?’

To take part in the chats, start following @DrStuClark http://twitter.com/DrStuClark and tweet your question at any time with the hashtag #askdrstu. Feel free to tweet suggestions for future topics too.

Together with the great folks at Project Syndicate, we’ve created a “Princeton Encyclopedia of the World Economy ” feature that appears on their homepage.  Click on the Wiki to find out the answer to the word of the day–or Terms of Trade!

The Examiner site reports that Yao Ming twittered about receiving a gift from former President George H. W. Bush–a copy of his 2008 book. The book is a day-by-day account of President Bush’s time in China as head of the United States Liaison Office in Beijing . The entries from 1974 and 1975 capture the culture (biking around Beijing) and the political conflicts (most famously with Henry Kissinger) of the era.

The Metanomics studio space in Second Life. The view from the top of the auditorium.

Metanomics host Robert Bloomfield (right) interviews Viktor Mayer-Schonberger.

An attentive, and interactive audience, listened in and posted questions via the chat function.

Viktor Mayer-Schonberger fields questions from the audience.