Rawi Abdelal is an associate professor of international political economy at Harvard Business School, and an expert in banking and foreign direct investment. He’s also the author of Capital Rules: The Construction of Global Finance (Harvard University Press, 2007), an in-depth account of how the ideas and institutions that underpin today’s financial system came to be. Abdelal publishes regularly on globalization and finance for such journals as Foreign Affairs. He recently discussed the underlying causes and consequences of the ongoing financial crisis in the United States with Canadian Business’s U.S. contributor Rachel Pulfer.
The U.S. housing market continues to implode. Analysts tell me it has at least another 20% to fall. And seven months in, the credit crunch shows no sign of letting up. How did the U.S. get to this point?
A country’s level of investment in its economy has to be equal to the sum of its private savings — savings by households and firms — its public savings and foreign savings. Over the past 15 years, our private savings rate has collapsed. For households, it is close to zero. And we’ve had a negative public savings rate for decades. Except for a few years under President Clinton, the last surplus was in 1969. So there’s only one source left for investment: foreign savings.
What is the link between the globalization of international financial markets and the current state of the U.S. economy?
Fifty years ago a country wouldn’t have let their excess savings leave their country — and we might not have let their excess savings come in. Such cross-country borrowing and lending is only possible in globalized financial markets.
Part of the reason we got into so much trouble is because we have been running these persistent current account deficits for decades. This has led to huge financial inflows and created an interest rate environment within the United States that is much more benign than would be warranted by our own financial practices. We have been using foreign savings for a long time, borrowing from the rest of the world to finance much of our economy.
What is wrong with that?
In one sense, it is a perfectly reasonable thing to do. The important question is: what do you do with the money you borrow?What the United States has done is finance a party. We financed an equity market bubble, with Nasdaq and the dot-coms. That popped. Then we financed a housing market bubble, which has popped. There remains the personal credit card bubble. We haven’t seen that pop yet — but it will.
There’s been concern in Canada about signs of economic protectionism in the United States. Where is that coming from?
Many Americans are increasingly skeptical of the value of free movement of labour and goods. We talk about how big a wall we should build between Mexico and Texas, not whether we should have one. And there are complaints about the quality of cheap Chinese imports, there is talk about branding China a currency manipulator, and speculation this has cost American jobs.
What about the concern over sovereign wealth funds?
Foreign companies — Sinopec, for example — have looked at purchasing assets in the United States. But there is skepticism among policy-makers about allowing those transactions. The irony is our current account deficit requires financing, yet we seem to want those investors to just buy Treasury bills. We make it out as though we have the power to pick and choose which capital we want to let in, but beggars can’t be choosers. We’re the beggars here.
What impact does this situation have on international consensus on whether capital should continue to flow freely across borders?
I don’t think we are likely to return to the consensus of the 1940s, which was deep skepticism of the value of cross-border capital movements. But a lot of the capital inflows into the United States are flowinginto the financial system, not the real economy. Treasury bills are pretty liquid; that capital can leave anytime it wants. So we could move toward a consensus on the regulation of speculative capital.
However, it is hard for me to see, in the absence of a profound systemic financial crisis like the Great Depression, that we would get another consensus as restrictive as the previous one. If you think about the ideas underpinning the system, and go from a scale of zero to 10 in terms of how much those ideas favour free capital mobility, let’s say 1944 was a one, and 1997 was a nine, and we’re at seven-and-a-half. Maybe we’ll end up at seven.