The Day After Russia Attacks
What War in Ukraine Would Look Like—and How America Should Respond
The leaders of the world's great industrial powers do not always share common views on economic policy issues these days. But on one subject they are certainly agreed: there has rarely been a time when the art of governance was more demanding and the choices of policy more circumscribed.
In the field of international economic policy, the going seems especially hard. Accordingly, it helps to go back to fundamentals: to ask what the nature of the underlying problem may be; to redefine the main goals; and to lay out broadly the directions toward these goals.
Practically all countries, whether industrialized or developing, capitalist or socialist, have been caught up in a common set of forces that are shaping and complicating their international economic policies.
First and foremost is the fact that the rate of global economic growth has been slowing down. Some see that slowdown as a long-term process which began in the 1960s and continued into the 1970s. Others attribute the slowdown to the vast changes in the world's energy situation that surfaced in the early 1970s, when prices rose by 400 percent and a portion of the world's savings was abruptly diverted to the world's oil-exporting countries.
Whatever the causes, the result has been that most governments have had a much harder time finding the resources to provide some of the things that their people have been demanding. Everywhere, governments are being asked to deliver a lengthening list of so-called public goods, including health services, educational opportunities, clean air, and police protection. And everywhere, they are being asked to reduce the risks to which their people are exposed, including the risks of disaster, unemployment and old age.
At the same time, while resources have been shrinking and demands have been growing, changes in the technology of international communication and international travel continue to bring the different national economies into closer and closer contact. The orbiting satellites of COMSAT link London to San Francisco as easily as to Liverpool. Concorde ties Paris to Washington more easily than to Marseilles. As these changes have occurred, businessmen and bankers have pushed outward from their home territories and established new multinational networks that link the various economies of the world more intimately than ever before. As a result, over the past decade or two, international trade has grown considerably faster than internal trade, and foreign investment considerably faster than home investment.
The United States has been no more immune from these forces than any other nation. For example, by the latter 1970s, the purchases of goods and services by federal, state and local governments amounted to over 20 percent of the nation's gross national product, as compared with a figure of 14 percent a quarter-century earlier. Over the same period, the total payments that our government was making to various disadvantaged groups in our economy, such as the aged and the unemployed, reached ten percent of gross national product, doubling the earlier ratio.
Evidence of the increased involvement of the U.S. economy with the rest of the world has been just as striking. American merchandise exports, which were only about five percent of our total production of goods in the early 1950s, had risen to over ten percent in the latter 1970s. At the same time, leading U.S. firms had so greatly increased their stake in overseas production that the output of their foreign subsidiaries and branches had grown to over one-quarter of the firms' U.S. production. Today, with upwards of $350 billion of assets held by Americans in foreign countries and $275 billion or so held by foreigners in the United States, we are irretrievably linked to the world economy.
In times of stress, national leaders have been tempted from time to time to cut off the outside world and retreat within a national shell. It was never easy and seldom sensible. But now the political and economic consequences of any such retreat are simply too large for any major country to bear.
In political terms, the destiny of Europe, the United States and Japan are inextricably linked. Reflecting that fact, the elections in France and Italy draw almost as much attention in the U.S. media as they do in Europe. At the same time, trends in U.S. domestic politics are followed with almost as much care in Europe and Japan as in the United States.
In economic terms, the linkage is just as deep. The growth of international trade, international investment, international licensing, multinational enterprises, and multinational banking has produced a new economic structure, accompanied by marked increases in overall efficiency. Leaders of most countries cannot seriously contemplate a major retreat as long as any alternative seems to exist.
There are some special characteristics of the U.S. government and U.S. politics, however, that have made it particularly hard for our government to act as if it fully recognized the link between its internal fortunes and its external ties. One such characteristic is the unique relationship of the Congress to the President. Under the Constitution, fortified by law and tradition, domestic economic affairs are the special domain of the Congress, while foreign economic affairs fall more heavily under the President's control.
At least that was the way it was when domestic affairs and foreign affairs could be readily distinguished. Today, however, practically every major issue in U.S. politics has strong foreign implications as well. As a result, what Congress sometimes sees as primarily a domestic issue, the executive branch often sees as primarily a foreign one. There are occasional signs that Congress and the executive branch may be struggling toward some kind of new relationship that would reflect that change in basic circumstances. But the struggle is still going on and the new relationship is far from having been achieved.
Meanwhile, as a nation, we must meet the challenges that go with conditions of increased interdependence. One fundamental need is to assure an appropriate compatibility between our domestic and our international economic policies. The issue is not new, but it has been given new urgency by the extraordinary growth and abrupt changes in international economic relations in recent years. The evolution that has taken place in the international monetary system over the past half century reflects the progress of our thinking on how best to meet this requirement.
Under the gold standard - at least as it was supposed to have operated - domestic economic policies were clearly and sometimes brutally subordinated to international imperatives. With exchange rates more or less permanently fixed, an external payments deficit led inevitably to specie outflow, a reduction in domestic money supply, price and wage reductions, and losses of income and employment. The adjustment process operated effectively, perhaps, but very harshly and inflexibly. Democratic governments became increasingly unwilling and unable to tolerate its rigors - as illustrated most dramatically by the British experience in the 1920s - and the system collapsed.
The Bretton Woods par value system represented a highly successful effort to counter the tendencies toward economic conflict, trade and capital restrictions and aggressive exchange rate behavior of the interwar period. It was based on a philosophy of cooperation, and, while it attempted to restore the framework of a gold standard, it incorporated greater flexibility and greater freedom for national policy formulation - most importantly by permitting par value changes in the event of "fundamental disequilibrium."
But the mechanisms of that system were based on the world of the 1940s: most importantly, the existence of one dominant nation, the United States, which could maintain the link to gold and whose currency served as the "nth currency," with the exchange rate determined by the actions of other countries. With relatively fixed supplies of gold for official reserves, the dollar became the residual supplier of rising world liquidity needs; and, in part because the rigidities of the exchange rate system led to a gradual overvaluation of the dollar, the United States' external position began to come under mounting pressure. The situation was sustainable for a time but became increasingly unsatisfactory, both to the United States and to other countries. When it became clear that conditions had changed in a fundamental sense - with the growth of Europe, Japan and the developing nations as strong competitors, and the inadequacies of U.S. economic policies in the latter 1960s - first efforts were begun toward reform of the system. The Special Drawing Rights facility in the International Monetary Fund was agreed upon in 1968 to provide the world with a supplementary reserve asset; and toward the latter part of the decade, the IMF began discussion of the possibility of introducing greater exchange rate flexibility into the system.
The IMF's exchange rate discussions did not lead to significant change, and the creation of the SDR facility alone could not deal with the structural imbalances that had developed. Ultimately the system based on par values and gold convertibility could not be maintained. With the suspension of gold convertibility by the United States in August 1971, the world embarked on negotiations aimed at achieving an unprecedented multilateral adjustment of exchange rates and payments imbalances in the near term, as well as more fundamental reforms of the system over the longer term.
The course of the negotiations on international monetary reform was punctuated and changed sharply by a series of dramatic developments in the world economy during the 1970s: commodity boom; rapid and disparate inflation rates; widespread adoption of floating exchange rates; steep increases in the price of oil; deep recession; and, finally, economic recovery.
From this experience and negotiation, a new system has emerged and is now embodied in the Second Amendment to the IMF Articles of Agreement. It retains the central Bretton Woods philosophy of cooperation and pursuit of open, liberal international trading and financial arrangements. But it represents a further major step in the historical evolution away from efforts to force stability on nations through an external mechanism (as the gold standard and Bretton Woods system had tried but failed to do), and in the direction of developing stability through the application of sound underlying economic and financial policies in individual countries.
It is widely recognized that the move to more flexible exchange rates in the past few years has been of great help to the world economy in dealing with the shocks noted above: by helping to begin the necessary process of adjustment to radically changed circumstances and by providing a release from severe balance-of-payments pressures under a more rigid exchange rate regime that might have led to a far more restrictive and uncooperative world economic environment. At the same time, greater flexibility in exchange arrangements has not permitted governments to pursue internal monetary and fiscal policies without regard to their external effects, nor has it freed countries from concerning themselves about developments in their exchange markets.
One notes increased ambivalence in some circles about the new system, perhaps because of growing realization that expectations on these points were not realistic. The exchange market implications of persistent large payments imbalances are often discomforting: export industries and workers are not happy about exchange rate appreciation; consumers do not like to see the prices of their imports rise because of depreciation; private and official entities holding large amounts of foreign currencies react strongly to exchange rate changes. These and other factors can bring powerful forces to bear on the process of national economic decision-making. Accordingly, though the existence of a flexible exchange rate system can make a major contribution to effective balance-of-payments adjustment, it does not obviate the need for national economic discipline, for setting the fundamentals right. Nor does it reduce the need for nations to consult and cooperate with one another in the formulation of their respective policies.
The United States' approach to the present imbalance in world payments is very much in line with the philosophy of the new international monetary system. We will continue to intervene in the exchange market, at times in large amounts, to counter disorderly conditions. But we recognize frankly that the key to exchange stability lies in the application by individual nations of sound financial and economic policies. This is why the Carter Administration has been so insistent on the need to get global fundamentals in line. This is why we have encouraged West Germany, Japan and other countries with appreciating currencies to grow more in keeping with their capacity and with the faster pace being maintained by the United States. This is why we have urged the adoption of energy legislation by the Congress which would eventually bring our own energy prices in line with the higher prices that others are already bearing and reduce our dependence on imported oil. This is why we are fighting for measures which will bring down our rates of inflation. And this is why we are strengthening governmental efforts to promote exports and increase the export consciousness of U.S. firms.
The prospects for orderly exchange market conditions are improving as growth and inflation differentials appear to be narrowing and global payments imbalances are coming down. Stability will be enhanced once the Administration's energy, anti-inflation and export programs begin to bear fruit. But if we are to succeed in gaining and maintaining a smoothly functioning international monetary system for the longer term, we must envisage a greater degree of surveillance in the IMF and elsewhere of each others' policies. Difficult as it may seem, governments must learn to communicate much more effectively about critical economic policies. Progress has been made in this direction in recent years, working through the Organization for Economic Cooperation and Development (OECD) and economic summit meetings, as well as through development of a new cooperative framework in the IMF. But the difficulties encountered in attempting to resolve problems among key countries in the past year illustrate how far governments have yet to go.
Like all governments, the U.S. government will have to reconcile itself increasingly to the fact that no country any longer is an island; that all countries, in surplus or in deficit, must take due account of the external repercussions of their domestic policies. Given the structure of our government, with its diffusion and duplication of authority in the Congress, the courts and the executive branch, such a change in attitude and practice will take some doing, but it is a step that must be taken.
In the field of international trade, as in the field of exchange rate policy, governments are found struggling between the same powerful countervailing forces. On the one hand, governments are obliged to respond to various demands from their electorates for economic security and economic equity; at the same time, governments are obliged to maintain strong economic ties with other countries in order to keep their economies growing.
To some degree, both these themes have always been present in U.S. trade policy. But in the first decade after World War II, the need to get the world economy rolling again was sufficiently urgent in the eyes of policymakers that the greater emphasis was placed on the reduction of the world's trade barriers. Through the General Agreement on Tariffs and Trade and later through the European Economic Community, the industrialized countries undertook a wholesale dismantling of their trade restrictions and a dramatic reduction of their tariff levels.
Looking back on the events of the past three decades, that emphasis seems to have been thoroughly vindicated. In that period, the economic growth of nations has been more rapid and more pervasive than for any such period in modern history. Nevertheless, in the latter stages of the period, as overall rates of growth began to slow up, the United States and other countries began to give greater weight to the objective of limiting the risks and redistributing the benefits that an open international society had helped to generate.
This shift in emphasis has been evident in a spate of new measures - some domestic, some international. In the United States, it has led to the adoption of trade adjustment provisions in the Trade Expansion Act of 1962, and to the broadening of such provisions in the Trade Act of 1974. Slowly, by trial and error, the United States is beginning to learn both the possibilities and the limitations of redistributing the burdens of adjustment. At the same time, at the international level, nations have been experimenting with various agreements, so-called orderly marketing agreements, chat are intended to stretch out the adjustment process whenever that process seems to be laying an intolerable burden on the economy. This kind of experimentation represents very strong medicine, to be taken cautiously, in small doses, and under rules that are widely accepted by other governments. But it represents part of the effort to find ways of cushioning the adjustment process, while keeping our eyes fixed unwaveringly on the objective of maintaining an open international society.
The problems of the policymaker in international trade, however, involve other issues of importance. For the past 30 years, the United States has been relying mainly upon the General Agreement on Tariffs and Trade, the GATT, to promote the concept of nondiscrimination and open international borders in international trade. The fact is, however, that an increasing proportion of the world's trade has been falling outside the rules of the GATT and similar agreements, much of it being conducted on the basis of the simple anarchistic principle of the relative power of the parties.
To be sure, the GATT's general rules have never been applied to much more than the trade in industrial products, and even then only to trade in such products between the industrialized countries. Agricultural products and oil and gas have always been handled as special cases. The less-developed countries have obtained a nearly unqualified right to avoid the GATT's rules for all their trade, whether with the rich industrialized countries or with one another. Finally, the state-trading non-market economies have never been well incorporated into the GATT structure of commitments.
Even with regard to the area covered by the GATT, a certain attrition has occurred. With tariffs reduced to comparatively low levels, with licenses and quotas on foreign trade a relative rarity, governments have been turning to other devices to promote their national industries - devices that are less obvious, but not always less powerful, than the tariffs and licenses they replace. These devices include preferences to domestic firms in government procurement, selective subsidies to individual firms, and the imposition of performance requirements on individual firms, including export targets and import limitations. The United States is hardly a leader in creating this new wave of beggar-thy-neighbor devices; but neither has it held aloof from the process. Our federal government was a pioneer in the fashioning of buy-at-home laws, and our various state governments have been learning rapidly how to offer subsidies to enterprises whose activities they wish to promote.
The mammoth negotiations that are presently going on at Geneva under the aegis of the GATT, the so-called Tokyo Round, may prove critical in signaling the first important counter-thrust against these destructive trends. Even so, they can only signal a beginning, to be followed up over the years by hard negotiations that will once more extend the scope of rules of the game in international trade.
It is possible, however, that many developing countries will be unwilling to accept a strengthening of the GATT's rules, particularly if those rules are to be applied to them.
If the developing countries demur, they may leave the United States and other like-minded countries with a very hard choice. To be sure, few governments would insist that the very poor countries should now accept the obligations that their membership in the GATT will eventually entail. But other nations that classify themselves as developing economies no longer fit comfortably in the category of the very poor. Having vastly improved their capacity to produce and sell for world markets, they must begin sharing with the advanced countries not only reciprocal rights but also some reciprocal obligations. As the newly industrializing countries begin such a transition, the preferences and exemptions in international trade that have been applied in order to help developing countries will acquire even greater value for the very poor that remain in that category.
Finally, there are the perennially unsettled problems of dealing effectively with the non-market economies. These problems are principally two. One is how to ensure that the costs and benefits of international trade and investment are fairly divided between us and them. The other - far more important in its implications - is to ensure that the spread of their trading practices and trading institutions does not force our market economies to give up their systems of trade, systems that stress nondiscrimination and open boundaries in the conduct of international economic relations. This remains an unsolved problem, which may eventually require mutually agreed common policies on the part of the market economies.
Perhaps the knottiest set of problems that confront us in the field of international economic relations stems from the phenomenal growth of foreign direct investment over the past few decades, accompanied by the multinationalizing trends so common in business and in banking. During those decades, most large companies headquartered in the advanced industrialized economies have acquired substantial producing facilities outside their home country, facilities that they usually operate in close concert with the home installations.
Some of the benefits of this development are fairly evident. At the same time, new problems have accompanied the benefits.
One of these problems has been the treatment of foreign-owned enterprises under the laws and practices of the countries where they operate. Speaking technically, such enterprises have typically been created under the laws of such countries and have been entitled to the status of nationals within those countries. In practice, however, practically every country has distinguished its treatment of foreign-owned enterprises in one way or another from that of nationally owned enterprises. Dealing with this problem has been difficult for many reasons.
One of these is that no appropriate institutions exist for developing effective rules of the game on this thorny subject. There was a time when nations sought to handle such problems through bilateral treaties of establishment, and many such treaties are still extant. But these have proved inadequate for the complex task.
Another major problem has arisen from the ambiguous nature of a foreign-owned enterprise operating in another country. The inescapable fact is that any international investment involves the interests of more than one national jurisdiction. As foreign direct investment has expanded, therefore, the problems associated with concurrent jurisdiction have grown apace. Home governments from time to time issue commands that can directly affect the behavior of the subsidiary or branch abroad. Host governments often do the same, commanding the foreign-owned subsidiaries in their jurisdiction in ways that could affect the parent at home.
Finally, governments everywhere have felt uneasy over the far-flung character of the operations of multinational enterprises, operations that extend well beyond any single national jurisdiction. In areas such as taxation and competitive behavior, the limits on their scanning capacities have led governments at times to feel that something important was being missed.
Problems of this sort have generated numerous reactions in international circles. Most common have been the innumerable proposals for "codes of conduct" to be applied to multilateral enterprises. Some of these efforts have a certain utility, such as the code recently adopted in the OECD. But most such approaches have missed the mark, largely because they have failed to recognize that the root of many of these problems lies in the inescapable issue of concurrent and overlapping jurisdictions, rather than in some built-in propensity of multinational enterprises to misbehave.
The task for policymakers is to reconcile two conflicting needs: the need of all governments to feel some sense of control over their own national jurisdiction; and the need to preserve the efficiencies that multinational enterprises can generate. Of course, as long as the world's leading multinational enterprises came mainly from the United States, it was unrealistic to hope that other governments might be interested in confronting this issue seriously. Today, however, many leading multinational enterprises are headquartered in continental Europe, Britain and Japan. A few even can be seen spreading from their headquarters in developing countries such as Mexico, Brazil and India. Accordingly, the opportunity for serious international discussions may be coming closer to hand. We shall have to meet that opportunity, when it arises, with new proposals that deal forthrightly with the problem of concurrent national jurisdictions.
The critical issues that confront the advanced industrialized countries, therefore, demand measures that are basic and systemic in nature.
The increases in the political and economic interrelations of the advanced industrial societies have been so great in recent years as to strain the existing institutional structures. Within such societies, the adaptation of political institutions to the new situation has barely begun. Between such societies, the institutions required for harmonizing and coordinating national action are also in a primitive and rudimentary stage.
Meanwhile, the possibility of effective action is being inhibited by various special factors. One is the special group of problems generated by the energy crunch. Another is the slowdown in the rate of growth of the advanced industrialized countries, a slowdown that adds to the difficulties of national leaders as they attempt to deliver an ever-increasing bundle of public goods and public safeguards to their national constituencies.
The challenge that these circumstances present for the leaders of the advanced industrialized countries is formidable. But the challenge is especially strong for the United States. Our country remains by all odds the largest and most powerful of nations. Our stake in maintaining a fair, open and efficient international order continues to be very large.
Despite the special difficulties of the moment, therefore, the United States can be counted on to support various initiatives for strengthening such an international order.
In the monetary field, for instance, the United States will give its full support to the International Monetary Fund in the execution of its new responsibilities for the surveillance of the international monetary system and of exchange rate policies of its members. This enlargement of the powers of the Fund promises to help in the effort to achieve stable underlying economic and financial conditions in member countries, in the prevention of disorderly foreign exchange markets, and in the avoidance of competitive devaluations among member countries. But the effectiveness of the provisions will depend on the quality of the cooperation that the Fund receives from its members.
In the field of international trade, the challenge is to widen the area in which the GATT's principles are applied and in which fair and open competition is maintained. To that end, one U.S. objective will be to increase the number of countries that are subject to the rules of the GATT, including notably some of the rapidly industrializing countries that have become major factors in world markets. Another U.S. objective will be to place effective limits on various techniques of trade protection that heretofore have been outside the limits of the agreed international GATT rules, such as subsidies and performance requirements.
In the field of international direct investment, the challenge is to develop an international environment that will allow investors to make their economic contribution, under conditions that are fair to all the parties; and to reconcile the sovereign powers of the various states that are the source or the destination of such investments, mediating conflicts where they arise. An international environment of that sort is not created overnight; it is made up of many different elements, such as nationalization policy, tax policy and competition policy. We have already begun to forge the needed institutions and arrangements, such as our program of bilateral tax treaties, the various systems of consultation developed inside the OECD structures, and the voluntary OECD code for multinational enterprises. But that is only a bare beginning, and the United States remains dedicated to moving much further toward the completion of this essential task.
The monetary, trade and investment issues discussed here are critical manifestations of a larger problem still. This is a world made up of separate nations, each with its own aspirations, its own history, and its own politics. It is also a world that is shrinking fast, creating new interdependencies and new opportunities. How best can these two unshakable facts be reconciled? How can we profit from the benefits of our growing interdependencies while pursuing our separate national needs? That is the basic challenge to which nations must respond.