2011 Panglaykim Memorial Lecture Center for Strategic and International Studies

> Pascal Lamy’s speeches


Ladies and Gentlemen
Dear Mari

It gives me great pleasure to be at the Center for Strategic and International Studies to celebrate the work of the late Panglaykim, a renowned economist, with a sharp view of the changing realities of Indonesia. But above all an extraordinary human being, a humanist.
The topic of my intervention today is no stranger to Indonesia.  With its more than 17 000 islands, its several hundred languages and dialects, its 300 ethnic groups, its religious diversity and its enormous biodiversity, Indonesia is a perfect reflection of our greatest challenge today: harnessing global diversity, weaving its strengths, managing its challenges.

Globalization dominates our era, but it is an increasingly fragile dominance. Even as global integration delivers enormous benefits — growing wealth, spreading technology, the rise of billions of people in the developing world — it also creates new risks — financial instability, economic imbalances, environmental stresses, growing inequalities, cyber attacks — that we seem to have difficulty addressing. Markets and technologies are pushing us together, but political pressures — economic insecurity, resurgent nationalism, global poverty and power shifts — risk pulling us apart. An integrated global economy requires political consensus and cooperation to sustain it. But nations and societies seem increasingly uneasy with a world on steroids that they feel powerless to control — and international co-operation is under strain.  Is globalization outpacing — even weakening — our ability to manage it?

This is not a new concern.  Since the industrial revolution, market capitalism's power to generate both incredible progress and enormous disruption­ — what Schumpeter called “creative destruction” — has preoccupied governments. And globalization is nothing if not the worldwide technology-driven spread of capitalism — a process that has been unfolding, in fits and starts, for three hundred years.

Karl Marx was wrong about a few things, but he was surely right about capitalism's inherent tensions and contradictions. “Capitalism has created more massive and more colossal productive forces than have all proceeding generations together”, he wrote in 1848, but it also represents the “uninterrupted disturbance of all economic and social conditions, everlasting uncertainty and agitation”. The same forces that explain capitalism's power to transform economies — innovation, risk-taking, competition, the survival of the economically fittest — also explain its power to disrupt, overturn, breed social insecurity and conflict. Capitalism, Marx fatalistically argued, contains the seed of its own destruction.

A century later, Karl Polanyi used similar arguments to explain why the open economy of the 19th century suddenly collapsed in the early 20th century — overtaken by war, economic depression, and totalitarianism. Open markets need social and political cohesion to work, he argued, but paradoxically free markets,  left unconstrained, soon undermine this cohesion. Individualism and competition are rewarded — but at the expense of equality and community.  Labour and capital flow freely to where they earn the most—but capital becomes divorced from production, and individuals become strangers in a strange land.  New winners are created — but the losers feel threatened. The result is a backlash against market capitalism among those trying to protect themselves from its harsh effects, the erosion of social and political cohesion, and the rise of insecurity and division.

One can disagree with the details of his argument, but it is hard to dismiss his basic insight: By transforming the economic and social order, capitalism also risks weakening, even destroying, the political foundation on which it rests.  His answer was not Marxist revolution, but political evolution — re-embedding markets in a re-invented social and political order.

The catastrophic end of the 19th century's version of globalization offers a cautionary tale for our age. On many levels — the flow of capital and goods, the ease of transportation, the advent of new transport and communications technologies — international integration approached — and in some ways surpassed — the level of globalization we have reached today. Labour flows were actually freer, as tens of millions migrated to the Americas, Africa and Australia without passports or immigration documents. International finance was anchored to the gold standard, linking the world together in a single monetary order.  It was an age dominated by the idea that global markets are self-regulating, unstoppable, and should be left unfettered. It was also a time of great optimism — the so-called “Age of Progress”.

Not only did the world economy grow more in 75 years than in the previous 750, but the circle of growth expanded dramatically — to new economic powers in Europe, in North and South America, and in Asia and Africa. New innovations — from railways, to telegraphs, to steamships — seemed to promise a world irreversibly linked together in prosperity and peace. The optimism about globalization's inevitability was captured by Norman Angell's The Great Illusion in which he argued that economic interdependence had made armed conflict between nations impossible and obsolete.  His book came out just four years before the world plunged into the nightmare of the Great War.

What went wrong? Beneath the progress of this first age of globalization, tensions were building. The rise of new economic giants, especially Germany, dramatically shifted the balance of power and made the old giants uneasy — prompting new defensive alliances, an arms race, and a scramble for colonial spheres of influence. New economies began to flood Europe with cheap agricultural products —benefiting the working poor but threatening farmers' livelihoods — while rapid industrialization increasingly divided politics along class lines. Nationalism was on the rise in Europe; ethnic conflict was splintering the Balkans; domestic pressures were mounting to turn inwards, abandon open trade, and block immigration. Many sparks ignited the First World War — as any schoolbook can tell us — but the one unifying cause was the disintegration of international trust and the break-down of political co-operation. It took thirty years — through two World Wars and the Great Depression — for the world to begin to rebuild the economic system it had lost.

What made it possible was the emergence of a new political consensus after the Second World War. Central to this new order was the leadership of the United States, the undisputed economic and political hegemon. A system of only one power, an “empire”, is the easiest international system to coordinate and in the post-war era the United States was “the One”. American isolationism had been one of the principal causes of the international system's weakness between the wars. Now the United States not only had the muscle to underwrite a new international economic system, but it had — along with Britain and other allies — a remarkably clear vision of what was needed, based on a shared assessment of the successes and failures of the past.

A key objective at that time was the return to open international trade and financial stability — since the protectionism and financial chaos of the 1930s were widely seen as root causes of the war.  Another objective was to underpin this integrated world economy with powerful new international institutions — the IMF, the World Bank, and the aborted International Trade Organization (turned into the GATT)  — to channel and reinforce international cooperation. This was in marked contrast to the 19th century's faith that global free markets best regulate themselves alone — requiring only periodic “crisis” meetings of the Great Powers. A third objective was to cushion the effects of openness and integration by ensuring that national governments retained the ability to “manage” demand (and thus employment), provide social insurance, and pursue redistributive policies — on the assumption, again learned from past mistakes, that economic openness and integration would be supported domestically only if its benefits and costs were more equitably shared.

So the new international economic system both resembled the old order and was radically different. Trade was now progressively opened multilaterally — not just bilaterally — and regulated by the GATT's international rules. The Bretton Woods institutions moved to the centre of the financial system — in charge both of overseeing the fixed exchange rate and of managing adjustments. Against the 19th century belief that economic integration — and maintaining the gold standard — took precedence over national monetary, fiscal and social flexibility, the post-war international economic system depended on ambitious and far-reaching national social systems — and America's New Deal, Britain's welfare state, or Europe's social democracy. As John Ruggie argued, it represented a system of “embedded liberalism” — a global balance between openness and regulation, capital and labour, markets and society.

The post-war economic order succeeded spectacularly — so spectacularly that globalization is now eclipsing it.  An early casualty was the Bretton Woods system of fixed exchange rates. Monetary stability encouraged investors to expand their financial activities across borders - gradually integrating financial markets. Financial integration, in turn, weakened the capital controls needed to operate the fixed exchange rate system — and  hindered governments' ability to maintain independent monetary and fiscal policies. Forced to choose between free capital movements, national macroeconomic independence, or fixed exchange rates, the US abandoned the latter in the early 70s — and the world has moved towards a free global capital market ever since.  In the post war era, capital controls were almost universal; now 3.7 trillion dollars — one twentieth of the value of the world economy — is traded across borders every day.  The sheer scale of these transactions—and the exotic financial instruments in which they are now packaged and repackaged—makes it increasingly hard to understand the international financial system, let alone regulate it.  We are a long way from Bretton Woods!

Less dramatically, the world trading system is also being overtaken by events.  The massive reductions in border tariffs — from over 40% on average in 1947 to less than 6% today — have exposed deeper structural differences between economies — in food standards, industrial policies, or legal systems — that are generating new “system frictions”.  Subjects that were never given much consideration when the GATT was created — such as environmental sustainability or resource scarcity — are of growing concern to an interdependent world — but to a non-negligible extent beyond the scope of existing trade rules. Even more challenging is the need to match an increasingly open world trading system with greater international fiscal and monetary coordination. Global macroeconomic imbalances were a major cause of the recent financial crisis. But the macroeconomic adjustment which conventional wisdom says is needed to reduce surpluses in Asia, and reduce deficits in America — has barely begun.

This adjustment challenge is made harder because of the growing pressure on national social system's and policies. The post-war welfare state was designed for a more static economic world less exposed to external forces—not for a world where, for example, trade as a share of US GDP has grown from less than 10% in 1970 to over a quarter today. The sense that post-war social programmes and labour laws were becoming out-dated, even counterproductive, in a globalizing economy—more social hammocks than social safety-nets or springboards—only reinforced growing calls, especially in the Thatcher and Reagan era, to dismantle the “nanny state”, cut taxes and roll back government. Some even made a virtue of the way global integration allegedly limited governments' freedom to advance social goals—Thomas Friedman describing globalization as a “Golden Straightjacket”. The previously discredited 19th century idea that government's job was to free up markets—and then stay out of their way—was back in vogue as the Washington consensus. And the post-war social contract between international economic openness and domestic social support was breaking down.

Perhaps the biggest change is globalization's impact on the geopolitical landscape. Globalization has both enabled — and rewarded — a shift in production, investment and technology to emerging economies. The result — as Martin Wolfe put it recently — is that the periphery is becoming the core and the core is becoming the periphery. The US remains a key player but it is no longer dominant. Fast-rising powers, like China, India, Indonesia and Brazil, play a role that was unimaginable even twenty years ago — while smaller developing countries want a say in a system in which they have a growing stake.  The simple — even simplistic — North-South divide has given way to a more complex world of many different South's and many different North's. This multipolar system is much more “democratic” than the old post-war order.  The days when a few countries could design and direct the international system are gone. Yet the old powers are cautious about sharing centre stage ­ — ­and worried about decline — while the new powers are timid about sharing responsibility.

Make no mistake.  Globalization is a revolutionary force – more revolutionary even than its 19th century predecessor.  The world economy is eight times larger than it was in 1950 — and world trade has expanded 33 times since then. Two decades ago, the web did not exist. Now 2 billion people — a third of humanity — use the internet every day; four billion people have mobile phones; 1 in 12 has a Facebook account.  It now costs less to ship a container from London to Shanghai than from London to Birmingham. Two hundred million people — almost the size of Indonesia— are currently migrants in foreign countries, integrating the world socially and culturally, as well as economically. Over 3 billion people—in China, India, Indonesia and other developing countries—are achieving in a generation what it took the West a century or more to achieve. This alone stands as the most significant economic event in history.  It is because of our open and interconnected world – a world on fast-forward - that material wealth is spreading, knowledge is expanding, health is improving, and the walls dividing us are falling down. This “one world” would have been unrecognizable to the Cold War generation — and unimaginable — even utopian — to those who lived through the nightmare of two World Wars.

Yet for all our successes, globalization remains a discontented dream. The recent financial crisis—and the “Great Recession” which followed—was merely the most cataclysmic in a series of global financial shocks that included the collapse of the European Exchange Rate Mechanism in the 90s, the peso crisis in 1995, the Asian crisis in 1997, the Russian crisis in 1998—and may include Europe again if the current sovereign debt problems are not resolved. These shocks have taken place against the background of growing fears that foreign competition is hollowing out industries and off-shoring jobs; that footloose corporations are under-cutting environmental and labour protection; that jet travel is spreading disease; that shrinking borders are blurring identities and cultural values; and that rising economic powers are threatening  security and peace.

Many of these fears are irrational—or worse.  But this does not change the fact that millions of people are increasing worried about unemployment and inequalities, about the health of the planet, about the safety of their children's food— and are questioning whether the benefits of globalization outweigh the risks. A recent poll suggests that only a third of Americans now view globalization positively — a far cry from the optimism that greeted globalization at the end of the Cold War.  Another poll found that only 37% of Europeans viewed globalization as an opportunity, while almost half saw it as a threat. Even more worrying are the signs that virulent nationalism and racism are on the rise, and that support for immigration, multiculturalism, and religious tolerance is under strain. We are experiencing what Freud called a “civilizational discontent”.  And this discontent is increasing the pressure on governments to turn away from multilateral co-operation and openness in favour of more narrow interests.

So is it back to the future?  Are we in danger of repeating the mistakes of the 19th century?  Or is there an alternative?  In his latest book, a rare and valuable insight into global issues, Dani Rodrik argues that we have to face up to the incompatibility between democracy, globalization and sovereignty of the nation-state - and  renounce one of these three.  Others go further and advocate “deglobalization”, turning back the clock on globalization.

My own view is that deglobalization should not and will not happen.It will not happen because its shaping factors are here to stay, even if they can lead to a slower globalization. The main engine of globalization is technological progress.  This has never regressed in human history.  True, the huge expansion of global finance, may abate as new rules to deleverage the financial industry and to limit risks reduce the excessive profit margins that ignited the financial crisis.  True, environmental constraints may increase the preference for sourcing goods and services locally, (although this may not result in an optimal allocation of scarce resources, such as water).  But, overall, I do not believe that the clock can be turned back.

Nor do I believe such a course would be desirable.Would any of the major global problems we face — from pandemics, to nuclear proliferation, to climate change, to economic imbalances — be easier to solve?  Should emerging economies also slow their participation in globalization if America and Europe decide to opt out? Are we going to switch off the 40 million Indonesian internet users? Or the 30 million Indonesian Facebookers?  Should jet travel or global supply chains be rolled back?  And are people — for all their discontents — really willing to forego the benefits that flow from more trade, more investment, more communication, the spread of knowledge and ideas?  Withdrawing from globalization — or severing interconnectedness — will not restore employment or rebuild industrial strength or re-inflate the sub-prime housing market. If the collapse of the 19th century's economic order teaches us anything, it is the disastrous consequences of turning inwards, acting unilaterally, and giving into the politics of insecurity and fear.

The essential problem today is too little governance of globalization. Our institutions, policies, and mind-sets have not caught up with the integrated and interconnected world we have created. The first age of globalization fell apart because there was no effective political and policy response to profound economic and social changes.  In the same way, the underlying weakness in today's economic order is fundamentally political.

Stating the problem is the easy part.  Providing answers is more difficult — and implementing them, more difficult still. One challenge is to re-invent international institutions — once universally idealized, now almost universally disparaged. Replacing the G8 with the G-20, which includes emerging countries like Indonesia, was an important step — an acknowledgment of today's multipolar world, and a tangible sign that the system can reform and adapt. And the G-20 is not the only innovation. From managing SARS and deforestation, to writing technical rules and accounting standards, to tracking illegal drugs and terrorists — international co-operation has never been as wide or as deep.  But this is clearly insufficient.  Re-inventing our institutions is about more than building agencies and vertical silos. It is about “networking” institutions in a better way — ensuring that the WTO, the IMF, the World Bank, and the vast UN system operate as a more coherent whole, not a medieval patchwork of fiefdoms. 

This leads to the challenge of policy coherence. As the world has grown more integrated, policy lines have become blurred — and policy-making has become more complex. WTO negotiations, for example, focus mainly on cutting tariffs or limiting subsidies. But these issues are increasingly impacted — even overshadowed — by shifting patterns of trade, new centres of production and competition, and volatile financial flows and exchange rates. Even the way we measure trade today no longer reflects the reality of trade flows.  It was fine when a country used to produce finished goods all by itself and export them to another country.  But today, production is globalized - linked together in vast global supply chains - and trade flows are increasingly being dominated by intermediate goods and services that can cross borders several times.  Hence a huge amount of double counting.  If we want numbers to properly reflect the reality of “Made in the World”, we have to switch to a value-added measure of trade, as we do for GNP.

In the same way, climate change negotiations are not just about the global environment but global economics as well — the way that technology, costs, and growth are to be distributed and shared.  Likewise, efforts to integrate poorer countries into the global economy have to focus on the complex challenge of building national capacity — helping countries to help themselves — not just ensuring that they conform to trade or financial rules.  These are not just global problems.  It is easy to forget at the international level — when the right hand doesn't always know what the left is doing — that the same national governments are members of all international organizations. Policy coherence – ultimately – begins at home.

An even bigger challenge is to strengthen the global system's legitimacy—by better reflecting societies' hope and fears, interests and concerns. This starts with designing domestic policies for an age of globalization—helping sectors and workers adjust to global change; by investing in education and training so individuals are empowered to take advantage of a more skills- and ideas-rich economy; and by better sharing the benefits—not just the burdens—of globalization.  The debate about whether job losses are the result of trade or technology misses the basic point that people need more creative and effective help in adjusting to massive economic change—regardless of the causes.  This is true for developed countries.  It is even more true in emerging countries where the speed of growth generates wider inequalities and where the construction of redistribution-based welfare systems takes time. As the architects of the post-war system realized—but our generation risks forgetting—people will support economic opening and integration only if everyone is benefitting from it.

Legitimacy also depends on democratising global governance—giving citizen's greater ownership of the system and greater say in its direction. Presidents and prime-ministers, congressmen and parliamentarians, trade unions and civil society movements, need to engage more actively in global issues and institutions. And global institutions need to be held more accountable to national parliaments and voters. Instead of globalizing local issues, we should be localizing global issues. This is not utopian.  The Internet, Facebook, and CNN or Al Jazeera are already creating the outlines of a global audience, global public opinion and — increasingly — a global sense of right and wrong from disparate cultures and communities throughout the world.  Our shocked reaction to the Indonesian tsunami in 2004 and the more recentJapanese one, our revulsion when the Egyptian police opened fire on protesters, our collective joy when Chilean miners were rescued – these were expressions of a new democratic energy that can be harnessed behind global and local policies. We must respond to the very human need for belonging, roots, and community—not by blending or erasing cultural differences, but by tapping into them. Too often globalization feels like the internet—everyone connected but no one in control. Too many people today feel powerless -and powerlessness poisons democracy.

This brings me to the importance of political leadership. Half a century ago, the architects of the post-war system were motivated by a simple and powerful idea — that a world based on freedom, openness, and shared prosperity offered our best chance for lasting peace. But the end of the Cold War produced no similar new vision. On the contrary, the Soviet collapse tended to reinforce the status quo. It encouraged the belief that we had reached the end of our policy debates — if not “the end of history”. And that foreign policy could take a back seat to more pressing domestic concerns. The result is a certain complacency — or, worse, paralysis — in the face of globalization.  An uneasy awareness of looming challenges, yet an inability to marshal the collective vision and will to tackle them. 

World leaders need to explain the future to the present—which takes political courage at a time when globalization is being attacked from both the extreme left and extreme right. They need to show how national interests are increasingly global interests; how our security hinges on the security of others; how international co-operation increases sovereignty, while isolation diminishes it. The days when one power — even a United States or a China — could solve its financial, environmental or even security interests unilaterally, without the help of with others, have gone forever.  We are — quite literally — all in this together.

Let me leave you with this thought.  The real challenge today is to change our way of thinking—not just our systems, institutions or policies.  We need the imagination to grasp the immense promise—and challenge—of the interconnected world we have created. And we need to reject the political temptation to respond to our need for roots and belonging by mobilizing “us” against “them”, “we” against “the other”.

Multilateralism may be messy, frustrating, two steps forward and one step back, as we know only too well in the WTO.  But the fiction that there is an alternative is naïve and dangerous. Naïve because it ignores that we are becoming more — not less — dependent on one another. Dangerous because it risks plunging us back to our divided past — with all of its conflicts and tragedies.  

The future lies with more globalization, not less - more co-operation, more interaction between peoples and cultures, and even greater sharing of responsibilities and interests.  It is “unity in our global diversity”  — or to quote the Indonesia's national motto, “Bhinneka Tunggal Ika” — that we need today. 

I thank you for your attention.


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