Judis: If we take another approach to your analysis, what you are saying is that there is no way we can have these open economies if we also have generous welfare states. More so, in your book, The Globalization Paradox, you state categorically that a problem exists with the model of the open economy. You go ahead and talk about the need for capital controls and why countries have to implement trade policies without infringing the World Trade Organization (WTO). In a nutshell, you are saying that there exists a big problem with a completely open global market.
Rodrik: I don’t find anything wrong with that. The global market should not be completely open. Rather, it should have a relatively moderate degree of openness. No country in the world wants to cut itself completely from the international trade and finance and international ideas and technology. However, we have come to learn that the successful relationships between a country and the world economy must always be managed and not just signing off barriers by pen and sitting hoping good things will follow.
Were trade agreements solely on free trade, one sentence would suffice. However, that is not the case. They consist of thousands of pages filled with a new set of regulations. “What are these regulations for and in whose interest are they?” you may ask.
There exists no country with a completely free trade policy since there must always be some trade management. There is no way we would import goods that meet our health and safety criteria so we have put controls in place to ensure this is put in place. We do not do this at the expense of free trade rather it is about our regulations.
The same can be said about financial globalization and capital markets. In my opinion, we have been accustomed to the norm that financial capital should be free to move without ant governing restrictions. The idea that free capital mobility is optimal has no justification whatsoever in economic theory. Such like are what we need to have a keen and pragmatic approach to before making decisions about them.
Judis: On the issue of capital controls and the global finance idea, what are capital controls and what is the effect of banning them?
Rodrick: during the Bretton Woods era, several countries put restrictions on capital mobility both into and out of the countries. This they did so that the domestic firms and banks could not borrow from international capital markets or from banks elsewhere forcing them to seek prior permission failure to which they would not be allowed to do so. This would mean that domestic banks and firms would not put their money in foreign countries.
This implied that the domestic financial markets would be segmented from international or financial markets elsewhere. This gave the countries the ability to operate their own macroeconomic policy without being affected by international money and fiscal policies. More so, it meant that one could have their own tax policies and industrial policies regardless of the implications of the capital and international capital. With this, it meant that you did not have to constantly check for market confidence in every policy formation or worry that lack of market confidence would cause capital to disappear.
Judis: Were there currency speculators then that drive the price of a currency suddenly up or down as there are now?
Rodrik: There existed restrictions on native residents trading on foreign currencies whereby you could not buy/sell foreign currencies without going through the central bank and there were also limits on foreign currencies you could trade. I think most of these restrictions in the 1950s and 1960s may have been excessive, but I think we went from the norm being that every country would have capital controls to run sound economic policies, which was a consensus view among the economists, to the 1990s where the consensus view became that every country should have free capital mobility, and if they didn’t have now, they should move to it.
Judis: So what have been the repercussions of having free capital mobility?
Rodrik:. The worst effect has been to aggravate financial crises. Even with the absence of international capital mobility, financial systems are always subject to booms and busts. Financial panics and crashes have always been with us. But if you were to put on the same chart two trend lines, one on the degree of international capital mobility, how free is capital to move, and another trend line on the incidence of banking or sovereign debt crises around the world, those two trend lines would be in phase.
The more financial globalization there has been the greater incidence of financial crises that are more severe than before. A time existed when you looked at these things, when Mexico, Brazil, Russia or India were going through financial crises, and you would have confidently said there is a problem with those countries, and that they mismanaged their economies, but when the United States or the Eurozone were having their crises, you suddenly knew that there was something systemic going on, that the root problem was in the nature of the free flow of capital.