Global Financial Turbulence in the Euro Area

About the Contributors

Authors and Edtitors

Alojzy Z. Nowak, Professor, Vice-Rector of The University of Warsaw, former Dean of The Faculty of Management, University of Warsaw, from 2005 until 2012.

Kazimierz Ryć, Professor of Faculty of Management, University of Warsaw, former Dean of Faculty of Management, The University of Warsaw from 1999 until 2005.

Yochanan Shachmurove, Professor of Economics and Business, The City College, The Graduate School and University Centre of the City University of New York.

Patrick O’Sullivan, Ph.D., Grenoble Ecole de Management, Visiting Professor at University of Warsaw, patrick.osullivan@grenoble-em.com.

Grzegorz Tchorek, Ph.D., The Faculty of Management, University of Warsaw, National Bank of Poland. ← 7 | 8 →

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Part I

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Alojzy Z. Nowak

Globalisation as a Macroeconomic Megatrend

Introduction

The process of globalisation really started with great geographical discoveries, which in many cases led to colonisation of the newly found territories. There is no doubt, however, that the dynamics of supra-national relationships of an economic nature received a violent thrust together with the quick growth of the capitalist system. The market as the key element of the system increasingly forced efforts aiming at abolition of all sorts of regulation and trade barriers.

Historical Stages Upon the Way to Globalisation of Economy

In international circulation, countries began to make use of their relative advantages stemming from geographic conditions, natural and human resources as well as military power. Adam Smith, a Scottish thinker and the author of free market theory, assumed three principal measures of value in his work An Inquiry into the Nature and Causes of the Wealth of Nations, namely: precious metals (including gold and silver), cereals, and human labour. At that time, indeed, these formed the basis for general considerations of utility and exchangeable value in any commercial and trade activities.

Another stage of globalisation can be found in great discoveries made throughout the 19^th century and, more broadly, with the industrial revolution and further growth of capitalism. Actually, it was quite early into the century that David Ricardo published, in 1817, his book The Principles of Political Economy and Taxation, being the first author to have proposed a concept of comparative costs which has become the basis of the theory of international trade exchange prevalent until our days. The essence of it comes down to explanation of the mechanism of mutually advantageous international exchange of goods and services in a situation of goods manufacturing costs being considerably lower in one than in another party to the relationship. The occurrence of relative differences in costs of production, measured with labour input is an important premise for development of specialisation and international trade. That theory, well proven in practice, gave an enormous impulse to international trade exchange.

The most informed analysis of capitalist development of the day in the early 20^th century, as well as the consequences for global economy was presented by ← 11 | 12 → John Maynard Keynes in the 1930s. The Great Depression on 1930s in the USA, which quickly spread into a devastating worldwide economic and social crisis, also causing a real decline in the world trade, was the most spectacular example of inadequacy of most previous theories about self-regulating markets. The trust in the classical liberal economic system was undermined.

In his most famous work, The General Theory of Employment, Interest and Money, published in 1936, the British economist argued that it’s not in the nature of the economy to overcome crises on its own. Accordingly, it should be up to state governments to act as crucial market regulators since stimulation of the economy can happen through increased state expenditure, including work done in the public sector, infrastructural investment projects, as well as through enlivened social consumption. Over time, these recommendations, based upon the concept of state intervention have become the foundation of both practice and economic policy of many governments until it is really and today they form an important element of macroeconomic theory.

The influence of Keynes’ theory upon the operation of the economy was also quite pronounced in the area of establishment of the new global deal with respect to international economic relationships. Despite his serious illness – a stroke suffered in 1937 – Keynes played a crucial role during the Bretton Woods conference in 1944 where, following years of exchange rate wars and omnipresent state protectionism of the WW2 period, a new monetary deal was established. A system of fixed exchange rates pegging individual currencies to the US Dollar was introduced and its parity exchangeable to gold was specified. This way, the system of fixed exchange rates of individual currencies was anchored in gold via the US Dollar.

The Bretton Woods system allowed for agreed changes of exchange rates of individual currencies in cases where a given country was experiencing permanent external imbalance. In such case currency devaluation could make the adaptation process, agreed with the International Monetary Fund, easier and less severe for the society. The new system relating currency with gold was soon named socially rooted liberalism and with the US Dollar acting as agent in maintaining the relationship with gold – a sort of benevolent tyranny had emerged in respect of exchange rates.

The Bretton Woods system performed well for many years in practical terms, however it was rather costly in political terms. Devaluation which made it easier to implement the program of adaptation to ever-changing market conditions was politically risky for governments because it required a great deal of social sacrifice. Anyway, the system worked because its alternative – a system of floating exchange ← 12 | 13 → rates – seemed even worse; it had been rejected after the WW2 in the wake of bad experiences with competitive devaluations and instability in the 1930s.

However, turbulence faced by the global economy in 1970s contributed to dissolution of the Bretton Woods system and resulted in gradual return of floating exchange rates. A system of floating exchange rates combined with the inflation target policy run by central banks should – in theory – ensure efficient operation of markets, but failed to do so in reality. Neither were currencies’ exchange rates reflecting the so-called economic fundamentals nor was the achievement of the inflationary target ensuring proper balance in the economy.

At the same time, 1960s and the later years of the 20^th Century have been a period of a great offensive by proponents of monetarist economics. Its most prominent exponent, Professor Milton Friedman (awarded with Nobel Prize in economics) challenged Keynes’s theory and argued that inflation directly depends on the size of money supply in an economy and that inadequate monetary policy, in the long run, always seems to lead to either price inflation or deflation rather than to changes in the level of production, so – contrary to s the assertions of Keynes’ advocates – policies of economic stimulation by the government (at least when associated with monetary expansion), resulting in higher inflation, and fails to bring a permanent reduction of unemployment. Accordingly, state intervention policy, instead of supporting commercial entities operating in the market, actually hinders them and acts as barrier to greater dynamics of commercial exchange between individual countries, thus disturbing the very foundations of healthy competition among them. Therefore, it is only free market – as previously maintained by Adam Smith – that provides favourable conditions to solve global economic problems.