Week 3
The end of Bretton
Woods
1971 - 1980
The collapse of Bretton Woods and
its consequences
• Two successive US administrations – Lyndon Johnson
(1963-1969) and Richard Nixon (1969-1974) carry out
expansionist, inflationary economic policies. Johnson
funds generous social programmes as well as increasing
US involvement in the Vietnam war.
• Under Nixon the Federal Reserve keeps interest rates
low, encouraging more public expenditure and
investment. The comparative higher inflation rates in the
US meant that the real value of the dollar was declining.
This would have required a deflationary policy to bring
US prices down. Nixon did not choose to follow that
route.
The collapse of Bretton Woods and
its consequences
• On August 15 1971, the dollar is devalued and de-linked
from gold. i.e. the dollar-gold peg, which was the key of
the Bretton Woods system, is terminated. In addition the
US administration imposed a 10% tax on imports so as
to put pressure on its partners and prevent their easy
access to the US market.
• December 1971, the Smithsonian agreement. Major
economic commercial powers accept a revaluation of
their currencies in return for the end of US extraordinary
tax measures.
• From 1976 (Jamaica accords) the “non-system” of
flexible exchange rates, and convertible currencies is
officially in force.
Stagflation in the 1970s.
• Oil crisis(1973). Opec enforces an oil embargo, which
produces a sharp rise in prices.
• Stagnation + Inflation. Western economies slump,
experiencing recession, and a fall in demand. At the same
time inflation picks up strongly because of sudden rise of
costs and prices.
• The stagflation scenario come as a shock to economists who
had worked on the assumption that there was a positive
trade-off between inflation, and employment, i.e. growth of
the economy (Philipps curve).
• Different economic strategies. The US follows an economic
strategy directed at domestic output recovery; West
European countries are more concerned with fighting
inflation; Japan seeks to maximize its exports, by penetrating
foreign markets (especially the US).
Western Europe faces the crisis of
the 1970s.
• 1950s- The Europe of the Six. The first treaties:
ECSC and EEC.
• 1960s- The creation of a Customs Union and
the CAP – The UK applies for membership and
faces a veto.
• 1970s- The EEC from 6 to 9. Economic
fluctuations undermine plans for a single
currency.
• The Franco-German axis and the creation of the
European Monetary System (1978).
Neo-protectionism in the 1970s.
• Neo protectionism by industrialised countries.
Invisible barriers also known as non-tariff barriers
hamper world trade.
- Voluntary Export Restraints (VERs) as an answer
the Japanese challenge. Agreement to limit sales on the
US market. Leads to higher prices and cartel-like profit
sharing.
-1974 Trade Act Section 301, authorizes actions
against commercial partners, deemed to carry out unfair
trade practices.
-1973 Multifibre agreement sets limits to imports of
textiles and clothing from developing countries
Anti-dumping actions by the Commission of the
European Community.
New economic doctrines: monetarism and
supply side economics
• The end of the keynesian consensus.
• Monetarism. This is a theory based on the quantity of
money. The state’s function is primarily to regulate the
money supply in the economy. It is supposed to keep
out of economic matters especially cut back on financing
social expenditure. To prevent inflation the Government
has to keep a balanced budget and run a tight monetary
policy (via high interest rates).
• Monetarists do not believe a healthy economic policy
should aim at full employment. They speak of a natural
unemployment rate for each economy (NRU), or, in more
sophisticated economic terms, NAIRU (Non-Accelerating
Inflation Rate of Unemployment).
New economic doctrines: monetarism and
supply side economics
• Supply side economics: advocates micro-economic
reforms such as flexibility in labour, capital markets,
deregulation, privatization to enhance productivity and
thereby encourage economic growth.
• Who were the monetarists? The Chicago School (Milton
Friedman) was the leading element. Margaret Thatcher
endorsed monetarism when she became UK Prime
Minister in 1979 So did Ronald Reagan, US President
from 1981 to 1989. Monetarist theories spread in most
countries, and some version of monetarism is embodied
in economic policies throughout the West.
The ISI Model in crisis
• ISI achieved industrialization in many countries.
• Dual economies, with modern sectors and poor rural and
shanty town populations. Income distribution unequal.
Growth rates unable to match the I. Countries.
• Growing balance of payments problems. Import needs
rose, but exports were not competitive on world markets.
Devaluation became chronic.
• Foreign loans in the 1970s generated large interest
payments.
• Huge subsidies generated budget deficits, which in turn
caused inflation, which led to more devaluation and/or
recession as a cure for inflation. Often military
dictatorships took power. See Brazil (1964), but also Chile
(1973), Argentina and many other countries
The export oriented industrializers.
• Asian Tigers follow a different path. They protect
their industries but strongly promote exports.
• In 1974 South Korea exported 41% of its
manufactured goods.
• Low wages, undervalued currencies. Little state
social spending. Highly competitive export
oriented sectors avoid balance of payments
problems.
• Low inflation.
The crisis of the Communist bloc after
1970
• Reforms of the system in the 1960s are discontinued
in the 1970s due to political pressure from the
Communist parties. Revolt and repression (Poland,
Czechoslovakia)
• Failure to increase productivity, quality production.
New technologies require flexibility which the system
resisted. Only the military compete with the West.
The civilian sector falls behind.
• Growth rates low. Exports uncompetitive. Eastern
countries take up loans like the ISI countries. They
also increase their imports from the West to keep up
their living standards.
• The USSR imports grain from the USA: a declaration
of failure.
• The only successful exports to the West are oil, gas
and other raw materials.
The Western world and the second
oil shock
• The US takes on inflation: Paul Volcker as
Chairman of the Board of Governors of the
Federal Reserve in 1979 raised short term
interest rates to above 20%. This
generated a domestic recession but
eventually beats inflation.
• High interest rate policies are adopted by
other European countries. Germany acts
as pace-setter in Europe.
Developing countries, the debt crisis, and the
new economic environment of the 1980s
• US and other countries’ commercial banks extended large
loans to developing countries and to the countries of
Eastern Europe in the 1970s. The loans were designed to
fund state-led industrialization and other government
programmes.
• 1979- Paul Volcker, chairman of the Fed, enacted a
monetary squeeze to fight US domestic inflation. Debtor
countries are confronted with a huge hike in interest rate
repayments.
• To remain solvent they had to negotiate new loans with the
IMF and reverse their domestic economic policies,
embracing market-reforms and cost-cutting, deflationary
economic packages.
• This painful development leads many countries to default
on their debts. A few countries managed the transition to
economic self-sustained growth.
The age of globalization
• Deindustrialization and the growth of the
service economy
• Technological innovation: the information
era and the telecommunication revolution.
• From the State to the market: privatization
and liberalization in the West – the end of
state socialism – the emergence of Asian
economies – the New economy of the
1990s.
Trends in the global economy
since the 1980s
• De-industrialisation and the emergence of
the service economy
• From the State to the market:
• privatisations and reform in Western Europe;
• the fall of Communism;
• the rise of the South Asian economy: a
global shift;
• the American miracle of the 1990s and the
“New Economy”
The INFRASTRUCTURE of
GLOBALISATION
• Technological change in the new era proceeds
at an increased rate over a wide number of
fields, biotechnology, microelectronics,
telecommunications, new materials.
• Broad application of new technologies. Newer
technologies, especially in computer and
electronics, are relevant to a broad array of
economic processes and other activities.
• Shortened process and product life cycle.
THE TELECOMMUNICATIONS NETWORK
AND THE COMPUTER AGE
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The space industry and satellites
Telecommunications from the
Telephone to the global highways
ELECTRONICS: from the wireless
telegraph, to the computer, to the
modern information age.
The rise of Internet and its impact on
the economy
Week 3
• Explain the origins of the Marshall Plan.
• Characterize ISI and its effects in Latin
America between 1945 and the 1970s.
• Was the Communist bloc (USSR and
Eastern Europe) an economic success or a
failute?
• Compare the Bretton Woods system with
the Gold Standard.
Week 3/4
• Industrialized countries:
• Key factors that brought about the collapse of Bretton
Woods’s system, during the 1960s.
• The effects of the oil shock on industrialized world, and
the economic policies of the West up to and beyond the
1979 interest rate hike.
• Developing countries:
• Why and to what effect developing countries became
large debtors in the 1970s, and suffered as a result in the
1980s?
• Socialist countries:
• Why did socialist economies enter into a crisis in the
1960 and 1970s?
• Key economic factors behind the collapse of communism
in the 1980s.
Questions on trade and
multinationals
• Issues surrounding the origins and nature of the
WTO.
• Describe the progress and collapse of the Doha
round negotiations (2000-2007). Who is to
blame?
• Arguments for and against FDI in developing
countries.