‘The Architecture Of Collapse’ And The Rising Instability Of The Global System by [email protected]
Wharton professor Mauro Guillen explains why instability is rising.
You’re not imagining it: More global crises are arising today than in past decades. Economically, politically and socially, it appears as if the fractures in the world’s systems are only getting worse. As crises multiply, two questions seem key: First, can the global system hold together and tamp down some of these issues? And second, why is all this happening now?
Wharton professor Mauro Guillen answers both of those questions, and many others in his new book, The Architecture of Collapse: The Global System in the 21st Century. Guillen, who is also director of The Lauder Institute at Wharton, joined us on the [email protected] Show on Sirius XM channel 111 to talk about what’s causing this surge of complex problems, and what, if anything, can be done to ameliorate it.
An edited version of that interview appears below.
[email protected]: How strong or weak is the global system right now?
Mauro Guillen: In terms of the structure of the global economy — and the political and economic institutions that we have in place to make things happen in an orderly way — it’s under a lot of stress. A very clear symptom of this is that since 1982 or 1983, for around the last 25 years, we’ve had many, many more crises — banking crises, currency crises, debt crises — in various parts of the world, than during the preceding decades?Twitter . We have gotten used to reading about a new crisis pretty much every other week in the newspaper. This is a sea change from the situation in earlier decades, and it is putting quite a bit of stress on all of those foundations that we hold so dear, that essentially help us get things done in the global economy.
[email protected]: What was the tipping point that started us on this path?
Guillen: The 1970s gave us the answer to that and so I’m mostly focusing here on the argument of what happened after the 1970s.
The 1970s, as you know, were essentially years of turmoil in the world, driven by two things: one was the oil shocks of 1973 and 1979, and the other was the demise of Britain’s world system, the global-financial architecture that emerged from World War II, and in particular, the decision in 1971 by President Nixon to abandon the gold standard and put an end to the dollar’s convertibility into gold. From then on, what we have is fluctuating currencies and so much more volatility in markets.
That got worse, I think, in the 1980s and 1990s because we introduced a number of other policies around the world, especially policies having to do with the liberalization of capital flows in a way that I don’t think has been constructive.
[email protected]: In the book, you use the term “complexity.” When you think about what’s going on in Europe right now with the Eurozone, and all the different players and all the different philosophies, you would think that there’s no way it could be anything but complex. Yet they have managed for the last 30 years or so to make it work. Why are we at this tipping point, where this “complexity” has really popped up again?
Guillen: I view complexity as something that is not necessarily bad, in the sense that it goes without saying that everything in the world has become more complex. We have more countries in the world today than ever before — nearly 200. We have more relationships among them. Some of those relationships [revolve around] trade, or the activity of multinational firms that invest in various markets — all of those kinds of linkages actually provide firewalls, cushions. We have more ways to cope with disturbances, shocks or with a small crisis, in one part of the global system so that it doesn’t spread throughout.
“We’ve had many, many more crises — banking crises, currency crises, debt crises — in various parts of the world, than during the preceding decades.”
Where I think the problem lies — and this is what I explain in the book in detail — is with a related concept, which is that of coupling. That is to say, the extent to which different components of the global system and the global economy are so tightly tied to one another that there’s very little room for error. If there’s a disturbance someplace and all of the parts are very tightly coupled, then that disturbance, that shock, reverberates throughout the entire system, diffuses extremely quickly.
The International Monetary Fund (IMF) finally recognized this [recently]. There are three main things that are driving this. One is the enormous rise in portfolio investment, which can be short-term capital flows. Next is the growth of cross-border banking. Then lastly, there’s the enormous growth in currency trading that has created a situation in which whenever there is a deviation from the normal state of markets in some part of the world, it very quickly spreads throughout the entire system.
An article three IMF economists published in early June made headlines around the world because it was the first time that the IMF recognized that the liberalization of short-term capital flows it had imposed on countries during the 1980s and 1990s has increased the probability of crises. They provide some estimates, to the effect that the probability of a crisis these days — especially in the emerging markets — is three times greater for those situations in which there are very high levels of short-term capital flows.
It’s the first time that the IMF has recognized this, and it’s remarkable that it has taken 20 years for the global financial community to understand that some of the steps that were taken for liberalization in the 1980s and 1990s have had the opposite effect.
They were meant to be reforms that would stabilize the situation. They were meant to be reforms that would help allocate capital more efficiently around the world. What we’re seeing is that the effects have been, most of the time, quite negative.
[email protected]: You also talk of the impact that foreign direct investment has on complexity.
Guillen: Absolutely. Foreign direct investment, unlike portfolio investment, is when companies set up a plant in a foreign location. Or they make an acquisition. They do that not as a financial investment; they do that because they want to do business in that part of the world. From many different points of view, this is something that, I strongly believe, over the last few decades has contributed to the stability of the global system.
“It has taken 20 years for the global financial community to understand that some of the steps that were taken for liberalization [of short-term capital flows] … have had the opposite effect.”
For a very simple example, consider a Japanese firm back in the 1960s that was producing in Japan — electronics, automobiles — and it was exporting throughout the world. That company, and the Japanese economy itself as a result, was more exposed to shocks. For example, it was sensitive to things that would affect the exchange rate, because it was producing in just one place and selling throughout the world.
Now take the same company, 20 or 30 years later