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Global macro & geopolitics from a small economy perspective

A world of giants, 1913, and exchange rates

David Skilling
22 February 2013

This is the latest edition of a series containing reflections on recent global economic and political developments and debates. This week, a few perspectives on issues facing small countries in terms of the balance between independence and integration.

A world of giants?
President Barroso of the European Commission, in a January speech, argued that “in a world of giants, size matters”. The argument is that to project influence and to advance interests, countries need to act collectively through regional organisations. This argument seems to resonate in a world in which classic multilateralism is weakening, and there is growing competition between the major powers. In a more complex international environment, countries may struggle to individually advance and protect their interests. But the extent of the advantage of large scale depends very much on what dimension of policy you are talking about. On military or security issues, or in international negotiations on trade or climate change, being part of a larger grouping is an advantage for small countries. In a world of giants, small countries need friends. But it is not clear that the world belongs to the giants. It is the small economies that are better able to align policy with local context and preferences, and to move responsively to changing circumstances – which may be a particular asset in a rapidly-moving world. Small economies, for example, seem to be responding better to the crisis. Centralised policy-making can come at a cost. The challenge for small countries is to preserve policy autonomy while bulking up in specific areas to build resilience and influence. Being small and alone can be deeply uncomfortable, but small and integrated may allow you to get the best of both worlds. The next piece offers an historical perspective on these issues.

2013 v 1913
There has been a spate of recent writing on the parallels between the current global situation and that prevailing a century ago, on the cusp of World War I; the emergence of a new global power, a deeply connected global economy, and so on. The theme of this writing is often to be cautious lest we repeat the mistakes of 1914. But there is another striking aspect of the global situation in 1913. Although the global economy was deeply connected, it was organised around colonial empires with high levels of protectionism between these groupings. Indeed, 100 years ago, there were only about 60 independent countries. World War I started the process of the disintegration of empire and the number of countries began to increase. This process accelerated over the past several decades, with the number of independent countries increasing sharply from 80 in 1945 to over 190 today. So 100 years on, have we reached the high-water mark of national autonomy? Is the movement towards a more distributed world beginning to reverse a century on, with the rise of big power politics and increased volatility that creates challenges for small countries? It would be an elegant symmetry, but I don’t think it is the case. Although volatility and the weakening of multilateralism create challenges for small countries, these can be dealt with through participation in regional and other groupings. The likelihood of a consolidation in the number of countries seems unlikely; if anything, centrifugal pressures seem to be emerging.

Don’t mention the currency wars
The recent G20 meetings in Moscow spent much time debating issues of exchange rates and currency wars. The consensus seemed to be that as long as you didn’t say that you were targeting the exchange rate, loose monetary policy to stimulate the economy is fine. This has the slightly Kafka-esque message that exchange rate policy is only an issue when you explicitly say that you are targeting the exchange rate. The reality is that those that can will continue to operate loose monetary policy that will have the effect of lowering the exchange, irrespective of whether this is the objective. My sense is that it is likely that we will avoid a conventional currency war with competitive devaluations, largely because those on the receiving end of the loose monetary policy are not in a position to do much about it. The large countries in the core can proceed, while those on the periphery – small countries and medium-sized countries from Brazil to Korea to Australia – will experience upward pressure on their exchange rates. It takes two to engage in a currency war. But the advantages of a flexible exchange rate regime diminish in periods when core exchange rates are being more directly managed. Many small and medium-sized economies are already part of currency arrangements (such as the Eurozone), and if these exchange rate pressures continue, such groupings may become more attractive to small countries as a way of managing their exposures – a case where integration may increasingly outweigh the benefits of independence.