Globalization and Resilience

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Globalization and Resilience

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Bibliographic details

• Authors: Prachi Mishra, ANTONIO SPILIMBERGO
• Published: May 24, 2022

Summary of central question and context

• Does globalization enhance resilience, have no effect, or diminish resilience?
• Two major economic disruptions examined: the global financial crisis starting in 2008 and the COVID-19 pandemic starting in 2020.
• Economists’ assessments were largely wrong for both crises: they underestimated risks from financial globalization in the financial crisis and overestimated fragility from trade globalization and complex production networks in the pandemic.

Key findings on the global financial crisis (2008)

• Prior consensus: financial globalization would allow diversification of risk, fill missing markets, and increase risk sharing.
• Noted caveat (2005): Raghuram Rajan warned that “even though there are far more participants who are able to absorb risk today, the financial risks that are being created by the system are indeed greater. ... They may also create a greater (albeit still small) probability of a catastrophic meltdown.”
• Overreliance on self-correcting markets: Alan Greenspan’s October 23, 2008 congressional testimony conceded excessive faith in free markets.
• Causes of fragility cited in literature: incomplete knowledge about networks, global imbalances, loose monetary policies that led to excessive risk-taking, improperly aligned incentives, and gaps in regulation.
• Scale of damage: a crisis whose initial magnitude was estimated at less than $200 billion wreaked havoc on the global financial system to the tune of several trillion dollars, resulted in devastating unemployment and social costs, and set off the worst recession since the Great Depression.

Key findings on the COVID-19 pandemic (2020) and trade resilience

• Pre-pandemic concern: just-in-time global value chains and low elasticities of substitution implied that loss of a single input could block entire production chains.
• Historical examples that supported fragility view: Hurricane Katrina and New Orleans in 2005; the Great East Japan Earthquake of 2011.
• Early projections (April 2020 WEO): forecasted a large drop in world trade, even as a share of world income.
• Actual outcome:
  • Initial decline in world merchandise imports occurred but was not as deep as projected.
  • Sharp rebound: by the third quarter of 2020 trade was well above levels projected before the pandemic.
  • October 2021 and January 2022 WEO issues projected the upsurge was likely to continue.
  • Trade soared well above pre-pandemic projections by the third quarter of 2020 even as a share of GDP.
  • Global commerce projected to be close to 25 percent higher in 2022 than predicted soon after the pandemic hit.
• Drivers of the trade rebound:
  • Demand-side: massive government fiscal stimulus increased demand for traded goods; consumption composition shifted from services to goods (electronics and other durables), boosting trade-intensive imports.
  • Supply-side: global value chains may have hidden strengths—participation could raise exporters’ vulnerability to foreign shocks while making them less susceptible to domestic shocks—allowing supply to catch up with booming demand.
• Bottlenecks and shortages: reports are common and were expected given the surge in trade; October 2021 WEO noted that early rise in shipping costs was driven predominantly by increasing demand.

Why forecasts and models erred

• Shared root cause: overreliance on stylized economic models that simplified microstructure of financial and trade markets.
• In the financial case: misplaced faith in markets and missing recognition of financial frictions and linkages.
• In the trade case: excessive emphasis on comparative advantage, economies of scale, and production networks without sufficient modeling of supply-side adaptation and demand composition shifts.
• Prominent reflections:
  • Joseph Stiglitz (2009): belief in market efficiency led to ignoring bubble evidence.
  • Pierre-Olivier Gourinchas (2021 lecture): post-crisis research has emphasized financial frictions and linkages.
  • Michael Spence: “we need better models for predicting how supply chains will evolve, including their likely responses to shocks.”

Policy and research implications / Recommendations

• Economic research should focus on better modeling of microstructure and linkages in financial and trade markets.
• Build models that can flag risks and guide preemptive policy responses rather than relying on oversimplified paradigms.
• Future research priorities:
  • Understand sectoral production frictions and cross-border linkages.
  • Improve predictions of supply-chain evolution and responses to shocks.
  • Study long-term effects of trade and financial linkages in light of events such as the COVID-19 pandemic and the war in Ukraine.

Source: F&D Magazine — Prachi Mishra; ANTONIO SPILIMBERGO. Published May 24, 2022.