Working Paper: CEPR ID: DP264
Authors: David Vines
Abstract: This paper reviews three problems of the world economy since the collapse of the Bretton Woods system; an unreliable price mechanism, spending imbalances between countries, and increased technological competition. It argues that the third phenomenon is the most fundamental and creates potential global instability. A model, stemming from Hicks's paper 'The Long Run Dollar Problem', is deployed to examine this question. We consider a world of two regions -- 'Asia' and the 'North' -- in which technical progress is rapid in Asia. In the case of export-biased productivity growth there are cheaper imports and almost no adjustment problems for the North. With import-biased technical progress in Asia, however, the North's wages and spending must both be reduced. Reasons are advanced as to why, in principle, the adjustment of wages and spending might not be forthcoming. I consider whether foreign investment might assist the adjustment process, but conclude that "adjustment processes do not work very well in the present world". This fact is used to suggest an explanation of present instabilities in world currency and financial markets.
Keywords: international monetary system; technological progress; financial instability
JEL Codes: 410; 431; 432; 620
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| export-biased productivity growth in Asia (O49) | cheaper imports for the North (F14) |
| cheaper imports for the North (F14) | rise in real income for northern consumers (R22) |
| export-biased productivity growth in Asia (O49) | northern balance of payments roughly in balance (F30) |
| import-biased productivity growth in Asia (O49) | price reductions in the North (R38) |
| price reductions in the North (R38) | wage reductions in the North (J31) |
| wage reductions in the North (J31) | spending adjustments in the North (H59) |
| import-biased productivity growth in Asia (O49) | economic instability in the North (N11) |