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In Conversation with Zhiwu Chen: On Recasting Trade's Role in History

Author(s): Zhiwu Chen

Date: Aug 17, 2016

Theme(s): Finance & Macroeconomics

Insights: In Conversation With

Asia Global Institute Director Zhiwu Chen positions trade, finance, and globalization as key drivers of civilization.

Editor’s Note:

There is a perception that, other than to make some people rich, trade and finance have done little to benefit greater society. This perception is especially true where globalization, which politics has put in the public crosshairs, is concerned. AGI Director Zhiwu Chen seeks to counter common perceptions and misconceptions surrounding the value of trade, finance, and globalization. These, he argues, are among the key drivers of civilization which has spread knowledge and saved lives by curbing incentives for violence. 

Q: How are you able to link the rise of trade and finance with the long-term decline in human violence?

It is tough to name an exact turning point in human history at which this happened, but we can say that the incentive structure that favored violence must have changed.

To give you an example, let’s look at the Great Walls of China, which were built to defend the Han Chinese from attacks by nomadic peoples from the north. China’s history over the last two thousand years points to a pattern of violence and attacks by northern nomadic tribes on the agricultural society of Han Chinese, especially at times of natural disasters such as drought. Because these nomadic peoples never settled down to develop agriculture or storage technologies, they were more exposed to such risk events as fluctuations in climatic conditions, while the Han Chinese found ways to store food and other necessities critical for survival. So whether the Hans experienced bad weather or a bad harvest, they would still, for the most part, have something to survive with. But the nomads were not as lucky and would be more nakedly exposed to the viscosity of nature.

The establishment, in the 20th century, of inter-regional trade networks supported by railroad, air, and auto transportation changed this situation. So even though northern regions of China continue to experience big drought seasons from time to time, we no longer see any of the people from the north trying to attack central or southern Chinese regions. It may be a bit tough to pinpoint an exact time before and after which things became dramatically different, as the change in the trade network followed a gradual process. By moving goods across space, trade has helped smooth the impact of weather shocks and other natural disasters on the people in affected areas.

Q: What of the link between finance and violence?

One way to understand how finance helps reduce violence in human societies is just to imagine someone being hit by some risk event like a natural disaster and being deprived of resources to live on. What would this person do and how would he survive? He might have a great ability to earn income in the future, but today he would face a survival challenge. So if there were banks or other financial institutions for him to borrow from against future income, he could actually use such financing instruments to smooth the distress on him caused by this natural disaster. Effectively, such financing would allow him to borrow money today but pay back gradually over an extended time horizon. That way, he would be able to remain as a good citizen, a law-abiding citizen. However, if such financing were not available and other forms of mutual assistance were absent as well, he would have no other choice but use violence, rob a bank, or break into someone’s house, in order to survive! This simple story can tell us why finance can help make it unnecessary to rely on violence for survival. Statistics show that when natural disasters hit, mortgage defaults, personal loan defaults, marital distress would all increase, along with a rise in crime rates.

Historically, societies that lacked financial markets are known to have resorted to costlier ways to mitigate risk. Farmers in India, for instance, have used their daughter’s marriage as a hedging instrument against risk events such as drought, flood and war. The more prone a village is to natural disaster risks, the further away the village’s parents would marry off  their daughters. They have done so because the further away two villages are from each other, the less likely that they will be hit by the same disaster.

Q: Do these institutions provide a level of risk-mitigation against global crises in the future?

Yes, trade networks and finance are for sure crucially important for this purpose. But we cannot expect trade and finance alone to do it all. Other human innovations and institutions have contributed to the long-term decline in human violence, including cultural innovations and social institutions such as marriage and family. Cultural norms and marriage institutions have all adapted to improve our ability to deal with risks and make our living more robust. Religions and the rise of the fiscal state have also contributed to the civilizing process.

If history is any guide, I have no doubt that going forward, this process will continue, even if there are rumblings on the way. For example,  there might be some possible backlash against the on-going globalization that has been with us for the last 30 years. Short-term setbacks can occur, as they have occurred many times in human history. But, in the end, human societies’ desire to live better, survive longer, will still dominate and will always win.

Q: What, do you think, might be the underlying cause of the next major crisis?

I would say that, globally speaking, geopolitical risk is a major upcoming challenge as it could shake things up much more than global financial crises of the type we saw in 2008. Of course we all talk about the need to prevent future global financial crises from happening, probably because financial crisis management and financial risk management are more operationally feasible today – at least we can talk about them more concretely – and they are more related to the type of things we are familiar with as we just experienced one not too long ago, whereas geopolitical risk events typically arise from clashes of cultures as well as conflicts in interest between countries and we have not had a large-scale geopolitical risk event since the Second World War. As a result, we can relate to financial crisis more concretely than geopolitical crisis. This is why I think the world is better prepared for financial crises than geopolitical crises. Definitely the international financial markets are not prepared for such risk events. That’s why I am more concerned about the geopolitical risks over the next decade or two.

After the 2008 financial crisis, decision makers in developed as well as developing countries were made much more aware of the presence and prospects of financial crisis risks. As a result, societies have been made much safer. Policy makers and business people are more aware of their threats, their presence, and at least some of them have taken actions to prevent such events from happening. On the other hand, geopolitical risks are not so much on people’s mind as everyone thinks they are so remote and abstract. If you pay attention to global financial markets and realize how little they have not priced in geopolitical risks in various parts of the world, you will see what I mean. This is why going forward, we may see more geopolitical surprises than financial surprises.

 

Fellow Patrick Low and AGI contributor Jean-Pierre Lehmann weigh in on a global backlash against globalization. 

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