The Future Course of Globalization: The Western world cannot decouple from the China-Russia axis

Senior Fellow (Specially Appointed), RIETI

You may have the sense that your lives have suddenly become difficult because of incidents that have emerged out of the blue—the high inflation and the war in Ukraine. However, these incidents did not really emerge out of the blue when we look back at the history since the 1970s.

The end of the Cold War era, which was marked by high inflation, ushered in the era of globalization, which brought low inflation. In fact, it was in the midst of the era of globalization that the seeds were sown for a new age that is now unfolding with the arrival of a new Cold War and high inflation.


The high inflation that gripped the world from the early 1970s resulted from the confluence of two factors, the “first revolution” of the theoretical framework of monetary policy, and the crude oil price upsurge. The goal of monetary policy before that revolution was to achieve exchange rate stability, rather than economic growth. However, after the United States severed the dollar-gold link in 1971, major countries shifted to a more accommodative monetary policy. In addition, inflation accelerated because Saudi Arabia and other oil-producing Gulf states used crude oil price hikes as an economic weapon following the onset of the Arab-Israeli war in 1973.

When inflation is expected to rise (when prices are expected to increase), holding commodities rather than cash becomes beneficial, a situation that prompts people to draw down savings and borrow more money to purchase commodities. As a result, price increases accelerate. To halt this cycle, it is necessary to raise the real interest rate (the excess interest rate over the expected inflation rate) by absorbing liquidity so as to make saving money beneficial relative to borrowing.

It was in the early 1980s that the inflation rate started to decline in the United States. Inflation expectations were brought down by the vigorous interest-rate-hiking campaign implemented by Paul Volcker, who was chairman of the U.S. Federal Reserve Board at the time. On the crude oil front, in the 1970s, Saudi Arabia, which hated the Soviet influence, responded to the price upsurge by increasing its oil output to support the U.S. economy. However, in the 1980s, crude oil prices plunged due to the impact of the promotion of energy conservation efforts.

The era of low inflation, which started around the mid-1980s, was also one of globalization. Energy price declines dealt a blow to the Soviet economy. Mikhail Gorbachev, who became general secretary of the Soviet Communist Party in 1985, made the decision to pull Soviet troops out of Afghanistan and learned from China’s economic liberalization. However, as pork-barrel measures intended to gain support for the political liberalization initiative triggered inflation, the Soviet Union disintegrated in 1991 amid economic turmoil.

Around the world, this was proclaimed as the “end of the Cold War,” but, as indicated by the Tiananmen Square incident in 1989, political liberalization did not proceed in China despite the progress in economic liberalization. However, based on the experience of the Soviet case, the Western intelligentsia at the time jumped to the conclusion that economic liberalization would make political liberalization inevitable.

China’s economic growth accelerated after the country joined the World Trade Organization at the end of 2001. Emerging Asian countries followed suit in achieving rapid economic growth, and as a result of the impact of Asia’s rise, the economies of developed countries, and particularly the U.S. economy, were transformed.

First, manufacturing industries in developed countries declined as they faced competition from China and other emerging economies. Second, global flows of finance converged toward the United States because financial markets in China and other Asian emerging economies were underdeveloped. Third, the huge Asian consumer market created by the region’s economic rise contributed to the rapid growth of data-driven IT (information technology) industries. The shift from manufacturing industries, which formed the foundation of the livelihood of workers with mid-level education, to the financial and IT industries, dominated by workers with higher education, contributed to the fueling of anti-globalization sentiment and created political unrest in the United States.

Afterwards, signs emerged of a return to a Cold War. As shown in the figure below, while the U.S. inflation rate still remained low due to an increase in production in China, which is a low-cost manufacturing base, energy prices continued to rise due to the energy-intensive structure of the Chinese economy. The high energy prices provided a tailwind for the attempt by Vladimir Putin, who took office as Russian prime minister in 1999, followed by his advance to Russian president in 2000, to revive authoritarian rule in Russia.

Maintaining low inflation since the 1990s despite oil price increases
Maintaining low inflation since the 1990s despite oil price increases
Note: The figures for 2022 represent the results in the first quarter of the year. The inflation rate is in terms of the U.S. CPI.
Source: Our World in Data, Federal Reserve Bank of Minneapolis

Because of the transformation of the U.S. economy, which increasingly concentrated on financial services while offshoring manufacturing to China, the low-interest-rate policy brought about increases in housing and other asset prices, rather than broader inflationary pressures. In the U.S. financial market, which attracts capital from around the world, intense competition for investment returns created a debt overhang. After housing price drops triggered a shift from the easy money environment to a credit crunch, the global financial crisis occurred in 2008.

The financial crisis was more serious than the Great Depression in the 1930s in terms of the impact on the financial sector in particular, but a descent into depression was prevented by the “second revolution” of the theoretical framework of monetary policy. Following the experience of the credit crunch, a theory that was rooted in fiscal and monetary policies adopted in Japan during the Great Depression era has taken hold in the United States and Europe. That policy, known as “Takahashi’s Fiscal and Monetary Policies” after the name of the Japanese finance minister at the time, dictated that while inflation should be addressed through monetary policy management by a central bank independent of government, the central bank and government should work as one when a deflation risk exists, with the central bank supporting governmental fiscal stimulus measures through government bond purchases.


At present, developed countries are once again facing an inflation crisis. There are three reasons for this situation. First, in a pandemic containment phase, supply tends to lag behind demand in recovery, resulting in shortages of goods. Second, the U.S. administration of President Joe Biden has expanded the demand overhang by implementing a huge economic stimulus package. The U.S. inflation rate has risen as high as 9% and high inflation expectations have taken hold. Third, Russia has been using energy price hikes as an economic weapon since the start of its invasion of Ukraine. Russia waited for the economic environment to turn inflationary before launching its military aggression.

The main cause of the high inflation rate in the euro area, which has surpassed 8%, is an energy price upsurge. However, as the “second revolution,” which effectively acted as a green light for a central banks to monetize fiscal deficits of governments in a deflationary phase, has taken hold, and southern European countries, such as Italy, are facing a difficult fiscal situation due to the start of an interest rate hike phase. When the European Central Bank (ECB) raised its key policy interest rate by 0.5 percentage points in July 2022, it also decided to introduce a new policy program to enable emergency government bond purchases in response to government bond price drops in southern Europe. This was the initiative that was developed to maintain the integration of fiscal and monetary policies even under inflation.

The current inflation is affecting the future course of the Ukraine war as well. If the European Union (EU) succeeds in rapidly reducing its dependence on Russian energy, Russia is expected to lose export revenue and to be forced to accept a truce under unfavorable terms. However, if energy prices continue to rise in the present situation, it would not only hurt the livelihoods of the people: it would also cause a further fiscal squeeze in southern European countries by forcing the ECB to raise interest rates. If the EU fails at reducing its dependence on Russian energy, Russia will be able to continue its military campaign in Ukraine until the military situation turns favorable.

The Ukraine war has not only debunked the myth that the Cold War has ended; it has also highlighted the weakness of the United States in its role as the savior of the free world. Although President Biden visited Saudi Arabia in order to ask for an increase in oil output, it is doubtful whether the Saudi side will meet the request, given the lack of benefits it may gain in exchange.

Looking back now, the relationship between the United States and Saudi Arabia began to deteriorate when the Cold War supposedly ended. Although the United States had been welcoming Saudi Arabia’s support for Islamic fundamentalist organizations as part of its strategy against the Soviet Union, the situation changed after the Soviet retreat from Afghanistan. Eventually, an Islamic fundamentalist organization launched the deadliest terrorist attacks on U.S. soil in history.

Having hastily ended the stationing of U.S. troops in Afghanistan, which was an approximately 20-year campaign to retaliate against terrorist forces, the Biden administration has little appetite for rebuilding the U.S. relationship with Saudi Arabia and exploring ways of maintaining the balance of power in the Middle East. However, now that energy has become the key to competition between political systems, it would be careless of the United States to assume that it can pull itself out of the quagmire of the Middle East.

It is possible to reduce dependence on Russian energy. However, as Chinese products have penetrated deeply into everyday life in the free world, it would be difficult to confront the China-Russia authoritarian axis by fully enforcing the kind of economic containment to which the Soviet bloc was subjected in the Cold War era. The only option available for the free world is to patiently compete with the authoritarian axis while keeping Western high-tech innovations and products away from Chinese control.

>> Original text in Japanese

August 9, 2022 Nihon Keizai Shimbun

January 5, 2023