The System Worked_How the World Stopped Another Great Depression
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WHY THIS MATTERS—AND WHAT COMES NEXT
Setting the record straight on global economic governance is important for three reasons. First, in the global political economy, the narrative matters. Stylized facts that have calcified into accepted wisdom among policymakers and public intellectuals become harder to challenge. Clearly, the emerging post-2008 consensus is that global economic governance has been an abject failure. If this becomes the accepted wisdom, then policymakers could waste valuable political capital trying to mend something that does not necessarily need fixing. The intrinsic need to understand the inner workings of global economic governance could not be clearer.
Second, the relative robustness of global economic governance represents a challenge to international relations theory. In 2008, it was far from obvious that the G20, BIS, WTO, and IMF would be able to do what they did. The major internatonal relations approaches—realist, liberal, and constructivist—shared a pessimistic outlook after Lehman Bothers collapsed. How agents and structures behave during crisis moments can reveal the deep, tectonic forces operating in world politics. The 2008 financial crisis stress-tested international relations paradigms as much as it tested global governance structures. An increasing amount of global political economy research is situated within a single paradigm called “open economy politics.” This paradigm assumes that outcomes in the global economy can be derived from building models up from the microfoundations of domestic preferences and institutions. As we shall see in chapter 4, on its own, open economy politics lacks a convincing explanation for post-2008 events.86 If alternative approaches can better explain what happened after the Lehman collapse, they merit a closer look.
Third, questions about global economic governance are no longer the exclusive province of global political economy scholars and policy-makers who are far removed from the public. For much of the twentieth century, international relations commentators thought of the security realm as the place of “high politics.” Economic cooperation was viewed as the more mundane realm of “low politics.” No longer. War has become rarer and economic conflicts have become more common.87 As two analysts at the US National Intelligence Council observed at the start of the Great Recession, “Artificial divisions between ‘economic’ and ‘foreign policy’ present a false dichotomy. To whom one extends swap lines and how the IMF is recapitalized are as much foreign policy as economic decisions. … Finance and markets are now high politics.”88 If the Great Game in the nineteenth century was about carving out spheres of territorial influence in Central Asia, the twenty-first-century equivalent is about carving out spheres of economic influence in the global marketplace. Global economic governance has become a pivotal arena for great-power politics.
The rest of this book is organized as follows. Chapter 2 looks at the policy outcomes, outputs, and operations of global economic governance to demonstrate that the system worked better than is commonly believed. Despite an initial shock worse than that of the Great Depression, the global economy managed to bounce back after the 2008 crisis. This was in no small part because global economic governance functioned properly to maintain economic openness and build resiliency into the international system. Chapter 3 dissects why the conventional wisdom about the value of global governance is so at odds with what global economic governance has actually accomplished. There are a number of reasons, including an exaggeration of its failures and misplaced nostalgia for past eras of global economic governance. Chapter 4 examines the role that material interests played in supporting global economic governance. To be sure, the complex interdependencies of globalization condition powerful interests to strongly prefer an open global economy. That said, a look at the Basel III banking accord negotiations also reveals the limits of a monocausal, interest-based explanation. Chapter 5 explores whether power-based arguments can explain these events. A net assessment shows that the great powers in the post-crisis economy are the United States, the European Union, and China. It also suggests that global economic governance functioned as well as it did because the United States retained economic primacy and exercised leadership; more surprisingly, however, the evidence also shows that China acted like a supporter rather than a spoiler in global economic governance. Chapter 6 examines the distribution of ideas in the post-crisis global economy. As it turns out, many of the economic ideas supposedly discredited during the 2008 financial crisis have demonstrated surprising resiliency—for good and ill. The final chapter considers where the system goes from here.
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Yes, the System Worked
THERE IS A BROAD and deep consensus that global governance failed the world in the aftermath of the 2008 financial crisis. This gives rise to two important questions, however: How can we know whether or not global economic governance “works”? Are there any observable metrics to use in assessing global governance besides pundit perceptions? These, in turn, give rise to questions about first principles. How is global governance supposed to work? What exactly do global governance structures do to facilitate the functioning of the global economy? In this chapter, we answer these questions in reverse order.
HOW CAN GLOBAL ECONOMIC GOVERNANCE WORK?
In theory, global governance structures can provide a welter of services to facilitate economic growth and international cooperation. International relations scholars have articulated multiple causal mechanisms through which global governance can facilitate cooperation. Even skeptics, for example, acknowledge that international institutions can serve as focal points in coordinating the global rules of the game.1Institutions inherently create a common set of rules or norms for all participants. They foster the convergent expectations that define cooperative behavior and the conditions under which revisionist actors are labeled as defectors.
The importance of institutions as focal points is a recurring theme in international relations. Indeed, the concept is intrinsic to political scientist Stephen Krasner’s original definition of international regimes: “implicit or explicit principles, norms, rules and decision-making procedures around which actors’ expectations converge in a given area of international relations.”2 More than a decade later, Robert Keohane and Lisa Martin reaffirmed Krasner’s notion: “In complex situations involving many states, international institutions can step in to provide ‘constructed focal points’ that make particular cooperative outcomes prominent.”3
International relations theorists have posited a number of additional roles for global governance structures. Another mechanism through which global governance can work is reassurance.4 Even after actors in world politics agree on the rules of the game, uncertainty is inherent because no one can know whether the agreements will hold up over time. If there is even a small possibility that others will defect from a previously agreed-upon regime, then each actor has to prepare its own contingencies for what it will do if someone else defects. That kind of worst-case scenario planning can in and of itself sow doubts among other actors, eroding the probability of sustained policy coordination. One of the simpler virtues of any global governance structure is that it allows key actors to periodically reassure each other that there has been no change in the status quo. For example, even though the initial fall 2008 G20 summit in Washington, DC, accomplished little beyond leaders’ pledges to maintain open markets, it reassured the major economies that they were on roughly the same page about how to respond to the crisis.5 This kind of reassurance prevents participants from back-sliding on their commitments. This, in turn, bolsters the credibility and reputation of the international regime.
The most prominent argument made by institutionalists is that global governance structures facilitate the monitoring and enforcement of cooperative agreements, rules, and norms.6 This view recognizes that the opportunities for cooperation in world politics are plentiful—but so are the temptations to defect. International regimes can tamp down the incentive to cheat through monitoring and enforcement. At the same time, by pledging to abide by clearly defined rules, actors also make it easier f
or others to monitor and detect their own noncooperative behavior. Even without enforcement, actors will incur reputation costs if they choose to defect. If the regime is codified, the additional legal obligations to comply raise the costs of defection even more.7 In the case of the WTO, for example, the codification of trade law has made it harder for governments to, even temporarily, waive their commitments to openness.8 If global governance structures have the capacity to punish (as in the case of the IMF) or authorize punishment by others (as in the case of the WTO), then their ability to sustain policy coordination increases dramatically.
Constructivist scholars posit a different causal mechanism through which global governance does its job. According to their logic, membership in international regimes enhances the normative desire to comply with the promulgated rules and regulations through the socialization of its membership group. Whereas rationalist explanations for compliance focus on the material costs and benefits, the constructivist approach centers on group size and socialization as promoting the internalization of norms and principles.9 International regimes can foster the acceptance of norms in several ways. Small, club-based structures can inculcate a desire to comply by conferring the privilege of membership and fostering the formation of close personal networks among participants. This is how the G7 and the Basel Committee on Banking Supervision have traditionally functioned.10 Norms can also derive power from the number of actors that accept them.11 The greater the number of actors accepting a given rule, the greater the social pressure on recalcitrant actors not to change position.12 If the representativeness of a global governance structure increases, its perceived “democratic” mandate concomitantly increases, thereby enhancing its legitimating power. On this dimension, United Nations–type, universal-membership organizations provide powerful compliance-inducing pressures as well.13
Global governance can also matter through the provision of expertise. Economists, scientists, lawyers, and other professionals based at international institutions have an independent legitimacy, conferred through their mastery of abstruse subject areas of global public policy. Given the arcane nature of most arenas of global governance, the influence of international governmental organization secretariats with reservoirs of such expertise is enhanced. In the case of environmental policy, for example, the United Nations Environmental Programme had a profound effect on how international actors viewed such policy problems as ozone degradation and climate change.14 To be sure, powerful actors often possess far greater resources than do global governance structures. Nevertheless, the research staffs and secretariats of international institutions can provide valuable independent expertise in the crafting of global rules and norms. Indeed, the prestige that their imprimatur, or stamp of approval, carries with weaker actors is one of global governance’s greatest strengths. International institutions can command the agenda and set the tenor of the debate over the promulgation and enforcement of new rules. This is particularly true during emergencies. In a crisis, actors start to question established ideologies, standard operating procedures, and rules of thumb. Paradoxically, it is precisely during such moments of uncertainty, when actors begin to question the status quo, that they often seek out experts to help them gauge possible courses of reform. This is true even if these experts were partly or wholly responsible for the policies that precipitated the crisis in the first place!
Finally, global governance can be useful to national leaders trying to ameliorate domestic political pressures. Even when global policy coordination leads to welfare gains for all actors, there are domestic political and economic costs associated with any international agreement. Within jurisdictions, any policy change can upset the status quo and trigger a significant redistribution of costs and benefits among national actors. Because politicians must cater to powerful domestic constituencies, leaders always have an incentive to act unilaterally to bolster their domestic coalitions—even if such actions are contrary to maximizing the national interest. International institutions can function as external constraints on such unilateral actions. Global governance can allow national leaders to implement or adhere to politically contentious policies and to displace some of the political blame to international institutions.15 Legally binding regimes, or those that activate powerful domestic norms, can help cement sustained cooperation even in the presence of powerful interest groups wishing to defect.16 Alternatively, international institutions allow leaders to signal their commitment to a set of policies to key interest groups. For example, leaders who are suspected of being hostile to trade liberalization can assuage skeptics by signing free-trade agreements.17
Clearly, there are multiple possible pathways through which global economic governance can work. It should be stressed that these causal mechanisms are additive rather than mutually exclusive. A regime that can function as a focal point, engage in reassurance, actively monitor and enforce agreements, provide expertise, and blunt domestic pressures is far more likely to work than a governance structure that only utilizes one of these causal mechanisms. Because my focus is on how global economic governance functioned after the start of the 2008 financial crisis, I am less concerned with which mechanisms matter more than whether they collectively mattered.18
How Does Global Governance Work?
Assessing the performance of global economic governance presents an empirical challenge because of the difficulty of identifying the counterfactual. For example, one can argue that the joint G20 statements in late 2008 and early 2009 on fiscal and monetary expansion were an example of effective global governance. After these communiqués, the G20 economies did boost fiscal spending and pursue expansionary monetary policies, in what seemed to be policy coordination. Another possibility, however, is that each G20 actor simply pursued the policies it would have pursued anyway, rendering the G20 superfluous. In other words, rather than coordination, this could have been a case of harmony. Even the best counterfactual analysis cannot completely eliminate this type of uncertainty.
Critics of the current system of global governance tend to rely on a few stylized facts that are meant to suggest that it is dysfunctional. The following are some of the most commonly cited failures in recent years:19
• The collapse of the Doha Round and the rise of protectionism. Just as the global economy began to implode in the summer of 2008, last-gasp efforts to reach an agreement on the Doha Round of the WTO negotiations stalled. Subsequent G20 pledges to abstain from protectionism and complete the Doha Round of world trade talks did not appear to have much effect on policy. Within the first six months of the crisis, seventeen of the twenty countries had violated their pledge, implementing a combined forty-seven measures to restrict trade at the expense of other countries.20 Six years after the financial crisis, most of the Doha Round remains unfinished. Indeed, the status of the round has been so moribund at times that one former US trade representative suggested abandoning the effort.21 At the same time, the United States, the European Union, and China became embroiled in high-profile trade disputes on tires, steel, and solar panels, testing the limits of the WTO’s dispute-settlement mechanism.
• The breakdown of macroeconomic policy consensus. For the first few years of the crisis, the governments of the great powers agreed on the need for expansionary monetary and fiscal policy to bolster growth in the fragile global economy. By the beginning of 2010, however, that consensus had frayed. The United States went to the June 2010 Toronto G20 summit committed to pushing for sustained Keynesian policies. What happened instead was a complete breakdown in the global macroeconomic policy consensus. Soon afterward, the European Union members of the G20 embraced austerity. In the subsequent eighteen months, numerous G20 members accused each other of starting “currency wars” with respect to unorthodox monetary policies.22
• The escalation of Europe’s sovereign debt crisis. As the full impact of the Great Recession was felt, an increasing number of eurozone economies found their fiscal fortunes collapsing. European institutions were extremely slu
ggish in responding. As the Greek government’s finances started to implode, the European Central Bank had only one economist monitoring the situation part-time.23 In the end, neither the European Union nor the European Central Bank moved quickly enough to stop the spread of financial contagion. The result was a double-dip recession across most of Europe, unemployment rates of more than 25 percent in Greece and Spain, and protests and riots in the most-affected countries. If the European Union, the most-powerful supranational institution in existence, could not cope with the Great Recession, why would anyone expect less powerful global governance structures to do better with bigger problems?
• The failure of climate-change negotiations. There were high hopes going into the Copenhagen climate-change summit in December 2009. Heads of governments attended; numerous great powers had made presummit pledges; and for the first time in years, the United States appeared seriously committed to negotiations. Nevertheless, the summit ended with only a weak, ad hoc agreement among the major economies that pleased no one. European Commission president José Manuel Barroso decried the accord as a “commitment to the lowest common denominator.” The summit also raised tensions between China, the United States, and the European Union.24 In the aftermath, China was blamed for obduracy; the United States, for poor leadership; and the European Union, for poor logistics. Not surprisingly, climate-change talks stagnated after the summit.
These facts, though true, are not the whole truth. To assess the effectiveness of global economic governance after the 2008 financial crisis, I follow Tamar Gutner and Alexander Thompson’s framework of using three different levels of analysis to assess the performance of global economic governance.25 First, what do the policy outcomes look like? How have global output, trade, and other capital flows responded since the start of the Great Recession particularly compared to similar crises in the past? Second, what do the policy outputs look like? Did the key international institutions provide policies that, based on settled theory and prior experiences, can be considered significant and useful responses to a global financial crisis? Would these policies have been implemented in the absence of these global governance structures? Third, have these structures demonstrated improved policy operations? A common complaint prior to 2008 was that international institutions had not adapted to shifts in the world distribution of power and preferences. Did they maintain their relevance and authority? Did they ensure that rising actors have the incentives to view participation and compliance with existing arrangements as valuable?