The System Worked_How the World Stopped Another Great Depression

by Daniel W. Drezner

  In the future, this expansion might impair the efficacy of these groups—but their legitimacy has been enhanced since 2008. Indeed, the G20’s assessment process has further enhanced the monitoring powers of many of these institutions. In requesting reports from the Financial Stability Board, as well as organizations ranging from the IMF to the WTO to UNCTAD, the G20 augmented the expertise and legitimacy of these governance structures. The pre-summit reports by these international organizations framed the discussions at the meetings.

  The IMF and the World Bank also changed after the financial crisis, albeit in ways that may not be apparent on the surface. The implicit compact by which a European is given the IMF managing director slot, and an American is appointed to the World Bank presidency, for example, has continued. Despite the scandals that engulfed IMF managing director Dominique Strauss-Kahn in 2011 and World Bank president Paul Wolfowitz five years earlier, former French finance minister Christine Lagarde replaced Strauss-Kahn in 2011, and American Jim Yong Kim replaced Wolfowitz’s successor Robert Zoellick as the new World Bank president in 2012.

  Beneath the surface, however, the Bank and the Fund have witnessed significant evolution. Power within the IMF is based on quota size, calculated using a complex formula of economic variables. Prior to 2007, the allotment of quotas in the IMF bore little resemblance to the distribution of world economic power. This has changed. One important step has been two rounds of quota reform that the IMF implemented in 2011. An additional quota reform was proposed in 2010 that will further reallocate influence toward the advanced developing economies. Despite fierce resistance from European members, this reform will be implemented pending US congressional approval. The goal of all three reforms has been to expand the voting power of the advanced developing economies. Once the latest round of quota reform takes effect, China will possess the third-largest voting share in the Fund, and all four BRIC economies will be among the ten largest IMF shareholders. There is also a planned shift to an all-elected Executive Board at the IMF, a move designed to further reduce the number of European representatives on the board.

  The World Bank Group underwent a parallel set of reforms. Between 2008 and 2010, the voting power of developing and transitioning economies within the main World Bank institution (the International Bank for Reconstruction and Development) was increased by 4.59 percentage points, and China became the third-largest voting member. The International Finance Corporation (IFC) approved an even larger shift of more than six percentage points. More important, the Bank’s Development Committee agreed that Bank and IFC shareholding would be reviewed every five years beginning in 2015, routinizing the process of reallocating power within the committee.119 At the same time, the Bank also took steps to improve its transparency. It is not surprising, then, that in the Council on Foreign Relations, April 2013 assessment of global governance structures, it was finance that received the highest mark among the different global issue areas.120

  While the appointments of Lagarde and Kim might appear to be politically retrograde, they represent bargaining that reflected the greater influence of the advanced developing countries. In both cases, the nominee had to woo developing countries to secure political support in advance of voting. China, for example, was an early supporter of both Lagarde and Kim despite the presence of emerging-market candidates.121 The appointment of Chinese national Min Zhu to be a deputy managing director of the IMF at the same time that Lagarde took over might have been one reason for this preference.

  The content of bank and fund policies has also shifted to better reflect developing-country concerns. In the wake of the 2008 financial crisis, the IMF began to change its attitude about the wisdom of capital controls. In February 2010, an IMF staff paper concluded that under some circumstances, capital controls could be a legitimate and useful policy tool.122 Dani Rodrik characterized the change in the IMF’s tune as a “stunning reversal” of its previous orthodoxy.123 By November 2012, the staff note had translated into the IMF’s official position. The fund allowed that capital controls could be “useful” in some circumstances, and that “[there is] no presumption that full [capital account] liberalization is an appropriate goal for all countries at all times.”124 As for the Bank, Kim’s appointment to the presidency in 2012 highlights the shift in priorities. Trained as a doctor and an anthropologist, Kim’s entire pre-Bank career had focused on health policy. This suggests that the Bank will use a more capacious notion of development going forward, consistent with developing-country preferences.

  The trade and investment regimes have displayed somewhat less vigor than global financial governance. But these regimes have not withered on the vine either. The multilateral trade regime would appear to have suffered the most from the Great Recession. The failure to complete the Doha Round negotiations in 2008 was a blow to the WTO. Nevertheless, the WTO as an institution has endured. In December 2013 in Bali, the WTO negotiated the trade facilitation part of the Doha Round, which outside analysts estimate will boost the global economy by $1 trillion over the next decade. Beyond Doha, the organization has expanded its reach in several ways. Geographically, the WTO finally secured the accession of the Russian Federation, the last G20 nonmember, after a slow-motion fifteen-year negotiation process. Since the start of 2007, the WTO has added seven members, including Ukraine and Vietnam.

  The WTO also adapted to play a crucial role in constraining the rise in protectionism. The WTO enhanced its monitoring and acted as a focal point for additional plurilateral liberalization. Beginning in late 2008, the WTO’s secretariat used the Trade Policy Review Mechanism to report to the G20 on a regular basis on increases in protectionism. After some initial reluctance, WTO members accepted the move as a useful increase in monitoring and transparency.125 The WTO reports on trade restrictions became accepted as authoritative. A comparison of the WTO’s monitoring reports with those of Global Trade Alert further shows some significant flaws with the latter. Global Trade Alert’s monitoring has been based on less reliable metrics, exaggerating the increase in protectionism.126

  WTO members also shifted their approach toward trade liberalization by expanding existing plurilateral agreements or starting new ones while still working on the Doha Round. China is negotiating to join the GPA, which requires that states not discriminate against foreign contractors for government contracts. The United States, the European Union, and eighteen other countries accelerated talks on a services liberalization agreement that would encompass most of the OECD economies as well as advanced developing countries.127

  Enthusiasm for greater trade liberalization has found an additional outlet: the “open regionalism” of regional and bilateral free-trade agreements (FTAs). The traditional expectation that an economic downturn would dampen enthusiasm for greater openness has not been borne out by the data on FTAs. In the four years preceding the collapse of Lehman Brothers, fifty-one FTAs were reported to the WTO. In the four years since Lehman, fifty-eight FTAs have been registered.128The United States and ten other countries are currently negotiating a Trans-Pacific Partnership, with other countries preparing to join. The United States and European Union are negotiating a Transatlantic Trade and Investment Partnership as well.

  To be sure, not all of these FTAs were created equal. Some have greater coverage of goods and services than others. Some might promote more trade diversion than trade creation. Nevertheless, their recent pattern of growth mirrors how FTAs spread in the late nineteenth century.129 Even if the current FTAs do not include the most-favored nation provision that accelerated trade liberalization in the nineteenth century, the political economy of trade diversion still generates competitive incentives for a growth in FTAs, thereby leading to a similar outcome.130As the export sectors in states lagging behind in FTA creation lose out from trade diversion, they begin to lobby their national governments to join the crowd and sign more trade agreements. This kind of competitive liberalization can lead to reduced trade barriers. Through their own shared understandings and dispute
-settlement mechanisms, FTAs also act as an additional brake on protectionist policies.131

  There is no multilateral investment regime to display resiliency. No single institution has the authority of a WTO in trade or an IMF in finance. Instead, a network of bilateral investment treaties (BITs) makes up the principal governance mechanism for investment. Compared to the growth pattern in FTAs, it would appear that the pace of expansion of BITs has slowed since 2008. According to UNCTAD data, an annual average of seventy-eight BITs were completed in the three years prior to 2008; an average of only sixty-one per annum were negotiated in the three years after 2008. That indicates a slowdown.132 A look at the longer time series, however, reveals that the Great Recession is not the cause of this slowdown. As figure 2.8 shows, the peak of BIT negotiations took place in the decade after the end of the Cold War. From 1992 to 2001, an annual average of 160 BITs were negotiated. After 2001, however, the number of negotiated BITs declined, following a standard diffusion pattern. Based on that kind of pattern of diffusion, the last three years have seen expected levels of BIT growth. Furthermore, in 2012 the United States introduced a new “model BIT” and started BIT negotiations with China, India, and other countriess, suggesting that there will be more significant liberalization going forward.133

  Conclusion

  When the subprime mortgage crisis began, there were rampant fears that global economic governance was dysfunctional and unprepared to cope with its severity. The Great Recession exacerbated those fears.

  FIGURE 2.8 Annual Count of Bilateral Investment Treaties, 1960–2011

  Source: UNCTAD

  Yet, a review of policy outcomes, outputs, and operations shows a different picture. If we step back, we find considerable evidence that global economic governance responded adroitly to the 2008 financial crisis and Great Recession. Even though the initial drop in output and trade levels was more acute in 2008 than in 1929, by any measure the global economy has rebounded more robustly over the past five years than it did during the Depression. Global trade and investment levels recovered from their plunge in late 2008 and early 2009. In part this is because the great powers and global governance structures successfully coordinated policy outputs that alleviated the worst effects of the financial crisis. A mélange of international coordination mechanisms facilitated the provision of liquidity and served as bulwarks against protectionism. Multilateral economic institutions adapted and responded to the 2008 financial crisis in a surprisingly nimble fashion. Key international organizations expanded their policy competencies and adjusted their governance structures to better reflect the distribution of power in the world. Contrary to pre-crisis expectations, global economic governance performed the necessary tasks to prevent the 2008 financial crisis from metastasizing into a prolonged depression. In short, the system worked.

  TABLE 2.1 The Functions of Global Economic Governance

  TABLE 2.1 compares the different ways in which international institutions can matter with what actually happened after 2008 based on the data in this chapter. Some of these results are unsurprising. The IMF, for example, with its considerable resources and expertise, mattered through a number of different mechanisms. Other results are more counterintuitive. Even with the trade facilitaton deal, the WTO did not really serve as a focal point for trade liberalization after 2008. But, on every other dimension, the organization was very relevant in containing protectionism. Similarly, the G20 has no independent staff or secretariat, but it served multiple roles. It was a useful focal point for great-power consultations on the global political economy, provided a forum for the great powers to consult with one another, and at crucial moments, usefully blunted domestic pressures. Although the G20 had no monitoring capabilities, it did empower other institutions to monitor commitments to economic openness. What is clear is that all of these regimes mattered in multiple ways. Monocausal explanations about why global governance is useful are clearly not satisfactory to explain their performance during the Great Recession.

  The evidence presented in this chapter suggests that the liberal economic order proved to be more robust than expected. As John Ikenberry has observed, “The last decade has brought remarkable upheavals in the global system—the emergence of new powers, financial crises, a global recession, and bitter disputes among allies. … Despite these upheavals, liberal international order as an organizational logic of world politics has proven resilient. It is still in demand.”134 Despite uncertain times, the open global economic order that has been in operation since 1945 does not appear to be closing anytime soon. After the biggest stress test the world has seen in seventy years, the open global economy endured.

  3

  Why the Misperception?

  RELATIVE TO PREVIOUS CRISES of similar severity, global economic governance responded in a surprisingly nimble fashion after 2008. Its ability to maintain the openness of cross-border flows played an important part in preventing a collapse of the global economy. Global governance structures supplied the necessary public goods and coordinating mechanisms to prevent the financial crisis from mushrooming into a full-blown global depression. The internal rules and memberships of key global economic governance structures were revamped to reflect shifts in the distribution of power. Whether one examines the outcomes, outputs, or operations of international institutions, the system worked—not perfectly, but “good enough.”

  As noted in chapter 1, few global policy elites and commentators agree with the points made in the previous paragraph.1 Despite easily accessible data, the conventional wisdom among most analysts is that global economic governance is badly broken and in desperate need of repair. By any reasonable metric, global governance structures did what was necessary to preserve the open global economy. This remains a counterintuitive fact despite the abundance of supporting evidence.

  Why is there such widespread misperception about the performance of global economic governance? Exploring the possible biases at work can be useful. Without a better understanding of why there is so much current confusion, it will be difficult to make any predictions for the future of global governance. In this chapter, I offer several reasons for this misperception: an exaggeration of the costs of perceived global governance failures, a misplaced nostalgia for prior eras of global economic governance, the distribution of benefits from current economic growth, and the conflation of national with global governance.

  Exaggerating the Failures

  There is an excellent reason commentators have been so skeptical about the state of global economic governance—there are numerous areas in which global economic governance did falter or fail. The Doha Round of world trade talks had stagnated for years. The breakdown of macroeconomic policy consensus between 2010 and 2012 acted as a genuine drag on global economic growth. No appreciable progress was made in climate change talks. Negotiations to update existing telecommunications protocols broke down in angry political posturing in late 2012.2 In other issue areas, such as cybercrime, there is not even a whisper of an effective international regime.3 On financial regulations, no reform has truly solved the “too big to fail” problem at the global level. There are prominent examples of dysfunctional outcomes in the security realm as well. It is safe to say that global governance since 2008 has been imperfect.

  The problem comes when one tries to weigh the significance of these governance failures relative to the successes detailed in the last chapter. And here we run into a dirty little secret of world politics: many international relations or politics commentators do not know much about economics or international economic policy. In fact, very few of them have the requisite interest to opine in detail about the global economy. International affairs professionals frequently talk about “high politics” and “low politics.” They usually relegate economic issues into the latter category and focus their energies on the former. Political pundits are even more disinterested in this topic.

  This lack of interest matters when political commentators try to assess economic policy or global e
conomic governance. They naturally rely on surface-level policy outputs as the most obvious metric. And as I just noted, many of the most obvious data points did suggest a breakdown in global governance. The snail’s pace of the Doha Round, the failure of the Copenhagen climate change summit, and the deadlock of the G20 summits seemed like sufficient evidence to proclaim that global governance was imperiled—hence the fast-congealing consensus that the international system was broken. It is difficult to correct such misperceptions once they are cemented, particularly if the topic in question is outside a pundit’s bailiwick.4 If international relations commentators collectively overestimated the costs of governance breakdowns, then groupthink can prevent a reassessment despite falsifying evidence.

  The best example from the Great Recession has been the repeated concern voiced about exchange-rate volatility and currency wars. Initially, there seemed to be valid reasons for such fears. Currency volatility spiked in fall 2008. Concerns escalated after developed economies began pursuing more unconventional forms of monetary policy. With interest rates set close to zero, central banks engaged in quantitative easing as a way of pumping more money into the economy. In 2010, the US Federal Reserve began hinting at a second round of quantitative easing, known colloquially as QE2. One of the policy externalities of quantitative easing was US dollar depreciation. A falling dollar boosts American exports and reduces American imports. It can also trigger an increase in capital outflows to countries that could offer appreciating assets or higher rates of return—in this case, the advanced developing countries.