The System Worked_How the World Stopped Another Great Depression

by Daniel W. Drezner

  The shift in the IMF’s position on capital controls did not lead to a wholesale rejection of capital account liberalization. The Economist described these newer controls as “lighter-touch” and “market-based.”125 Still, this represented a shift in the global policy climate against the financial sector. To explain this development, Rodrik proposed an intriguing hypothesis: “What made finance so lethal in the past was the combination of economists’ ideas with the political power of banks. The bad news is that big banks retain significant political power. The good news is that the intellectual climate has shifted decisively against them.”126 Rodrik’s emphasis on the role of power and ideas in determining the outcome of global economic governance is intriguing. This chapter suggests the limits of material interests in explaining the functioning of global governance; the next two chapters turn to the role of state power and economic ideas.

  5

  The Role of Power

  IN THE POST-2008 WORLD, the best place to look to get an analytical grip on relative economic power might be Iran. Focusing on a midsized economy that has been diplomatically isolated for a generation might seem odd to those interested in global economic governance. When we think about economic power, however, Iran is a revealing example. The recent economic sanctions imposed on Iran are a good test of the use of economic power as a means of constructing and enforcing the rules of the game.

  In 2010, the United Nations Security Council voted to impose a fourth round of economic sanctions on Iran following its refusal to cooperate with the International Atomic Energy Agency. The United States and the European Union announced their intent to impose additional financial sanctions. Most observers doubted they would be effective.1 After all, China, South Korea, and other Pacific Rim power-houses would simply buy up the oil that did not go to Europe. Indeed, Iran’s lead negotiator on the nuclear question bragged to Der Spiegel, “Do you really believe there are sanctions that can hit us that hard? We’ve lived with sanctions for thirty years, and they can’t bring a great nation like Iran to its knees. They do not frighten us. Quite the opposite—we welcome new sanctions.”2

  The United States and the European Union obliged. The financial restrictions were so comprehensive that the Society for Worldwide Interbank Financial Telecommunication (SWIFT) ended all transactions with the Iranian banks named in the sanctions. Iran was effectively cut off from twenty-first-century finance. In 2012, the European Union also implemented an embargo on Iranian oil. By 2013, it was clear that the sanctions had been more crippling than experts had thought they would be. Iran’s oil export revenue was cut in half between 2010 and 2012, and overall oil production was at its lowest levels in twenty-five years. China has purchased Iranian oil in recent years, but Beijing has also exploited the sanctions regime to impose below-market purchase prices and payment in shoddy consumer goods rather than hard currency.3 These moves have served China’s interests—but China’s behavior has also served the transatlantic goal of imposing economic costs on Iran.

  Iran’s economy, compared to its peer group of oil exporters, has deteriorated badly since 2010.4 Iran’s economy shrank in 2012 and 2013. Inflation increased to over 50 percent as the rial plummeted in value relative to other currencies. The combination of financial sanctions and reduced oil exports left Iran with useful currency reserves of less than $20 billion. By fall 2013, Iran’s president Hassan Rouhani had publicly acknowledged that the effect of sanctions had been severe and said that quick negotiations were required to settle the nuclear question.5 Despite widespread perceptions of receding Western influence, it appears that the US and EU actors wielded sufficient economic power to bring Iran to the negotiating table.

  Global economic governance did what was necessary during the Great Recession. The previous chapter found that material interests can only partly explain why the system worked. This chapter assesses the crucial role that power plays in sustaining global economic governance, particularly when the global economy is experiencing downturns. In Politics in Hard Times, political scientist Peter Gourevitch observes:6

  In prosperous times it is easy to forget the importance of power in the making of policy. Social systems appear stable, and the economy works with sufficient regularity that its rules can be modeled as if they functioned without social referent. In difficult economic times this comfortable illusion disintegrates. Patterns unravel, economic models come into conflict, and policy prescriptions diverge. Prosperity blurs a truth that hard times make clearer: the choice made among conflicting policy proposals emerges out of politics. The victorious interpretation will be the one whose adherents have the power to transfer their opinion into the force of law.

  Gourevitch believes that hard times reveal the power politics that determine national policies. This applies to world politics as well.

  Nevertheless, assessing economic power during the post-2008 era is not for the faint of heart. For the past few years, I have challenged the students in my global political economy classes to identify the actors belonging to the current roster of great powers. The answers I have received have been heterogeneous, to say the least. They range from safe choices like the United States to more unorthodox suggestions, such as Goldman Sachs, WikiLeaks, and the China Development Bank. A healthy fraction of my students has argued that there are no current great powers. This assessment reflects views expressed in the burgeoning literature about the diffusion of power in the world that was discussed in Chapter 1. The problem of accurately assessing economic power is not limited to students, however. Economists and political scientists are uncomfortable with such discussions. Most economists do not like to think about power. Many international relations scholars do not like to talk about economics.

  How has the 2008 financial crisis affected the global distribution of power? The conventional wisdom is that power has shifted from the OECD economies to the BRIC economies. On one level the conventional wisdom is true; the BRIC economies are rising relative to the OECD countries. That statement, however, masks the divisions within each cluster of actors. China has risen to be a great power of the first rank; the rest of the BRIC countries have not. And, though China may be rising, it has not risen nearly as high as perceptions suggest. Similarly, although American economic power has declined, it has not declined by all that much—and it has declined from a position of unparalleled hegemony. The United States remains the most powerful economic actor in the global economy, permitting it to exercise leadership in global governance through a variety of means. When the United States, the European Union, and China act in concert, global governance rests on a strong foundation. Although the distribution of global power has become less concentrated, the perception that it is diffusing rapidly does not square with the reality.

  In this chapter I briefly review the literature on the relationship between the distribution of power and the functioning of global economic governance. While a hegemon is commonly thought to be a necessary and sufficient condition of governance, the state of thinking is more complex than that simple statement suggests. Hegemonic actors need to attract supporters and discourage spoilers. I discuss elite and public perceptions about economic power, and why those perceptions might not be entirely accurate, and then section audit the capabilities of the great powers. As will be seen, popular perceptions about the global distribution of power are inaccurate; the BRIC economies are not as powerful as they are perceived to be, and the established powers are not as weak. The current global political economy rests on a troika of great powers—the United States, the European Union, and China—and the United States remains the first among equals. The chapter explains why this troika was able to make global governance function. The United States still exercised leadership on key policy dimensions. More intriguingly, China largely acted as a supporter rather than a spoiler of global economic governance.

  Great Powers and Global Governance

  Beginning with Charles Kindleberger, global political economy scholars have argued that the existence of a hegemonic
power is necessary to sustain global economic order.7 The empirical validity of “hegemonic stability theory,” however, has been a running debate in global political economy for the past four decades. On the one hand, scholars now reject the notion that hegemony is either a necessary or sufficient condition for an open global economy. There are a welter of substitutes for hegemonic power in the international system. Formal or informal global governance structures can facilitate cooperation among a concert of powerful actors to provide global public goods in the absence of an undisputed hegemon.8

  Furthermore, the mere existence of a liberal economic hegemon is not necessarily a sufficient condition for effective global governance. “Supporters” also play a crucial role in the spread of economic openness by buttressing and adhering to the rules of the global economic order.9 Supporter states possess significant reservoirs of power in world politics, albeit fewer capabilities than the most powerful actor. Supporters can matter because of their strategic position within global economic networks.10 For example, in the nineteenth century, the United Kingdom sponsored both the gold standard and the principle of free trade. Neither concept went global, however, until supporter states, such as France and Germany, also embraced these regimes.11 The collapse of the interwar trading system happened when supporter states like Germany and the United States transitioned into spoiler states. Spoilers are revisionist actors relative to the status quo, with sufficient capabilities to disrupt preexisting regimes. As the United States’ relative power waned during the Bretton Woods era, supporter states like Germany, Great Britain, and Japan played crucial roles in sustaining the system.12

  Although the precise causal mechanisms remain disputed, it is nevertheless true that hegemonic eras are strongly correlated with greater levels of globalization.13 If one updates Stephen Krasner’s oft-cited analysis about the distribution of state power and the structure of foreign trade, the correlation between hegemonic power and economic openness seems clear. In five of seven eras since 1820, the presence of a strong or rising hegemon is correlated with greater openness, while a declining hegemonic power was correlated with greater levels of closure.14 Furthermore, institutionalists acknowledge that power is still the crucial criterion for membership in any “k-group” or “hegemonic coalition”—the concert of great powers that must cooperate in order to articulate and enforce global economic governance.15 Should the hegemonic coalition agree to coordinate policy, those nations can jointly supply the necessary global public goods for proper implementation.16 If the distribution of power diffuses, the requisite membership in the hegemonic coalition increases.

  Although an economic hegemon would appear to be strongly correlated with effective global governance, it is really the existence of a hegemonic coalition that is the necessary and sufficient condition.17 If a great-power concert exists, global governance structures are seen as critical actors in the coordination process. Whether the governance outcome is achieved through consensus or coercion, it will be viewed as effective. However, if no bargain can be struck among the potential coalition members exists, then these same global economic governance structures will experience intractable deadlocks, inconsistent articulations of policy, forum shopping, and weak enforcement. If one rationale for global governance structures is that they can bring about effective multilateral cooperation, then this ability is irrelevant if either the distribution of power or the distribution of interest is too diverse.18

  As noted in chapter 1, the conventional wisdom about post-crisis world politics is that the distribution of power has become widely diffused. Compared to the pre-crisis era, any expected hegemonic coalition needs to be larger. An increase in the number of great powers automatically decreases the likelihood of effective governance outcomes. Most formal models of cooperation demonstrate that as the number of relevant actors increases, the transaction costs of creating a functioning concert increase as well.19 Introducing more actors into a small group also decreases the likelihood of finding a bargaining core existing among the participants. The number of issue areas in which governance should function is automatically reduced.

  Perceiving, Measuring, and Defining Economic Power

  After the Lehman Brothers collapse, which actors qualified for membership in the hegemonic coalition? Who are the great powers in the Great Recession? Before the 2008 crisis, it was a straightforward matter to identify the great powers in the global political economy as the United States and the European Union.20 Even then, however, there was considerable talk about the rise of the BRIC economies and their effect on the global political economy.21 The outward signs seemed manifestly clear. Even before the collapse of the subprime mortgage bubble, for example, India and Brazil were invited into the “green room” of key negotiators during the Doha Round, effectively wielding veto power when necessary. In 2008, it was China, not the United States, that applied the coup de grace to Doha. Russia attempted to jump-start a natural gas cartel that could match OPEC in global influence. All the BRIC economies took steps to invoice trade in their national currencies rather than dollars, with no retaliation from either the G7 economies or the IMF.22 Post-crisis, new terms such as the “Second World,” “BRICSAM” (the BRIC countries plus South Africa and Mexico), and “Global Growth Generators” were bandied about to describe other emerging powers.23

  The power of these actors, particularly China, flourished at the same time the power of United States and the European Union seemed to wane. In 2010, China officially surpassed Japan as the world’s second-largest economy, and in 2012, China displaced the United States as the largest trading state in the global economy. The IMF projected that China would overtake the US economy in terms of purchasing power parity by 2016. The US National Intelligence Council predicted that by 2025, China’s power would approximate that of the United States.24 According to at least one estimate, by 2011, China already had a larger GDP than the United States, beginning in 2011.25 Part of China’s power comes from this perception of its inexorable rise. Multiple projections have identified China as the economic hegemon by the year 2050.26

  With the onset of the Great Recession, China began to use its economic power to influence its near abroad.27 Holding substantial dollar-denominated debt, Beijing pressured the United States to alter its economic policies.28 In assessing the post-crisis distribution of power, two analysts from the US National Intelligence Council concluded, “The state wealth Beijing has already amassed, over $1 trillion of which resides in U.S. government-backed securities, gives China ample leverage in shaping the future economic landscape. … The manner in which China deploys its reserves is among the most decisive factors determining global outcomes to the current crisis.”29

  This perceived shift in the distribution of power is revealed in both public opinion and elite discourse. Since 2008, the Pew Global Attitudes survey has included a question asking respondents to identify the world’s leading economic power. The answers have been telling, as figures 5.1–5.4 demonstrate. In 2008, pluralities or majorities in twenty of the twenty-two countries that were surveyed (and ten of the twelve G20 members surveyed) said that the United States was the world’s leading economic power—including Chinese and American respondents. Clear majorities in ten of the twenty-two countries surveyed said the United States. In no country did a majority of respondents say China. By 2012, however, there had been a wholesale shift in public attitudes. Pluralities or majorities in eleven of the twenty-two countries now said China was the world’s leading economic power. Clear majorities in five countries named China; only in Turkey and Mexico did majorities of respondents name the United States. In five of the original G7 economies strong majorities or pluralities named China as the world’s leading economic power. When the survey results are combined, there is an aggregate swing of twenty points from the United States to China between 2008 and 2013.

  FIGURE 5.1 Respondents in 2008 Who Said the United States Was the World’s Leading Economic Power

  Source: Pew Research Global Attitudes
Project, Global Indicators Database, http://www.pewglobal.org/database/indicator/17/survey/all/

  FIGURE 5.2 Respondents in 2008 Who Said China Was the World’s Leading Economic Power

  Source: Pew Research Global Attitudes Project, Global Indicators Database, http://www.pewglobal.org/database/indicator/17/survey/all/response/China/

  FIGURE 5.3 Respondents in 2012 Who Said the United States Was the World’s Leading Economic Power

  Source: Pew Research Global Attitudes Project, Global Indicators Database, http://www.pewglobal.org/database/indicator/17/survey/all/

  FIGURE 5.4 Respondents in 2012 Who Said China Was the World’s Leading Economic Power

  Source: Pew Research Global Attitudes Project, Global Indicators Database, http://www.pewglobal.org/database/indicator/17/survey/all/response/China/