The System Worked_How the World Stopped Another Great Depression Read online

  THE SYSTEM WORKED

  THE SYSTEM WORKED

  HOW THE WORLD STOPPED

  ANOTHER GREAT DEPRESSION

  DANIEL W. DREZNER

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  Library of Congress Cataloging-in-Publication Data

  Drezner, Daniel W.

  The system worked : how the world stopped another great depression / Daniel W. Drezner.

  pages cm

  ISBN 978–0–19–537384–4 (hardback : alk. paper) 1. Global Financial Crisis,

  2008–2009. 2. Financial crises—Government policy. 3. Finance—Government

  policy. 4. Recessions—21ST century. 5. Economic history—21ST century. I. Title.

  HB3722.D74 2014

  330.9’0511—dc23

  2013044640

  1 3 5 7 9 8 6 4 2

  Printed in the United States of America

  on acid-free paper

  This book is dedicated to Stephen D. Krasner, the Graham H. Stuart Professor of Political Science at Stanford University, a giant in the study of global political economy and, some moons ago, my dissertation adviser. In my professional career, Steve pushed me to think more rigorously and systematically about power than any other colleague. It’s payback time.

  CONTENTS

  Acknowledgments

  1. The Puzzle of Successful Global Governance

  2. Yes, the System Worked

  3. Why the Misperception?

  4. The Role of Interest

  5. The Role of Power

  6. The Role of Ideas

  7. Where Do We Go from Here?

  Notes

  References

  Index

  ACKNOWLEDGMENTS

  This book has been an intellectual exercise in trying to figure out why I was so wrong six years ago and why so many other smart analysts have been so wrong since.

  Back then, I had a pretty good idea for a book—it would be a clarion call about the sclerotic state of multilateral economic institutions. In it, I would sagely observe that the last major burst of international institutional creation had been in the late 1940s and point out that the distribution of power looked a wee bit different in the twenty-first century. If current mismatches between global governance structures and the distribution of power were allowed to fester, then those structures would rest upon very shaky foundations. The rise of the BRICs clearly mandated such reforms. I would warn that although reforming global governance was a thankless task, failure to take action would leave these institutions ill-equipped for a severe global shock. Proactive steps would be necessary to prevent the global economy from experiencing the 1930s all over again.

  Before I could start writing in earnest, however, Lehman Brothers went bankrupt, the federal government bailed out AIG, and the Reserve Primary Fund broke the buck. My warning was overtaken by events; the severe global shock had happened.

  It was impossible to write a book on global economic governance when the global economy seemed to be melting down in real time. So, I stepped away and wrote on some issues that were not changing at the speed of light. I paid attention to the 2008 financial crisis and, like most other commentators, took a jaundiced view of how the global political economy was performing. I also got distracted by zombies for a spell.

  By the time I doubled back to re-examine the state of global economic governance, I noticed two odd trends. First, the closer I looked at the performance of “the system,” the clearer it became that the meltdown I had expected had not come to pass. Second, most other observers nonetheless remained deeply pessimistic about the functioning of the global political economy. Indeed, book after book on the financial crisis was arguing the exact opposite thesis to my initial impressions. I could not blame these commentators for being so pessimistic because I had felt that way too when the crisis began. Nevertheless, I had come to believe that I was wrong then and that they are wrong now.

  I have racked up numerous debts during the thinking and writing of The System Worked. I am particularly grateful to David McBride at Oxford University Press. He was supportive of my original book proposal and even more enthusiastic about what the book turned out to be. Most important, Dave displayed superhuman patience while I sorted out exactly what I wanted to write. Sarah Rosenthal, Molly Morrison, and Ginny Faber also made superhuman efforts to convert my scribblings into this attractive-looking text you’re now reading.

  I also thank the Fletcher School of Law and Diplomacy and the Michael and Andrea Leven Foundation for enabling me to take a sabbatical year to focus on this project. I am particularly grateful to Peter Uvin and Stephen Bosworth, who were, respectively, the academic dean and dean of the Fletcher School during the start of this project. They provided unstinting support. I will assume that it is simply a coincidence that both leaders left Fletcher before I finished my manuscript. Similarly, I thank Fletcher’s current dean, James Stavridis, and academic dean, Ian Johnstone. My other colleagues at Fletcher—particularly Kelly Sims Gallagher, Nancy Hite, Zeynep Bulutgil, Jenny Aker, Jeswald Salacuse, Joel Trachtman, and Michael Klein—made working on this project more bearable. My staff assistants, Karen Mollung and Paulette Folkins, made the trains run on time. My research assistants at Fletcher—Dahlia Shaham, Maggie Riden, and Rebecca Perlman—were also extremely helpful in chasing down answers to some of the more abstruse questions I asked them. Estefania Marchan and Aaron Melaas did outstanding jobs of poring over the manuscript with fresh pairs of eyes, offering valuable perspectives and some last-minute research assistance. Martin Weiss at the Congressional Research Service and Amare Bekele at UNCTAD provided enlightenment when it was needed on some very obscure questions involving IMF quotas and bilateral investment treaties.

  During my sabbatical year, Beth Simmons was kind enough to lend me an office at Harvard University’s Weatherhead Center for International Affairs. Thanks to her, Jeffry Frieden, Bob Ross, Prerna Singh, and Dustin Tingley for making me feel at home there.

  As I’ve wrestled with these issues, I’ve been the beneficiary of a rolling conversation with international political
economy and international relations scholars across an array of venues—coffee breaks, small conferences, large meetings, and invited talks. I thank Kate McNamara, Walter Mattli, Duncan Snidal, Henry Farrell, Layna Mosley, Christina Davis, Mark Blyth, Courtney Fung, Bruce Jones, Abe Newman, Leslie Johns, Miles Kahler, Jonathan Kirshner, Michael Mastanduno, Manjari Chatterjee Miller, G. John Ikenberry, A. Iain Johnston, Carla Norrlof, Zhu Feng, Robert Ross, Pan Rui, David Victor, Steven Bernstein, Brad Glosserman, Peter Gourevitch, Todd Hall, Alan Alexandroff, James Lindsay, John Mueller, Matthias Matthijs, Eric Rauchway, Kevin Gallagher, Kevin H. O’Rourke, Randall Schweller, David Andrew Singer, Alexander Thompson, Tom Wright, and Charli Carpenter for their thoughts and feedback.

  Portions of this book were presented at the School of Advanced International Studies at Johns Hopkins University, CSIS Pacific Forum, University of Toronto, Nuffield College, The Ohio State University, Boston College, Chicago Council on Global Affairs, and Council on Foreign Relations. I thank the attendees at these talks for their hospitality and their critical feedback—not necessarily in that order. A much earlier version of chapter 2 appeared as a working paper in the Council on Foreign Relations’ International Institutions and Global Governance series, and a still earlier but revised version appeared in the January 2014 issue of World Politics. At CFR, I thank Stewart Patrick, who provided invaluable feedback, and Trish Dorff, who was indispensable in getting the paper published. I am grateful to Ilene Cohen and the four anonymous referees of the paper at World Politics. The two anonymous referees for Oxford University Press also provided invaluable feedback at light speed. Thank you, whoever you are.

  I’ve also been the beneficiary of an ongoing online conversation about these topics in the blogosphere and on Twitter. Even though I have not actually met many of my online interlocutors, their links, feedback, and snark benefited me tremendously during the drafting of this book. So thanks to Heidi Moore, Joe Weisenthal, Noah Smith, Justin Wolfers, Greg Ip, Jay Ulfelder, Ezra Klein, James Pethokoukis, Zack Beauchamp, Gady Epstein, Tony Fratto, Pascal-Emmanuel Gobry, and Will Winecoff.

  Finally, I am very, very, very grateful to my family. This book took its toll on Erika, Sam, Lauren, and our dog Mimi. As the months passed and deadlines loomed, I spent more time locked away with piles of paper and less time engaging with my loved ones. They never complained or rebelled. The thesis of this book might very well be proven wrong in the coming years. But, after unintentionally stress testing my wife and kids, I am pretty secure in the knowledge that my family system works really well.

  Daniel W. Drezner

  Newton, Massachusetts

  February 2014

  THE SYSTEM WORKED

  1

  The Puzzle of Successful Global Governance

  THE CONVENTIONAL WISDOM ABOUT global economic governance resembles an old Woody Allen joke: the quality is terrible—and yet such small portions. In other words, the view for quite some time has been that global governance has produced bad policy, and yet not enough of it. The punchline of this book is that the conventional wisdom is wrong. In response to the 2008 financial crisis—contrary to expectations—global economic governance responded in an effective and nimble fashion. In short, the system worked.

  Many people who are paid a lot of money to write about the world believe that the system of global governance is broken. Ordinarily, such collective pessimism, accurate or not, is unproblematic. So long as the global economy hums along, whether or not there is faith in governance structures matters very little. Unfortunately, in recent years, the performance of the global economy has been anything but ordinary.

  THE PROBLEM

  The 2008 financial crisis posed the greatest threat to the global economy since the Great Depression of the 1930s.1 During the first twelve months of what is now commonly called the Great Recession, economic output, global trade, and global equity values all plummeted lower than they did in the first year of the Depression, as figures 1.1–1.3 demonstrate. The International Monetary Fund (IMF) calculated that banks and other financial institutions lost more than $4 trillion in the value of their holdings as a result of the crisis.2 The McKinsey Global Institute conservatively estimated that the global decline in asset values led to aggregate losses of $27 trillion in 2008, or roughly 50 percent of global economic output.3 The International Labour Organization determined that global unemployment increased by 34 million people between 2007 and 2009.4 Five years after the start of the subprime mortgage crisis, concerns about systemic risk were still elevated.5

  FIGURE 1.1 Global Industrial Output, 1929 versus 2008

  Source: Eichengreen and O’Rourke 2010

  The demand for effective global economic governance is at its greatest during severe crises. I define global economic governance as the set of formal and informal rules that regulate the global economy and the collection of authority relationships that promulgate, coordinate, monitor, or enforce said rules.6 Even if national governments are the primary actors in world politics, they rely on a bevy of formal and informal institutions—the IMF, World Trade Organization (WTO), Bank of International Settlements (BIS), and Group of Twenty (G20) nations—to coordinate action on a global scale. These structures range from those with the ample resources, influential staff, and codified legal status of the IMF to the informal, resource-poor network of national officials of the G20. In the case of foreign direct investment (FDI), global governance is not even all that multilateral. Instead, a dense network of bilateral arrangements and private arbitration bodies governs investment.

  FIGURE 1.2 Global Trade Flows, 1929 versus 2008

  Source: Eichengreen and O’Rourke 2010

  FIGURE 1.3 Global Stock-market Capitalizations, 1929 versus 2008

  Source: Eichengreen and O’Rourke 2010

  Global governance structures can be the policymaker’s pacifier. In an anarchic world, they provide a host of public goods and services, reducing uncertainty for all the participating actors.7 When these structures function well, they facilitate communication and foster shared understandings among the policy principals, as well as reduce the transaction costs of policy coordination.8 When they function poorly, a lack of trust and a surfeit of uncertainty among the actors stand in the way of cooperation. During normal economic times, global institutions articulate rules that advance the core principles animating the global economic order.9 During abnormal times—such as the Great Depression, the collapse of Bretton Woods, or the Asian financial crisis—it is hoped that global economic governance structures will ensure sustained multilateral cooperation, even if it means that core principles will have to be reformed. Early in the 2008 crisis, Menzie Chinn and Jeffry Frieden noted, “The 1929 recession became a depression largely because of the collapse of international cooperation; the current crisis may head in that direction if international collaboration fails.”10 In the modern era, a primary aim of these structures during a crisis will be to keep barriers to cross-border exchange low. An open global economy lessens the stagnation that comes from a financial crisis, preventing a downturn from metastasizing into a depression.11 The question in 2008 was, would the system do what was necessary?

  THE CHALLENGES OF GLOBAL GOVERNANCE

  There were excellent reasons to believe that global economic governance would fail in 2008. Even as the demand for global solutions rose, the supply seemed dodgy. Among both the public and elites, skepticism about the ability of global economic governance structures to ameliorate economic problems had increased in the decade before the crisis. In part, this reflected the waning reputation of governance more generally. World public-opinion polls show that a majority of citizens believe that their national government wastes more than half of its tax receipts on programs that do not benefit their countries.12 Polling about global governance structures has been rarer, but prior to the financial crisis, public attitudes toward multilateral institutions like the United Nations were trending downward as well.13

  That public skepticism about global governa
nce has increased should not be surprising given the nature of the commentary about these institutions. The public may little note or long remember specific things said about the United Nations or the World Bank, but decades of disrespect eventually seep into the collective subconscious. Since their inception, global governance structures have invited scorn outside the United States because bodies like the IMF are viewed as puppets of America’s hegemonic power. Inside the United States, partisans on both ends of the political specturm have spent decades bashing one international institution or another, degrading the reputations of all of them. Left-leaning critics decry international financial institutions for coercing developing economies into adopting “market fundamentalism.”14 Neoconservatives loudly argue that international institutions, such as the United Nations, do nothing but constrain the United States into no-win scenarios.15 These organizations have been roundly accused of preferring bloviation over action.

  The problem is that international institutions all too often resemble caricatures, riddled with corrupt officials and sclerotic structures. The global governance of sports provides a high-profile example of the fecklessness of some international institutions. Corruption plagued the International Olympic Committee (IOC) for its first hundred years of existence.16 By the end of the twentieth century, the IOC board members in charge of selecting the games’ host cities were accustomed to accepting bribes, gifts, and favors from the various bidders. Eventually, the scandal over Salt Lake City’s bid to host the 2002 Winter Olympics led to a scathing internal IOC report acknowledging decades of corruption. Six board members were purged as a result. Yet, despite the scandals, IOC president Juan Antonio Samaranch was allowed to finish his term, with all its perquisites, including more than $200,000 in annual living expenses. Although the IOC did create an ethics commission to monitor the bidding process, the new commission reports to the IOC’s executive board; it does not exercise any independent power.17