The System Worked_How the World Stopped Another Great Depression Read online

  FIGURE 2.6 Trade Restrictions, 1955–2011

  Source: World Trade Organization

  Some post-2008 measures—such as those taken to bail out national banks, which can have a strong home bias—are not captured in these traditional metrics of nontariff barriers. It is therefore possible that such “murky protectionism” was on the rise as more traditional nontariff barriers were on the wane. The data suggests otherwise, however. The Global Trade Alert data—which casts the widest net in terms of measuring trade restrictions—shows a protectionist surge at the beginning of the crisis, followed by a relative decline in the ratio of trade-restricting to trade-liberalizing measures. Furthermore, 60 percent of the G20 temporary trade barriers imposed since 2009 were from countries that were responsible for less than 15 percent of all G20 imports.62 Even if the number of trade-restricting measures increased, their aggregate effect on trade was minimal. The WTO’s June 2013 estimate was that the combined effect of all post-crisis protectionist measures by the G20 had reduced trade flows by a total of 0.2 percent.63 The WTO estimate jibes with academic estimates that “the Great Recession of 2009 does not coincide with any obvious increase in protectionism.”64 This is a striking contrast to the Great Depression. Economists estimate that increases in tariffs and nontariff barriers in the 1930s were responsible for more than 40 percent of the reduction in global trade.65 Today’s quick turnaround and the growth in trade levels further show that these measures have not seriously impeded market access.66 What is particularly striking is that pre-crisis trade models predicted an increase in protection five to seven times greater than what actually transpired.67

  Global governance played a significant role in this outcome. The G20 acted as a useful forum for reassuring participants not to raise their trade barriers, particularly toward the countries most affected by the Great Recession.68 This is consistent with research showing that membership in the WTO and related organizations acted as a significant brake on increases in tariffs and nontariff barriers.69 The major trading jurisdictions—the United States, the European Union, and China—adhered most closely to their WTO obligations.70 Peripheral countries have reversed course on specific protectionist actions in response to WTO warnings.71 The WTO’s dispute settlement mechanism helped to contain the spread of protectionist measures triggered by the Great Recession; compliance with these rulings did not wane after 2008.72 As Alan Beattie acknowledged, “The ‘Doha Round’ of trade talks may be dead, but the WTO’s dispute settlement arm is still playing a valuable role.”73 The WTO’s Government Procurement Agreement (GPA) helped to blunt the most blatant parts of the “buy American” provisions of the 2009 fiscal stimulus in the United States, thereby preventing a cascade of “fiscal protectionism.”

  Policy advocates of trade liberalization embrace the bicycle theory—the belief that unless multilateral trade liberalization moves forward, the entire global trade regime will collapse because of a lack of forward momentum.74 The last four years suggest that there are limits to that rule of thumb. The Financial Times/Economist Intelligence Unit surveys of global business leaders reveal that concerns about protectionism stayed at a low level.75 Figure 2.7 shows that corporate officers were far less concerned about protectionism and currency volatility than they were about economic uncertainty. Reviewing the state of world trade, Carnegie Endowment for International Peace’s Uri Dadush and his colleagues conclude, “The limited resort to protectionism was a remarkable aspect of the Great Recession.”76 Former US trade representative Susan Schwab concurs, noting, “Although countries took protectionist measures in the wake of the crisis, the international community avoided a quick deterioration into a spiral of beggar-thy-neighbor actions to block imports.”77 At a minimum, the bicycle of world trade is still coasting forward.

  From the earliest stages of the financial crisis, central banks took concerted and coordinated action to ensure both discounting and countercyclical lending. Indeed, even most skeptics of post-2008 global economic governance acknowledge this point.78 The central banks of the major economies slowly cut interest rates in the fall of 2007. A few months later, the central banks of the United States, Canada, the United Kingdom, Switzerland, and the eurozone announced currency swaps to ensure liquidity.79 By fall 2008, they were cutting rates ruthlessly and in a coordinated fashion, “the first globally coordinated monetary easing in history,” as one assessment put it.80 Global real interest rates fell from an average of 3 percent before the crisis to zero in 2012. In the advanced industrialized economies the real interest rate was effectively negative.81 Not content to just lower interest rates, most of the major central banks also expanded emergency credit facilities and engaged in more creative forms of quantitative easing. Between 2007 and 2012, the balance sheets of the central banks in the advanced industrialized economies more than doubled. The BIS—which has been unsympathetic to loose monetary policy—acknowledged in its 2012 annual report that “decisive action by central banks during the global financial crisis was probably crucial in preventing a repeat of the experiences of the Great Depression.”82

  FIGURE 2.7 Private Sector Perceptions of Threats and Risks to the Global Economy

  Source: Financial Times/Economist Intelligence Unit

  Central banks and finance ministries also took coordinated action during the fall of 2008 to ensure that cross-border lending would continue, so as to avert currency and solvency crises. That October, the G7 economies plus Switzerland agreed to unlimited currency swaps in order to ensure liquidity would be maintained in the system. The United States then extended its currency-swap facility to Brazil, Singapore, Mexico, and South Korea. The European Central Bank expanded its euro-swap arrangements with Hungary, Denmark, and Poland. China, Japan, and South Korea, and the Association of Southeast Asian Nations (ASEAN) economies broadened the Chang Mai Initiative into an $80 billion swap arrangement to ensure liquidity. The IMF created the Short-Term Liquidity Facility, designed to “establish quick-disbursing financing for countries with strong economic policies that are facing temporary liquidity problems.”83 The IMF also negotiated emergency financing for Hungary, Pakistan, Iceland, and Ukraine. In the ten months after September 2008, the IMF executed more than $140 billion in standby arrangements to seventeen countries.84

  Over the longer term, the great powers bulked up the international financial institutions’ resources so they could provide for further countercyclical lending. In 2009, the G20 agreed to triple the IMF’s reserves to $750 billion. In response to the worsening European sovereign debt crisis, G20 countries combined to pledge more than $430 billion in additional resources in 2012. The fund created multiple new credit facilities for its least-developed members, and established a flexible credit line that enabled members to sign up for precautionary arrangements without triggering market panic. Outside reviews of the fund’s performance concluded that the IMF’s response to the Great Recession “was larger in magnitude, was more rapid, and carried fewer conditions” than in prior crises.85 The World Bank’s International Development Association (IDA), which offers up the most concessionary form of lending, also increased its resources. The sixteenth IDA replenishment in December 2010 was a record $49.3 billion, an 18 percent increase of IDA resources over 2007 levels. The seventeenth IDA replenishment in December 2013 was $52 billion, a 5.5 percent increase from 2010 levels. Based on Kindleberger’s criteria, it is clear that global economic governance responded rather well to the 2008 financial crisis.

  To be sure, there are global public goods that go beyond Kindleberger’s original criteria. Kindleberger himself later recognized the need for “coordination of monetary and fiscal policies among major nations.”86Other international political economy scholars have stressed the need to coordinate, clarify, and reform cross-border-exchange regulations after a crisis. Again, the international system was active in these areas after 2008. Between the popping of the subprime mortgage bubble and the June 2010 G20 Toronto summit, the major economies were agreed on the need for aggressive
and expansionary fiscal and monetary policies. The combined G20 stimulus in 2008 and 2009 amounted to approximately $2 trillion—or 1.4 percent of global economic output.87 The estimated effect of fiscal and monetary policy coordination was to boost global economic growth by approximately 2 percent.88As discussed in greater detail in chapter 6, even reluctant contributors like Germany eventually bowed to pressure from economists and G20 peers. Indeed, in 2009, Germany enacted the third-largest fiscal stimulus in the world.89 Germany’s acting against its initial set of preferences is an example of global economic governance leading to greater policy coordination, rather than flowing from a simple harmony of preferences.

  Progress was also made in the regulatory coordination of finance and investment rules. There were developments in two particular areas: investor protectionism and banking regulation. The rise of sovereign wealth funds before 2008 had ratcheted up restrictions to cross-border investment by state-owned enterprises and funds. The OECD articulated its own guidelines for recipient countries but warned that unless the funds demonstrated greater transparency, barriers to investment would likely rise even further.90 In September 2008, an IMF-brokered working group approved a set of “generally accepted principles and practices” for sovereign wealth funds. These voluntary guidelines—also called the Santiago Principles—consisted of twenty-four recommendations addressing the legal and institutional frameworks, governance issues, and risk management of sovereign wealth funds.

  The expert consensus among financial analysts, regulators, and academics was that these principles—if fully implemented—would address most recipient-country concerns. One newspaper characterized the new rules as “a rare triumph for IMF financial diplomacy.”91 And indeed, after the IMF approved the Santiago Principles, sovereign wealth funds began displaying significantly greater transparency.92 Not coincidentally, national security exceptions to FDI have waned. Overall, investor protectionism has declined.93 In their 2013 report to the G20 on the state of cross-border investment, the OECD and UNCTAD concluded, “On the whole, G20 members have continued to honor their pledge not to introduce new restrictive policies for international investment. Almost all new investment policy measures that G20 members adopted during the reporting period tended to eliminate investment restrictions, and to facilitate inward or outward investment.”94

  International regulators also significantly revised the Basel core banking principles. At the November 2010 Seoul summit, the G20 approved the Basel III banking standards. Basel III took only two years to negotiate—markedly less time than the six years it took to hammer out Basel II. The new rules, scheduled to be phased in over the rest of this decade, increase the amount of reserve capital banks must keep on hand and add new countercyclical capital buffers to prevent financial institutions from engaging in procyclical lending.

  Financial-sector analysts and scholars have debated whether Basel III is a sufficient upgrade in regulatory stringency, and whether it will be implemented too slowly or not at all (see chapter 4 for a more detailed discussion).95 There is consensus, however, that Basel III upgrades the Basel II standards in terms of preventing bank failures.96 Furthermore, Basel III standards were approved despite fierce resistance from the global banking industry. By November 2011, the Financial Stability Board (FSB) had designated the systemically important global banks that would be required to keep additional capital on hand. The FSB is working with the International Organization of Securities Commissions to identify systemically important nonbank financial entities.

  The final and most obvious global public good that global governance can provide is international security—protecting the global commons in the air, space, and sea from security threats. Here, global governance also performed rather well. For example, in response to the worsening piracy problem, the United Nations Security Council quickly passed two resolutions—nos. 1846 and 1851—authorizing the use of force against pirates off the Somali coast. An ad hoc coalition of more than twenty-five countries formed the Combined Task Force 151 (CTF 151) to patrol the Gulf of Aden. Other countries that were not formally part of the task force—including China and Iran—also sent patrol ships. Reviewing the myriad efforts, a RAND analyst concluded, “The international response represents an unprecedented level of inter-governmental cooperation that has been achieved in a remarkably short period of time.”97 These efforts made a substantial contribution to the decline of piracy attacks.98 CTF 151 and other activities off the coast of Somalia led to the arrests of nearly 1,200 pirates. Prosecutions have taken place in twenty countries, and top pirates have announced their “retirement” in response to more perilous conditions.99 In September 2013 the ICC International Maritime Bureau concluded, “The pro-active responses by the [CTF 151] navies toward suspicious/potential Somali pirates has ensured that the threat of piracy is continually addressed and removed from the water. As attacks continue to drop the presence of the navies cannot be underestimated.”100

  Operations

  The degree of institutional resiliency and flexibility at the global level has been rather remarkable. Once the acute phase of the 2008 financial crisis began, the G20 quickly supplanted the G7/G8 as the focal point for global economic governance. At the September 2009 G20 summit in Pittsburgh, the member countries avowed that they had “designated the G20 to be the premier forum for our international economic cooperation.”101 This move addressed the worsening problem of the G8’s waning power and relevancy—a problem of which G8 members were painfully aware.102 The G20 grouping comprises 85 percent of global economic output, 80 percent of global trade, and 66 percent of global population. The G20 is not perfectly inclusive, and it has a somewhat idiosyncratic membership at the margins, but it is a far more legitimate and representative body than the G8. As Geoffrey Garrett puts it, “The G20 is globally representative yet small enough to make consensual decision-making feasible.”103 As a club of great powers, the G20 has the capability, when there is consensus within, to lead effective policy coordination across a wide range of issues.

  Having the capacity to be an effective body and actually being one are two different things. Even skeptics of global economic governance acknowledge that the G20 successfully coordinated monetary and fiscal policies at the outset of the crisis.104 The conventional wisdom, however, is that the G20’s political momentum stalled out in 2010 after countries disagreed on macroeconomic imbalances and the virtues of austerity.105 The reality is more complex. It is certainly true that consensus on macroeconomic policy broke down, but much of the rest of the G20’s Framework for Strong, Sustainable and Balanced Growth agenda went forward.106 According to the University of Toronto’s G20 Information Centre, compliance with G20 commitments actually increased over time. The research group measured G20 adherence to “chosen priority commitments.” Measured on a per country average, G20 members have steadily improved since the 61.5 percent compliance rate for the April 2009 London Summit commitments, rising all the way to 77 percent for the June 2012 Los Cabos Summit.107

  An obvious rejoinder is that this kind of finding inflates compliance because the pledges made at these summits are so modest.108 If the G20 has scaled back its ambitions—even in its “priority commitments”—compliance is easier. Nevertheless, the focal-point function of the G20 signaled European leaders to take more vigorous action on the eurozone crisis in the fall of 2011.109 Great powers also used the G20 as a means of blunting domestic pressures for greater protectionism—at precisely the moments when the group was thought to be losing its political momentum.110 For example, the G20 served as a useful mechanism to defuse rising domestic tensions in the United States concerning China’s undervalued currency. In April 2010, in response to congressional pressure for more robust action, US Treasury secretary Timothy Geithner cited the G20 as “the best avenue for advancing US interests” on China’s manipulation of its exchange rate.111 This successfully deflected momentum in Congress to take unilateral action against China.

  At the same time, Chinese central bank off
icials and advisers signaled a commitment to modify its posture on exchange rates.112 Immediately prior to the June 2010 Toronto G20 summit, China announced that it would let the renminbi appreciate against the other major currencies. For the next three years, the renminbi nominally appreciated at a rate of 5 percent a year—more so if one factors in the differences in national inflation rates. Significant appreciations in the renminbi occurred in advance of G20 meetings, indicating China’s desire to avoid clashes over the currency issue at those summits.113 By late 2012, the renminbi hit record highs against the dollar, and China had dramatically curtailed its intervention into exchange-rate markets.114 In the three years after China’s pledge, the renminbi appreciated by 15 percent against the country’s major trading partners. This contributed to a shrinking of global current account imbalances of more than 30 percent since the start of the crisis.115 Assessing the state of current account imbalances in September 2013, The Economist concluded that “the world has rebalanced.”116

  Other key financial bodies also expanded their membership and authority as a response to the 2008 crisis. In March 2009, the Basel Committee on Banking Supervision enlarged its membership from thirteen advanced industrialized states to twenty-seven members by adding the developing-country members of the G20. The Financial Stability Forum was renamed the Financial Stability Board in April 2009 and given greater responsibilities for regulatory coordination; its membership expanded to include the developing-country members of the G20. During this period, the Committee of the Global Financial System also grew from thirteen countries to twenty-two members, adding Brazil, China, and India, among others. The Financial Action Task Force on Money Laundering added China, India, and South Korea to its grouping. Prior to 2008, the G7 countries dominated most of these financial standard-setting agencies.117 That is no longer the case in terms of membership. Political scientist Miles Kahler described this expansion in membership as “the most dramatic innovation in global governance in the wake of the global economic crisis—and one likely to be the longest lasting.”118