The System Worked_How the World Stopped Another Great Depression

by Daniel W. Drezner

  This approach is best suited to counter the standard counterargument that global economic governance is either irrelevant or ineffective. It is frequently posited that successful episodes of global governance are merely the low-hanging fruit of the global political economy, because they only happen when a harmony of preferences makes governance easy to achieve.26 If true, this critique renders international institutions epiphenomenal. The approach used here addresses this challenge by paying special attention to instances in which countries agreed to take actions that contravened powerful domestic interests. If countries adhere to a global policy that imposes costs on entrenched interests, it is a sign that genuine coordination, rather than harmony, is occurring. Examining the operations level will also refute the claim that global governance is epiphenomenal. Within these structures, the post-2008 goal at the operations level was to reallocate influence among the states. But governance reforms are intrinsically difficult to execute because such steps go against the interests of the actors whose power will be diluted. If process reforms nevertheless went through, we can infer that here, too, there was genuine policy coordination rather than a simple harmony of preferences.

  Outcomes

  How well has the global economy recovered from the 2008 crisis? The key question to ask is, compared to what?

  The burgeoning literature on economic downturns suggests two factors that imposed significant barriers to a strong recovery from the Great Recession: it was triggered by a financial crisis, and it was global in scope. By any measure, financial crashes trigger economic downturns that last longer and have far weaker recoveries than do standard business-cycle recessions.27 The global nature of a financial crash makes it extremely difficult for individual nation-states to simply “export their way” out of the problem. Countries that have experienced severe national financial crises since World War II have usually done so when the rest of the global economy was unaffected.28 This was not the case for the Great Recession, which affected wide swaths of the global economy. The proper baseline for comparison is therefore the last severe global financial crisis—the Great Depression.

  By any metric, the global economy rebounded much more robustly post-2008 than it did during the Great Depression. Economists Barry Eichengreen and Kevin O’Rourke compiled data comparing global economic performance from the start of the crises (see figures 2.1–2.3).29 Two facts stand out in their comparisons. First, the initial drop in global industrial output and world trade levels at the start of the 2008 financial crisis was more precipitous than what followed the October 1929 stock-market crash. One year into the 2008 crisis, the falloff in industrial output was greater than it had been eighty years earlier during the same period; the drop in trade flows was more than twice as large. Second, the post-2008 rebound has been far more robust. Four years after the onset of the Great Recession, global industrial output was close to 10 percent higher than when the recession began. In contrast, four years after the 1929 stock-market crash, industrial output was at only two-thirds of pre-crisis levels. Global equity markets after 2008 also outperformed their 1929 counterparts.

  A similar story can be told about aggregate economic growth. Global economic output shrank by approximately 3 percent in 1930, and then contracted at annual rates of approximately 4 percent for the next two years.30 In contrast, according to the IMF’s World Economic Outlook series, global economic output shrank by 0.59 percent in 2009, but was followed by growth in 2010 of 5.22 percent and of 3.95 percent in 2011. Indeed, the average growth in global output between 2010 and 2012 was on par with the average growth rate in the decade that preceded the financial crisis. More intriguingly, the growth continued to be poverty reducing. Despite the 2008 financial crisis, extreme poverty continued to decline across all the major regions of the globe. In the teeth of the Great Recession, the World Bank reported that the first Millennium Development goal of halving the 1990 levels of extreme poverty had been achieved ahead of schedule.31 The United Nations Development Programme reported that despite the 2008 financial crisis, there has been a more rapid improvement in human development since 2001 than during the 1990s—in no small part because poorer countries were better able to access global markets.32 Consistent with this finding, the Legatum Prosperity Index, developed in 2009, has demonstrated small but persistent increases in global prosperity levels in the five years since the start of the Great Recession.

  FIGURE 2.1 Global Industrial Production: Great Depression versus Great Recession

  Source: Eichengreen and O’Rourke 2010

  FIGURE 2.2 Global Trade Volumes: Great Depression versus Great Recession

  Source: Eichengreen and O’Rourke, 2012

  FIGURE 2.3 Global Equity Markets: Great Depression versus Great Recession

  Source: Eichengreen and O’Rourke, 2012

  An important reason for the quick return to positive economic growth is that cross-border flows did not dry up after the 2008 crisis. The Swiss Economic Institute (KOF) constructs the KOF Index of Globalization, which covers a variety of cross-border exchanges, including trade, capital flows, remittances, tourism, and other metrics.33 The mean scores for all countries and G20 members can be seen in figure 2.4. The Great Recession clearly caused globalization to plateau. But, at the same time, KOF’s aggregate data for all countries showed no reduction in their globalization indices. Indeed, there was a very small increase.34 Looking at the G20 economies in particular, we find that the mean national scores on both overall levels of globalization and economic globalization show the same pattern: a slight dip from the 2007 peak, and then a slight recovery by 2010.35 For the G20, the 2010 average index score was the second highest in history, behind the 2007 peak.

  This finding holds when one examines the components of cross-border exchange. Compared with the Great Depression, for example, post-2008 trade flows rebounded robustly. As Eichengreen and O’Rourke observe, and as figure 2.2 shows, four years after the 1929 stock-market crash, trade flows were down by 25 percent compared to pre-crisis levels. Four years after the start of the Great Recession, trade flows were more than 5 percent higher than their pre-crisis levels. Even compared with other postwar recessions, the post-2008 period witnessed a more vigorous bounce back in trade flows. Indeed, the growth in world trade since 2008 has been even more robust than in other postwar recoveries.36 The Economist estimates that global exports as a percentage of global economic output have been higher on average between 2011 and 2013 than during the three years prior to 2008.37 The Great Recession had only modest effects on aggregate trade flows.

  FIGURE 2.4 KOF Index of Globalization, 2000–2010

  Sources: Swiss Economic Institute

  Other cross-border flows have also rebounded from Great Recession lows. Multiple private-sector analyses conclude that global foreign investment assets have fully recovered from the financial crisis and are now valued between 10 and 15 percent higher than their pre-crisis highs.38 Cross-border capital flows have also recovered from early 2009 lows, though they are still well below 2007 highs. Nevertheless, even the fiercest proponents of financial globalization allow that this slowdown might be a good thing. The McKinsey Global Institute characterized it as “a healthy correction” because some of the spikes in pre-crisis flows had been the result of unsustainable and unproductive trends. Many corporations, for example, had devoted more of their energies to financial engineering, leading to excessive leverage and investments in the carry trade and repo markets.39 Indeed, in the run-up to the 2008 financial crisis cross-border lending was far more procyclical than domestic lending was.40 The Economist’s Greg Ip has acknowledged that “a few constraints on global finance are not necessarily a bad thing,” and said that “in retrospect, much of the rise in cross-border lending was foolish.”41 Returning to pre-crisis levels on these dimensions would not necessarily be viewed as boosting sustainable economic growth.

  The more resilient components of cross-border capital flows rebounded well, however. Global FDI returned to robust levels. Accord
ing to the United Nations Conference on Trade and Development (UNCTAD) 2013 World Investment Report, the pre-crisis average of FDI inflows between 2005 and 2007 was $1.49 trillion. Between 2010 and 2012, the post-crisis, three-year FDI inflow average was $1.47 trillion—a negligible difference.42 Furthermore, as with economic growth trends, an increasing proportion of FDI went to the developing world. Remittances from migrant workers have also become an increasingly important revenue stream to the developing world. The 2008 crisis barely dented that income stream. Cross-border remittances to developing countries quickly rebounded to pre-crisis levels and then rose to an estimated all-time high of $389 billion in 2012. Total cross-border remittances were more than $519 billion in 2012 and are estimated to exceed $700 billion by 2016.43Excluding intra-European bank lending, other cross-border capital flows also approximate pre-crisis levels. With FDI and remittances now occupying a greater share of cross-border capital flows, they are far more resilient to financial shocks than in pre-crisis capital markets.

  Finally, the Great Recession did not lead to a deterioration in international security. Because political instability and violence can impinge on cross-border flows, increases in international conflict can dampen cross-border trade and exchange. During the initial stages of the crisis, multiple analysts asserted that the Great Recession would lead states to increase the use of political violence as a tool to stay in power.44They voiced genuine concerns that the global economic downturn would lead to an increase in conflict—whether through greater internal repression, diversionary wars, arms races, or a ratcheting up of great-power rivalries. Violence in the Middle East, piracy on the high seas, border disputes in the South China Sea, riots in European cities, and even the disruptions of the Occupy movement fueled impressions of a global surge in public disorder. As fiscal austerity in the developed economies curtailed social spending, economists predicted an explosion of unrest.45

  Initially, there was some evidence of deterioration. Following the 2008 financial crisis, there was a spike in global piracy, particularly off the Horn of Africa. The International Maritime Bureau reported that in 2009 alone, there was a 40 percent surge in piracy attacks, with attacks near Somalia quadrupling during the same period. The Institute for Economics and Peace, which has constructed the Global Peace Index annually since 2007, reported in 2013 that there had been a 5 percent deterioration in global peace since 2008.46

  A closer look at the numbers, however, reveals more encouraging findings. What seemed to be an inexorable increase in piracy, for example, turned out to be a blip. By September 2013, the total numbers of piracy attacks had fallen to their lowest levels in seven years. Attacks near Somalia, in particular, declined substantially; the total number of attacks fell by 70 percent in 2012 and an additional 86 percent in the first nine months of 2013. Actual hijackings were down 43 percent compared to 2008/9 levels.47 The US Navy’s figures reveal similar declines in the number and success rate of pirate attacks.48 Security concerns have not dented the opening of the global economy.

  As for the effect of the Great Recession on political conflict, the aggregate effects were surprisingly modest. A key conclusion of the Institute for Economics and Peace in its 2012 report was that “the average level of peacefulness in 2012 is approximately the same as it was in 2007.”49 The institute’s concern in its 2013 report about a decline in peace was grounded primarily in the increase in homicide rates—a source of concern, to be sure, but not exactly the province of global governance. Both interstate violence and global military expenditures have declined since the start of the financial crisis. Other studies confirm that the Great Recession has not triggered any increase in violent conflict. Looking at the post-crisis years, Lotta Themnér and Peter Wallensteen conclude, “The pattern is one of relative stability when we consider the trend for the past five years.”50 The decline in secular violence that started with the end of the Cold War has not been reversed. Rogers Brubaker observes that “the crisis has not to date generated the surge in protectionist nationalism or ethnic exclusion that might have been expected.”51

  None of these data suggest that the global economy has operated swimmingly since the start of the Great Recession. Inequality continued to rise, and unemployment persisted at a high level in many parts of the developed world. Compared to the aftermath of other postwar recessions, growth in output, investment, and employment in the developed world all lagged behind. But the Great Recession was not like other postwar recessions in either scope or kind; expecting a standard V-shaped recovery was unreasonable. Given the severity, reach, and depth of the 2008 crisis, the proper comparison is with the Great Depression. And by that standard, the outcome variables look impressive. As Carmen Reinhart and Kenneth Rogoff conclude, “That its macroeconomic outcome has been only the most severe global recession since World War II—and not even worse—must be regarded as fortunate.”52

  One of the reasons for the relatively unscathed world economy has been the persistence of global economic openness. The salient data on cross-border flows suggests that globalization remains unbowed. Global trade flows bounced back after the dip during the acute phase of the crisis. FDI has returned to pre-crisis levels. The Great Recession failed to dent the growth in cross-border remittances. As a result, transnational capital flows rest on a more resilient foundation. Overall levels of cross-border finance remained lower compared to pre-crisis levels—but that was primarily due to the drying up of procyclical cross-border lending, particularly in Europe. International violence and insecurity also decreased during this period. The worst one can say about economic globalization in the post-2008 period is that it plateaued. Contrary to expectations and perceptions, the open global economy persisted.

  Outputs

  It could be that the global economy experienced a moderate bounce-back in spite of rather than because of the global policy response. At the dawn of the twentieth century, for example, cross-border flows grew dramatically despite efforts by governments to raise barriers to exchange.53 Economists like Paul Krugman and Joseph Stiglitz have been particularly scornful of both policymakers and central bankers.54 In assessing policy outputs, Charles Kindleberger provided the standard definition of what should be done to stabilize the global economy during a severe financial crisis: he recommended “maintaining a relatively open market for distress goods,” and providing liquidity to the global financial system through “countercyclical long-term lending” and “discounting.”55 Serious concerns were voiced in late 2008 and early 2009 about the inability of anyone to provide these kinds of global public goods, threatening a repeat of the beggar-thy-neighbor policies of the 1930s.56 On the surface, the open market for distressed goods did seem under threat. The near-moribund status of the Doha Round, the rise of G20 protectionism after the fall 2008 summit, and the explosion in antidumping cases at the onset of the financial crisis suggested that markets were drifting toward closure. The WTO found that anti-dumping initiations surged by 30 percent in 2008 alone. In its June 2013 assessment, the free-trade group Global Trade Alert warned of a massive spike in protectionist measures leading to “a quiet, wide-ranging assault on the commercial level playing field.”57 The Economist’s Greg Ip lamented the rise of “gated globalization” because of rising trade protectionism.58

  By Kindleberger’s criteria, however, public goods provision has been quite robust since 2008. Warnings about an increase in protectionism have been vastly overstated. Figure 2.5 shows the way three different indices gauge shifts in trade protectionism from 2007. One component of the KOF Index of Globalization measures legal restrictions on cross-border flows of goods, services, and capital: tariffs, nontariff barriers, and capital controls. This component showed a modest decline after its 2007 acme—but the key word is “modest.” Between 2007 and 2010, the drop-off among the G20 economies was 3.6 percent; among all the countries measured, however, the drop-off was only 1.3 percent. Other indices that measure trade restrictions suggest that the KOF index might be overly pessimistic. Simon Fra
ser University’s Economic Freedom of the World report shows that the average freedom to trade internationally increased slightly between 2007 and 2011.59 The Heritage Foundation’s Index of Economic Freedom provides an even more optimistic picture. Its global index of trade freedom increased by 3.5 percent between 2008 and 2013.

  FIGURE 2.5 Indices of Trade Freedom

  Sources: Swiss Economic Institute, Heritage Foundation, Simon Fraser University

  Note: KOF data ends in 2010; Simon Fraser data ends in 2011.

  The nonexplosion in protectionism is mostly attributable to minimal increases in tariffs. The average tariff levels of the G20 economies continued to decline after the 2008 crisis,60 and the surge in WTO-recognized nontariff barriers quickly receded. As figure 2.6 shows, the surge never came close to the peak levels of these cases. By 2011, antidumping initiations had declined to their lowest levels since the WTO’s founding in 1995. Both countervailing duty complaints and safeguard initiations also fell to pre-crisis levels. The combined effect of protectionist actions for the first year after the peak of the crisis affected less than 0.8 percent of global trade.61 Furthermore, the use of these protectionist measures declined further in 2010 to cover only 0.2 percent of global trade. Five years after the start of the Great Recession, the combined effect of these measures remains modest, affecting less than 4 percent of global trade flows.