The System Worked_How the World Stopped Another Great Depression

by Daniel W. Drezner

  Claiming that the United States was the global economic leader during the Great Recession might sound odd. After all, US influence over global governance structures certainly declined. As is discussed further in chapter 6, the G20 governments rejected the Obama administration’s push for continued fiscal stimulus at the June 2010 G20 leaders’ summit in Toronto. Later in 2010, G20 leaders categorically rejected Secretary Geithner’s suggestion to apply quantitative limits on macroeconomic imbalances. Looking at governance structures, the expansion of the Basel Committee on Banking Supervision and the Financial Stability Forum to encompass all G20 countries showed the apparent dilution of US hegemonic power.106 At the same time, countries as variegated as Cyprus, Thailand, and Colombia made contributions to double the IMF’s lending capacity in 2012, while the United States was domestically constrained from proffering a dime.107 As of the end of 2013, the United States had not passed the necessary legislation to allow IMF quota and governance to proceed. The limited ability of the United States to manage the Doha Round was likely due to its declining share of global imports and Congress’s failure to give the president trade promotion authority.

  American leadership during the recent crisis nevertheless turned out to be more robust than many experts perceived.108 In some areas, such as combating antipiracy, the leadership of the United States was not surprising given its capabilities. The United States organized the Contact Group on Piracy off the Coast of Somalia in early 2009, which coordinates antipiracy activities in the region. Indeed, the creation of Combined Task Force 151 was announced at the headquarters of the US Navy’s Fifth Fleet in January 2009, and a US Navy admiral was named its first commander. While numerous other countries have cooperated, the United States took the lead in coordinating antipiracy operations.109 The Brookings Institution’s Bruce Jones concluded, “That force was a visible manifestation of America’s alliance reach.”110

  Though perhaps hidden from public view, US leadership also mattered in other areas. This was particularly true in the financial realm. As early as 2007, the Federal Reserve’s decision to announce currency swaps provided a way for European financial institutions to improve their positions. Indeed, in 2008, foreign banks made up a majority of the top twenty borrowers from the Fed’s emergency lending programs.111 In agreeing to currency swaps in fall 2008, the Fed prevented a global liquidity crisis. As one European central banker put it, “In a way, we became the thirteenth Federal Reserve district.”112 The 2008 TARP, the AIG bailout, and the Federal Reserve’s myriad emergency credit facilities did not just stabilize the US financial sector—these funds also found their way onto the balance sheets of European financial institutions, helping to prevent a meltdown on that continent as well. In opening up those swaps again to the European Central Bank in May 2010, the Fed helped avert a crisis in the European financial markets.113 After the crisis abated, and US capital rushed out to the rest of the world, the United States functioned “as a global insurer,” in the words of one economist.114 Other great powers rapidly discovered that US dollar hegemony anchored their economies to the United States on financial issues. It is therefore unsurprising that United States–led and European Union–supported financial sanctions exacted a significant toll on the Iranian economy.

  Domestic politics may have prevented a more robust US policy response. Partisan gridlock, however, did not prevent the United States from pursuing a plethora of emergency rescue packages (via TARP), expansionary fiscal policy (via the 2009 American Recovery and Reinvestment Act), stress tests of large financial institutions, expansionary monetary policy (via interest rate cuts, three rounds of quantitative easing, and Operation Twist), and financial regulatory reform (via Dodd-Frank). These actions helped to secure multilateral cooperation on macroeconomic policy coordination for two years, as well as Basel III. Moreover, even though the United States has been slow to pass quota reform legislation through Congress, by most accounts America played a leadership role in negotiating the IMF reform.115 On financial regulation, the United States exercised leadership using myriad dimensions of its power.

  The United States also demonstrated leadership in other issue areas in which China was initially reluctant to cooperate. On the question of macroeconomic imbalances, the United States took the lead in pressuring Beijing to allow the renminbi to appreciate and to allow G20 monitoring. China initially stonewalled the G20 information-sharing process because of a reluctance to discuss its exchange-rate policies and a desire to avoid external pressure to revalue. Beijing missed a November 2009 deadline to provide information about China’s economic plans going forward. When Chinese officials did submit information, it was historical and vaguely worded rather than forward looking.116 In response, the United States coordinated a March 2010 letter from the leaders of five countries—the United States, Canada, Great Britain, France, and South Korea—to the other G20 members. The letter raised the issue of exchange rates in relation to reducing trade imbalances, and urged all members to accelerate their compliance with G20 processes.117 In June 2010, President Obama sent another letter to his G20 colleagues stressing the importance of “market-determined exchange rates.” Three days later, the People’s Bank of China announced that it would “enhance the RMB exchange rate flexibility.”118 The slow appreciation of the renminbi, then, began after US-coordinated application of pressure. Even after the announcement, the United States continued to coordinate action within the G20 to maintain pressure on China.119

  Another example of US leadership was the creation of a transparency regime for sovereign wealth funds. The United States led the way in calling for action in this area. In spring 2007, the Treasury Department stated publicly that the funds raised “broad, strategic issues for the international financial system” and called for the IMF to draft best practices to address these issues.120 The United States then used the size of its capital markets to secure cooperation from capital exporters. For example, a key step in securing the 2008 Santiago Principles came when the United States persuaded two of the largest sovereign wealth funds—the United Arab Emirates’ Abu Dhabi Investment Authority (ADIA) and the Government of Singapore Investment Corporation (GIC)—to jointly issue a set of policy principles regarding the funds and recipient countries. They included commitments to governance and to transparency standards, as well as a pledge to use commercial, not political, criteria to evaluate investments.121 Because ADIA’s and GIC’s transparency scores ranked among the lowest of all sovereign wealth funds, their commitment to these US-articulated principles signaled a clear policy reversal.122 Both funds subsequently agreed to accept the voluntary Santiago Principles as a way of securing access to the US market. GIC’s deputy chairman explained, “The greatest danger is if this is not addressed directly, then some form of financial protectionism will arise and barriers will be raised to hinder the flow of funds.”123 A few days before the policy principles were articulated, Abu Dhabi’s director of international affairs wrote an open letter to the Wall Street Journal stressing the importance of maintaining an open investment climate.124 An Arab League report urged acceptance of a code of conduct, arguing that it would alleviate Western pressure to restrict sovereign wealth funds’ access to their capital markets.125 Survey evidence also indicates that fund managers believed there was a linkage between agreeing to a code of conduct and warding off investment protectionism.126

  China initially resisted these pressures to form a new regime. At one point during the negotiations of the Santiago Principles, Gao Xiqing, the president of the Chinese Investment Corporation, told 60 Minutes that an IMF code would “only hurt feelings” and characterized the idea as “politically stupid.” Later, he was more blunt, characterizing the process as “political bullshit.”127 In the end, however, US power and European Union support mattered. At the key meeting in Santiago in 2008, the more-established sovereign wealth funds, together with the recipient countries, were able to apply sufficient pressure on new capital exporters to ensure agreement.128

 
The eventual Chinese accommodations on these issues highlight the second major contributor to functional global governance—China’s surprising role as a key supporter of the status quo. This assertion is counterintuitive, given the raft of arguments that Beijing has acted as a revisionist actor in the global political economy.129 It is true that in some arenas—such as export subsidies, cyberattacks, and territorial disputes—China has been reluctant to engage constructively with other actors. Nevertheless, on a number of key policy dimensions, China bolstered the power of existing policy coordination rather than undermine it. Furthermore, the arenas in which China dissented from the global consensus were those in which its voice mattered the least.

  China acted like a supporter rather than a spoiler in multiple issue areas. On antipiracy, China dispatched a naval task force to the Horn of Africa soon after the salient UN Security Council resolutions were passed in December 2008. This represented the first sustained Chinese naval presence in the region in 500 years. Although Beijing has its own commercial incentives to protect shipping, the Chinese government stressed that it was honoring its obligations as a responsible global actor.130 US officials repeatedly praised China’s ongoing participation in the task force, and the two countries began conducting joint military exercises on antipiracy techniques in 2012.131

  Evidence of Chinese supportership can also be seen in macroeconomic policy coordination. In 2008 China enacted one of the largest packages of fiscal spending as a percentage of GDP among the G20 economies. China acted out of self-interest in doing this, but the salutary effect on the global economy was still significant.132 Beijing also extended swap lines and dollars to distressed trading partners during the depths of the 2008 financial crisis.133 Beginning in 2010, China also took steps to reduce its role in rising macroeconomic imbalances. It allowed the yuan to appreciate slowly over the next few years. Combined with higher domestic inflation, China’s real exchange rate showed significant appreciation, with a concomitant effect on macroeconomic imbalances. According to a Peterson Institute for International Economics study, by fall 2012, the renminbi was only “modestly” undervalued. The McKinsey Global Institute estimated that, due in no small part to the appreciation of the renminbi, the overall size of macroeconomic imbalances shrank by 30 percent in the first four years after the 2008 financial crisis.134

  On trade matters, China’s role as a supporting state becomes manifestly clear. On the one hand, China exploited loopholes in global economic governance to keep its currency undervalued. In doing so, China violated the spirit of the rules of the game.135 At the same time, China also adhered to the letter of the law in implementing its trade policy—and for China, the letter of the law imposes significant constraints.136 When China entered the WTO in 2001, the accession negotiations imposed significant strictures limiting Beijing ability to raise China’s protectionist barriers. In contrast to other developing economies, for example, China’s “bound” tariffs—the highest rate at which tariffs can be set—were at a comparatively low level when they joined the WTO. Similarly, stricter limits were placed on its ability to use nontariff barriers as well.

  Despite China’s rising power, the hard law of the WTO, along with its myriad bilateral and regional free-trade agreements, functioned as a binding constraint on China’s trade measures. A World Bank research paper on movement in Chinese tariff rates since 2008 concluded that China’s commitments to the WTO and other preferential trade agreements explained more than 95 percent of the variation.137An analysis of China’s use of temporary trade barriers reveals a similar finding. Compared to the other developing country members of the G20, China’s use of those measures covers the smallest trade-weighted share of imports—smaller, in fact, than the share covered by US temporary trade barriers.138 China’s compliance with adverse WTO rulings has been better than that of either the United States or the European Union.139 Christopher McNally concludes, “China has adopted largely non-disruptive policies supportive of the rules-based multilateral order. China’s economy has been integrated globally by relying on multilateral institutional frameworks, especially the WTO. And so far China has mostly complied with its WTO commitments and avoided any aggressive role in trying to change the nature or rules of the organization.”140

  Stepping back to view the bigger picture, we see that China largely refrained from challenging the status quo in global economic governance.141 It requested and received larger quotas in the IMF and the World Bank, as well as a larger voice in other global governance clubs. Still, none of these moves involved a shift in the underlying rules of the game. Most of China’s demands were designed to give Beijing a greater voice in existing global governance structures—not to revise the purpose of their missions. When opportunities arose for China to subvert these regimes—such as when Pakistan sought Chinese aid as a substitute for IMF loans in fall 2008—Beijing did not take action.142 The biggest exception to Chinese quiescence proved the rule.

  In 2009, the head of the People’s Bank of China suggested ending the dollar’s status as the world’s reserve currency. This was clearly a revisionist aim, but China’s government had neither the resources nor the inclination to do so. Other central bankers were aware of the People’s Bank’s constrained influence within the Chinese state.143 Even China’s fellow BRIC partners resisted the proposal.144 In the end, the suggestion was mostly symbolic. For the issue areas where China did have the power to alter global governance rules—as in trade—Beijing adhered to the status quo.

  China was the only actor powerful enough and distinct enough from the established great powers to act as a truly revisionist actor in the world of global economic governance. However, China did not act in this manner at all (see chapter 6). On the contrary, in the first five years following the 2008 crisis, China acted primarily as a responsible stake-holder. It did not advocate abandoning either the open trading system or the open investment regime. This behavior is consistent with the assessment by China scholars that the country will continue to demonstrate willingness to comply with other global governance mechanisms over time, and remain reluctant to articulate a truly revisionist set of policy demands.145 Iain Johnston provides a concise snapshot of China’s post-crisis behavior.146

  The pundit and media world thus tended to miss a great deal of ongoing cooperative interaction between the United States and China throughout 2010. Examples include the continued growth of US exports to China during the year … [and] a Chinese decision to continue the appreciation of the renminbi prior to the Group of Twenty meeting in Toronto in June 2010. …

  In addition to these U.S.-specific cooperative actions, throughout 2010 China continued to participate in all of the major multilateral global and regional institutions in which it had been involved for the past couple of decades, including the World Trade Organization, the International Monetary Fund, the United Nations Security Council, the Association of Southeast Asian Nations (ASEAN) Plus 3, the China-ASEAN Free Trade Agreement, UN peacekeeping operations, and antipiracy activities in the Gulf of Aden. There is no evidence that … it began to withdraw from global institutional life or to dramatically challenge the purposes, ideology, or main organizational features of these institutions to a degree that it had not in the past.

  Since the start of the Great Recession, China’s behavior has reinforced rather than subverted the existing set of global governance rules. China was a supporter and not a spoiler.

  There is one final aspect of the post-2008 distribution of power that aided in the functioning of global economic governance. It is certainly true that the post-2008 hegemonic coalition was larger and more heterogeneous than the pre-2008 coalition. The cumulative effect of such a power shift, however, is to reinforce preexisting policies in the absence of any overwhelming consensus for change. Because changing the status quo becomes hard for all actors, such change is more likely to persist. In the case of global economic governance, this path-dependent effect was fortuitous. Pre-crisis global economic governance was already locked i
n with a bias toward greater openness. The response to the crisis was crafted with the assumption that this openness was locked in. The erosion of coercive power made it difficult for any actors eager to dislodge Washington Consensus norms to actually do so.

  Conclusion

  This chapter has examined the distribution of power in the wake of the 2008 global financial crisis to understand why the system worked reasonably well. Despite some decline, the United States possessed sufficient reservoirs of power to take an active leadership role. Even though America’s traditional supporters had also declined in influence, the European Union was still powerful enough to matter as a key supporter of US leadership. Equally important, China acted like a responsible stakeholder after the 2008 financial crisis. In the arenas in which China could have blocked neoliberal norms, it refrained from doing so. On key aspects of global governance, the troika of the United States, the European Union, and China formed a sufficiently large hegemonic coalition to maintain the relevance of the principal rules of the global economic game. Although the distribution of power diffused somewhat, there remained a sufficient concentration for a great-power concert to preserve the system.

  Comparing the current situation with the analogous moment during the Great Depression, we can discern why events unfolded differently this time around. Looking at the distribution of power, for example, the interwar period was truly a moment of great-power transition. At the start of the Great Depression, the United Kingdom’s lack of financial muscle badly hampered its leadership efforts. Even as it was trying to maintain the gold standard, Great Britain held only 4 percent of the world’s gold reserves.147 The United States had amassed much of the world’s gold reserves, but the US government was unwilling to aid the beleaguered European economies. The situation was very different in fall 2008. The United States still possessed significant material capabilities, as did the European Union. China, the most likely challenger to the liberal international order, acted to support rather than spoil the system. Combined, the great powers were able to avert the worst-case scenarios.