International Policy Coordination: The Long View
Abstract: This paper places current efforts at international economic policy coordination in historical perspective. It argues that successful cooperation is most likely in four sets of circumstances. First, when it centers on technical issues. Second, when cooperation is institutionalized – when procedures and precedents create presumptions about the appropriate conduct of policy and reduce the transactions costs of reaching an agreement. Third, when it is concerned with preserving an existing set of policies and behaviors (when it is concerned with preserving a policy regime). Fourth, when it occurs in the context of broad comity among nations. These points are elaborated through a review of 150 years of historical experience and then used to assess the scope for cooperative responses to the current economic crisis.
Review by: Manuel Bautista González
“The question is whether those who talk the talk also walk the walk.” (Eichengreen 2011: 1)
Financial turmoil in the European Union has been increasing in the last months. According to The Economist, credit in the eurozone is tighter than it was in the worst months after the Lehman bankruptcy. “Forget about a rescue in the form of the G20, the G8, the G7, a new European Union Treasury, the issue of Eurobonds, a large scale debt mutualization scheme, or any other bedtime story. We are each on our own”, wrote Simon Johnson and Peter Boone earlier this week (Johnson and Boone 2012). Paul Krugman has brought attention to the horrific consequences of the defeat of the European monetary experiment: “Failure of the euro would amount to a huge defeat for the broader European project, the attempt to bring peace, prosperity and democracy to a continent with a terrible history. It would also have much the same effect that the failure of austerity is having in Greece, discrediting the political mainstream and empowering extremists” (Krugman 2012).
It is in this context that this paper written by Barry Eichengreen and distributed by NEP-HIS on 2012-01-03 is an opportune “breathless historical review” (Eichengreen 2011: 29) of past attempts of international policy coordination in monetary, fiscal and financial matters from the last quarter of the nineteenth century to our days. In so doing, Eichengreen provides an interesting narrative centered in politics and institutions that complements optimally a reading of his classical work on the history of the international monetary system and global capital markets (Eichengreen 2008) as well as his most recent account of the US dollar as a dominant international currency (Eichengreen 2011b).
The revision of nearly 150 years of international economic policy coordination allows Eichengreen to establish that the likelihood of international economic policy coordination is directly dependent upon the technical nature of he problems at stake, the degree of institutionalization, the commitment of incumbent authorities to preserve the policy regime, and the harmony of interests between nation-states.
- Technical complexity requires the existence of “epistemic communities”, i. e., groups of individuals that agree on the proper “diagnosis [...] and response” (Eichengreen 2011a: 2) of the problems in the discussion agenda. Cooperation is rapidly implemented if policymakers act drawing lessons from their “scientific and technical” common pool of knowledge (Eichengreen 2011a: 4). This idea sounds very plausible in principle. Questions arise, however, on the representativity and the legitimacy of sustained technocratic rule in matters that demand broader views than those provided by economic theory and methods alone. Who keeps an eye on economists and policymakers as producers and users of technical knowledge and who holds them accountable when the policies they advocate result in tremendous losses of social welfare?
- With regards to the degree of institutionalization, Eichengreen stresses the importance of binding mechanisms and existing norms and procedures for two reasons: to deal with problems in non-casuistic ways and to avoid situations where individual actors can derive gains at the cost of others.
- Eichengreen considers that national authorities are more willing to cooperate when collaboration results in the preservation of existing financial and monetary regimes, rather than to create new rules of the game. In this, the role of “vested interests” (Eichengreen 2011a: 3) is crucial: that the conservative and self-interested actors urge to preserve the existing state of affairs becomes more visible during financial crises.
- Lastly, the author asserts that comity between nations will pave the way for successful coordination efforts. Here, historians would stress the importance of identifying ideological and cultural elements shared by the actors in charge of implementing international economic policies: Eichengreen recognizes the existence of divisions amidst members of the discoursive communities in charge of international policy coordination due to the adherence to different schools of thought in macroeconomics and finance, as well as the identification of interests in the developed core or the emerging periphery.
After developing his theoretical framework for the success of international economic policy coordination, Eichengreen then revises the historical record, beginning with the international monetary conferences of the last quarter of the 19th century, which were mostly concerned with the adoption of an international monetary standard.
Here, Eichengreen’s tale is very illustrative of how domestic vested interests (creditors and debtors, financiers and industrialists, workers and entrepreneurs) intervene in the process of policymaking at the international level. The play between domestic actors and national authorities and its repercussion in the international arena is a political economy aspect that (in my opinion) has to be central in any serious discussion of the distributive consequences of shocks in the international monetary and financial system throughout history.
In this respect, two other aspects are worth considering. The first is that Eichengreen asserts that before World War I, Britain did not behave as “hegemon”, imposing her financial and monetary interests over the rest of the world, rather leading by example due to its economic success (Eichengreen 2011a: 8). The second is that the international gold standard resulted from “self-interested national decisions”, and it was not an international agreement, an aspect that tends to be lost in optimistic and nostalgic accounts of this period in financial history. (Eichengreen 2011a: 8).
Instances of technical cooperation between central banks occurred with the Baring Crisis of 1892, the financial boom and bust of the United States in 1907 and other occasions. This cooperation was ad hoc, “episodic” and self-interested (Eichengreen 2011a: 9), but the important lesson to derive is that agencies in different countries were collaborating to look after the preservation of the existing policy regime.
Paradoxically, the zeal placed by European authorities in the reestablishment of the gold standard in the interwar period might have undermined its strength, by making it “more elastic but also more fragile” (Eichengreen 2011a: 10). Diverging national interests did not help, either. Differences between the French and the rest of the countries on the right way to organize the international financial system showed the existence of an understanding between private and public actors in France to compete against London for the “financial-center status” (Eichengreen 2011a: 11).
The gold standard did not operate with clearly codified rules of the game: it was until the end of World War I that the first agencies dealing with international economic matters were created, namely the Economic and Financial Committee of the League of Nations and the Bank for International Settlements. The one problem, however, was the lack of legitimacy and support resulting from the US refusal to join the League of Nations. The Great Depression of the 1930s and the international contagion of the crisis from Austria and Germany to the rest of the world ended the prevailing policy regime: “by 1933, there remained no international system, in any meaningful sense of the term, to preserve” (Eichengreen 2011a: 12).
The window of opportunity created by the changes in the international balance of power after World War II allowed the creation of the International Monetary Fund and the World Bank, supranational agencies that were to play a substantial role in the Bretton Woods system, which in opposition to the gold standard codified the rules of the game in the international financial and monetary system. The IMF in particular was the organization in charge of dealing with “cooperation on exchange rates” (Eichengreen 2011a: 13). The path to assert the Fund’s authority was not free of obstacles. As a nascent exercise in supranational cooperation, the Fund came up to be an international fair broker, providing liquidity to clients in problems and intermediating between them and other governments and banks to top up their funding demands, provided certain conditions were met (Eichengreen 2011a: 14-15).
By the end of the 1950s, the dollar-gold Bretton Woods system became a policy regime “to operate and defend” (Eichengreen 2011a: 15): thus, a new international financial order came into being, at times where Socialism was an ideological foe that united the interests of the “free” world. Nevertheless, the Bretton Woods system reliance on a worsening American financial position vis-à-vis the rest of the world brought tensions and pressures to reform the policy regime. The European countries found themselves divided in terms of what to do with the situation: the British pushed for the adoption of a new reserve asset, the French favored the return to the gold standard system, West Germany did not differ with the official US position, which was not so assertive until mid-1965 (Eichengreen 2011a: 16). The system would definitely collapse in August 1971: according to Eichengreen, the great policy lesson to derive from Nixon’s aggresive stance is that “short-run concessions [usually come] at the cost of ability to cooperate in the longer term” (Eichengreen 2011a: 17).
The postwar era and the reconstruction eased the adoption of regional cooperation mechanisms in Europe, where a diversity of organisms (such as the Organization for European Economic Cooperation and the European Economic Community) and arrangements (as the European Payments Union) emerged. The end of the Bretton Woods era propelled the efforts to augment monetary cooperation in the region. In what might be surprising to contemporary observers, the capital sin of monetary unification without fiscal coordination was discussed in Europe… since the 1970s. Here the discussion was led by the Bundesbank officers, who sought to construct a mechanism aligned with the interests of Germany in the form of the European Monetary System (Eichengreen 2011a: 18).
The demise of Bretton Woods coincided with the rise of capital flows across the globe. The “recycling of petrodollars into syndicated bank loans to Latin American sovereigns” fueled economic boom in the region that would end in 1982, with the beginning of the debt crisis (Eichengreen 2011a: 19). The IMF became the ideal agency to represent the interests of creditors, who insisted on the importance of debtors repaying. The conditional lending programs of the IMF induced economic stagnation and accelerated the pace of structural change throughout the region. Historical questions arise on the desirability of austerity measures as opposed to debt restructuring, for if anything, the Latin American lost decade does not presage optimist times for the European peripheral countries in the years to come. After reading Eichengreen, one cannot help but infer a question: why do the vested interests insist in making debtor countries pay while reducing their chances to grow and produce a sustained flow of resources with which to service their debt? In other words, is austerity the only way out of a crisis?
The Latin American debt crisis of the 1980s was the picture behind acerbic negotiations between the United States, Germany, Japan and other developed countries on the ideal exchange rates of their currencies, i. e., the prices reflecting real imbalances in their current accounts. This is one of the sections where Eichengreen best describes the international dimensions of diverging views of economic actors in the domestic arenas. Take the example of devaluing your currency against the dollar: what exporters might experience as a blessing, agents with debts denominated in dollars might perceive the rise in the exchange rate as a threatening menace.
Eichengreen then reviews three of the most important financial crises in the 1990s, those that happened in Europe (1992-1993), North America (1994-1995) and East Asia (1997-1998).
- The opportunistic, self-interested actions of the Bundesbank after the German reunification to prevent inflation by raising interest rates undermined the stability of the European Exchange Rate Mechanism in the early 1990s. This was a case of domestic priorities that created negative externalities in the international dimension by creating opportunities for speculation, such as George Soros’s bet against the pound sterling in August 1992 (Eichengreen 2011a: 22). Lacking the intellectual consensus necessary to effectively oppose national political concerns, “efforts to cooperate were politicized” (Eichengreen 2011a: 23): as a result, Great Britain and Italy were ejected from the Exchange Rate Mechanism and the European peripheral countries (Spain, Portugal, Ireland) had to readjust their exchange rates. The instability of these years created the intellectual basis to push for the monetary unification of Europe, without a corresponding commitment to coordinate fiscal policy.
- The Mexican crisis of 1994-1995, aptly named by the IMF managing director Michel Camdessus as the “first financial crisis of the 21st century” (Eichengreen 2011a: 23), derived mainly from a bank-credit boom led by private consumption. After capital flight and a harsh devaluation, the balance sheets of firms and families worsened: banks faced a deteriorating portfolio and were on the verge of bankruptcy. Loans from the IMF and the United States government allowed to stabilize the exchange rate, but inflation and unemployment increased and the economy contracted swiftly. However “painful”, the Tequila crisis offered “a template” for international cooperation in following financial crises (Eichengreen 2011a: 24).
- The Asian crises of 1997-1998 that affected Thailand, Indonesia and South Korea were mostly due from an investment boom that manifested itself in the accumulation of commercial real estate (Thailand) or excess industrial capacity (South Korea). A sudden and “violent revision of expectations” (Eichengreen 2011a: 25) in Thailand was quickly spread to the other countries: contagion demanded international intervention. The IMF lent some funds and the rest were topped up by the World Bank and the Asian Development Bank, as well as with resources from the US government and other nations. The main consequences of the Asian crisis were two:
- In 1998, the Group of Twenty Two (G22) countries created study groups to prepare reports on the need of transparency and accountability in international financial markets, on the stability of financial systems and the due management of financial crises, and
- Regional mechanisms of economic cooperation in Asia increased their importance, as policymakers in the region (including those from China) realized how interdependent their economies had become in the last half of the 20th century.
Eichengreen then revises the conventional explanation for the crisis that never came, that is, the crisis that doomsayers predicted would happen due to global imbalances in the late 2000s. The crisis would have operated through a sudden revision of expectations and the liquidation of U. S. treasury bonds, which would have decreased the value of the dollar vis-à-vis other currencies in the world and rised interest rates. The IMF and other international forums (the G20 summits) were deeply concerned about this possibility, but in so doing they tested effectively their own limits, for “the Fund remains reluctant to bite the hand that feeds it; we have yet to see it launch withering critiques of Chinese currency manipulation and U.S. fiscal profligacy” (Eichengreen 2011a: 28).
The global crisis of 2007-2009 saw the adoption of swap agreements between central banks of the world, a commitment not to repeat the disastrous experience of Lehman Brothers’s disorderly bankruptcy, willingness to coordinate fiscal stimulus and to avoid protectionist responses. However, the crisis that began the Great Recession also exposed the problems of international policy coordination: lack of communication and close collective efforts between national authorities, as well as the repercussions of domestic policies that might in fact be begging-thy-neighbor show that there is still large room to improve concerted actions on this matter.
The European episode of this prolonged tragedy has seen the adoption of the Mexican and Asian mold to crisis treatment: “emergency funding [... and] fiscal austerity [... without consideration of] debt restructuring”, since the last step, necessary as it would be for indebted economies in stagnation “would have undermined the position of financial institutions in the creditor countries” (Eichengreen 2011a: 29). Eichengreen superbly demonstrates the power of financial lobbies to advocate for their interests, at the cost of the well being of many social strata in affected countries; at the same time, efforts to reform and regulate the financial sector are co-opted by these powerful vested, “concentrated interests” which are the most effective to mobilize in the defense of their own interests (Eichengreen 2011a: 30).
Eichengreen’s article is destined to become a classic on the topic. It is an extraordinary intellectual exercise in economic policy, international relations and economic history. Eichengreen raises questions about the governance and the power relations in the international financial system, the desired level of accountability for actors moving in the national, the international and the supranational level, and the legitimacy of international cooperation initiatives with regards to constituencies that prove (at least in the European case) less willing to asume the costs of financial failure. The intellectual and policymaking consensus on the need of austerity seems to be broken (Huffington 2012): social cohesion is deteriorating from Greece to Spain, and the top-down adoption of economic reforms à la Latin America in the 1980s seems to be at odds everywhere.
The international contagion of financial crises is one of many problems that are effectively challenging the capacity of the nation-state as an adequately-scaled agency with the necessary tools to fix the negative externalities of a much more interdependent and globalized world.
- Eichengreen, Barry (2011a) “International Policy Coordination: The Long View”. NBER Working Paper 17665 (December).
- Eichengreen, Barry (2011b) Exorbitant Privilege. The Rise and Fall of the Dollar and the Future of the International Monetary System. Oxford: Oxford University Press.
- Eichengreen, Barry (2008). Globalizing Capital. A History of the International Monetary System. Princeton, NJ: Princeton University Press.
- Huffington, Ariana (2012). “Austerity: 2011’s Darling Becomes 2012’s Pariah.” Huffington Post, posted May 29, 2012, 4:58 pm (accessed May 30, 2012 8:14 pm), available at http://www.huffingtonpost.com/arianna-huffington/austerity-europe-us_b_1552657.html.
- Johnson, Simon and Peter Boone (2012). “The End of the Euro. A Survivor’s Guide.” Huffington Post, posted May 27, 2012, 5:56 pm (accessed May 30, 2012 6:47 pm), available at http://www.huffingtonpost.com/simon-johnson/euro-collapse_b_1549444.html.
- Krugman, Paul (2012) “Apocalypse Fairly Soon.” International Herald Tribune, May 17, 2012 (accessed May 30, 2012, 6:47 pm), available at http://www.nytimes.com/2012/05/18/opinion/krugman-apocalypse-fairly-soon.html?_r=1&smid=tw-NytimesKrugman&seid=auto.