‘A New Era of Geo-economics: Assessing the Interplay of

Economic and Political Risk ’ IISS Seminar

23-25 March, 2012

SECOND SESSION: Defining Economic and Financial Power

The Future of Globalisation in the Light of the Economic Collapse of 2008

Robert Skidelsky Emeritus Professor of Political Economy, University of Warwick

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The Future of Globalisation in the Light of the Economic Collapse of 2008

Introduction

Since its collapse in the autumn of 2008, the world economy has gone through three phases:

a year or more of rapid decline; a bounce back in 2009-2010, which nevertheless did not

amount to a full recovery; and a second, though so far much shallower, downturn in the

developed world over the last year.

The resulting damage over the past four years has been huge. The world economy

contracted by 6% between 2007 and 2009, and recovered by 4%. It is 10% poorer than it

would have been, had growth continued at the rate of 2007, and the pain is not yet over.

Today, we are in the first stages of a second banking crisis.

Economics is in a mess. With the shattering of the dominant Chicago School paradigm,

whose rational expectations hypothesis ruled out, by assumption, the kind of collapse we

have just experienced, two old masters, Friedrich von Hayek and John Maynard Keynes,

have risen from the dead to renew the battles of the 1930s, equipped this time with

explanations for what has gone wrong.

The Hayekian argument is that lax monetary policy made it possible for the commercial

banks to lend more money to businesses than the public wanted to save out of its current

income. Hence, a whole tranche of investments – ‚malinvestments‛, Hayek called them –

was being financed by credit creation, not genuine saving. This led to a bubble in the real

estate and financial sectors which powered a consumption boom. When (belatedly) the

money tap was turned off, the bubble burst and the American economy slumped. The slump

is simply the liquidation of the unsound investments.

By contrast, the problem for Keynesians was not insufficient saving, but insufficient

investment. Investment is governed by uncertainty, while saving is a stable fraction of

income. Keynes’s economy tips over into recession when, for some reason, profit

expectations decline relative to the volume of saving being done. Businesses start to prefer

liquidity to investment. This pushes up the rate of interest, or cost of borrowing, just when

you want it to come down. Saving and investment are then brought back into balance, not by

a fall in interest rates, but by a fall in incomes. The recession of 2008-2009 was caused by a

collapse in investment, not by over-indebtedness; over-indebtedness was a consequence, not

a cause.

Both explanations have an international dimension. The Hayekian story starts with the over-

issue of dollars by the U.S. Federal Reserve, made possible by the dollar’s role as the world’s

leading reserve currency. This enabled Americans to live beyond their means and to spend

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more than they produced. Cheap money created a consumption boom in the United States,

and a manufacturing boom in China.

The Keynesian story starts with Chinese over-saving. The Chinese save a much higher

proportion of their incomes than their economy, as organised, can absorb. It was the

voluntary recycling of excess Chinese savings into the United States’ economy by means of

the Chinese central bank’s purchase of U.S. Treasury bills which allowed the United States to

become the world’s ‚consumer of last resort‛. The ‚money glut‛ in the United States was a

consequence, not a cause, of the more fundamental ‚saving glut‛ in China.

The two stories are derived from contrasting theories about how a market economy works.

The first sees it as a self-regulating mechanism, in which the ‚invisible hand‛ smoothly

channels the self-interested actions of individuals towards a social optimum in the absence

of monetary disturbances. The Keynesians accept the social value of the market system, but

deny that, in the presence of irreducible uncertainty, it is optimally self-regulating. The

‘invisible’ hand guides economies not to a social optimum but to ‘underemployment’

equilibrium. As such, government intervention is needed to ensure full use of potential

resources.

After the brief excitement of Keynesian ‘stimulus’ in 2008-09, recovery policies have settled

into a broadly Hayekian mould. The prevailing emphasis is on the need for banks and

‘sovereigns’ to repair their balance sheets, on the need for governments to restore fiscal

discipline, and on financial regulation (or re-regulation) to prevent banks from financing

‘malinvestments’. Meanwhile we (or those of us in the developed world) must accept the

‘new normal’ of zero or low growth, or even contraction, till these repair jobs are completed.

Then we can then all roar ahead again, hopefully more modestly than before. Except for

proposals, still largely to be implemented, for ‘macro-prudential’ banking regulation, the

previous paradigm of the self-correcting, optimizing market system is unshaken.

I start from a different position, partly influenced by Keynes, but also by political and

international relations theory, that the achievement of peace and prosperity requires more

government, not less.

The present combination of economic fragility and weak international institutions suggests

either that the global economy will contract to the ambit of existing government authority,

or government authority will have to expand to meet its needs; in brief we are faced with

the choice between world government (in a sense to be developed below) and

distintegration.

This essay will be divided into five sections. The first addresses the question of why we need

governments. The second and third examine two theories of ‘spontaneous’ order, centred on

the notion of a ‘natural’ equilibrium. The fourth discusses the theory of ‘surrogates’ for the

absent world government. The fifth applies these ideas to the post-recession situation.

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i. The Problem of Order

Order is always a problem: that is why we have governments. Order is a particular problem

in international relations because there is no world government.

The problem of order received its classic exposition in Hobbes. In Hobbes’ view men are

naturally warlike, but the ‘war of all against all’ is too costly so they voluntarily sign a ‘social

contract’ to set up a sovereign vested with monopoly power over the means of violence.

Economists say much the same thing in a different language. Order is a public good which

will not be supplied, or will be seriously undersupplied, by voluntary agreement. The

solution to the problem of order is compulsion. The state is called into being to solve the

public goods problem.

In Hobbes’s view, the sovereign is legitimate by virtue of his ability to keep order: there is no

inherent right of rebellion. With Locke, there is another requirement for legitimacy – that of

justice. Consent can be rightly withdrawn if rule is unjust. In the liberal tradition justice is an

integral part of any lawful order of rule.

There is no ‘social contract’ between states. There is no global sovereign, but 194 states each

claiming sovereignty over their own actions. Public goods theory predicts that both

prosperity and peace will be undersupplied in the ‘international anarchy’. This thought led

many, especially in the period spanned by the two world wars, to advocate a world

federation. The economist Lionel Robbins pointed to the failure of classical economic theory

‘to appreciate the chronic insufficieny of the political structure to safeguard peace and

prosperity in general....Resting, so far as policy within states was concerned, upon the

assumption of a firm foundation of law and order backed by an apparatus of coercion, it

blandly assumed that between states harmony would be secured by the mere perception of

self-interest’. 1

At the same time, the world is not violently unstable, in either its economic or political

relations. For most of the last two hundred years the political pattern has been one of

prolonged periods of peace, interrupted by short wars. The economic pattern has been

similar: long periods of growth, interrupted by short periods of depression.

How has relative order in international life been achieved in defiance of Hobbes? The

answer must be that in economic life and in international relations are to be found principles

of order which depend only minimally on the coercive power of the state.

The most powerful metaphor of spontaneous order is the concept of equilibrium. Derived

from eighteenth century physics, it portrays the social world as tending towards a state of

1 Lionel Robbins, Money, Trade and International Relations, 1971, p. 218

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balance, constantly re-adjusted as change in one of its elements upsets it. The equilibrium of

prices and costs in market economics has its counterpart in the ‘balance of power’ in

international politics. A world in equilibrium is both stable and preserves the elements in its

system. However, equilibrium is a long-run condition, a point of attraction like gravity, not a

continuous condition. The pendulum constantly swings between excess and insufficiency of

order. Keynes said the last word about the concept of economic equilibrium: ‚But this long

run is a misleading guide to current affairs. In the long run we are all dead‛. 2

Order may be thought of as having both spontaneous and designed elements. States learn to

live with each other and evolve rules of behaviour which make for reasonably orderly

relations; they also fight wars to ‘restore the balance’. Similarly, the market system is part

of both the spontaneous and designed order. For Adam Smith and his followers markets

are the result of spontaneous sociability: the propensity to ‘truck, barter, and exchange’

arises from the geographical mismatch between wants and the means to supply them.

However, Smith recognised that a state was needed to restrain the predatory power of

business and maintain the rules of competition. For those in the darker tradition of Karl

Marx and Karl Polanyi, the ‘market system’ springs from relations of power and is a

mechanism for maintaining it. It is therefore always a contested order, and has to be

enforced by government. As Thomas Friedman well put it, ‚The hidden hand of the market

will never work without the hidden fist‛.3

The question of how much ‘governing’ the world needs can no more be answered a priori

than can the question of how much governing countries need. Philosophers have argued

that perfectly just societies would require little or no government, because there would be

no discontent. Exactly the same arguments can be heard in the international sphere. The

more unjust or unequal the international order is, so the argument runs, the more it will

need to be maintained by power. It follows that a state of global justice, should that be

attainable, would remove the need for global government.

There is a more fundamental reason for supposing that government (or power) is necessary

to avert periodic breakdowns. This lies in the existence of inescapable uncertainty

concerning the effects of our actions. Government is needed to make up for imperfect

knowledge of consequences by preventing gambles which threaten systemic catastrophe.

This argument applies a fortiori to gambles which might involve the whole world in disaster.

ii. Spontaneous Orders: Free Trade

From the point of view of order today, the basic issue is whether we view the market system

as conducive to harmony or conflict, and in what proportions. Those who view its

2 J.M.Keynes, A Tract on Monetary Reform, Collected Writings, vol.iv, p.65 3 Thomas Friedman, "What the World Needs Now", New York Times, 28th March, 1999

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operations as fundamentally harmonious require correspondingly little in the way of

management and regulation. Those who believe it is potentially unstable, disruptive, or

exploitative will argue for a much thicker layer of governmental managment of the market

economy.

In the heady days following the fall of communism, the optimistic view prevailed.

Globalisation was seen by its more enthusiastic adherents as a complete answer to the

problem of international order. It was an expression of the belief, which gained increasing

academic currency from the 1980s onwards, that markets were, or could be made, perfectly

efficient, if governments stopped interfering with them. With the coming to power of

Margaret Thatcher and Ronald Reagan in 1979 and 1980 respectively, financial and other

markets were de-regulated, taxes were cut, trade unions were bashed and the international

institutions were emasculated. However, it was not all a retreat of government. A key

institutional innovation of these years was the establishment of the World Trade

Organization in 1995, which aimed to set and impose rules of trade and punish offenders.

This, in essence, was the system which collapsed in 2008.

Globalisation seemed to offer a complete answer to the main problems of international

society – the problems of poverty, political repression, and war – through a set of linkages

assumed to be self-evident. Trade was the principal engine of economic growth, and

economic growth was the chief means of reducing poverty. Political freedom grew naturally

with economic prosperity. Prosperous states were unlikely to go to war with each other

because the causes of war would no longer exist; economic interdependence also raised the

costs of going to war. International relations of the classic kind, conceived as a zero-sum

game, would disappear.

The globalists paid little attention to the role of public power in maintaining order, partly

because the private power of multinational banks and corporations was airbrushed out of

the simplified economics which dominated the Reagan-Thatcher epochs. US power was seen

purely as a facilitator in setting up the system of free exchange. The globalists’ idea of global

government was building up a set of institutions and rules (‘regimes’) suitable for a world

‘becoming’ global; on the analogy with law and order in a domestic jurisdiction, a matter of

legal codes, judges, and policing.

The debates that took place within this globalist framework were essentially about how

much ‘governance’ the new order of free markets required. On the one side, the market

fundamentalists projected their ideal of laissez-faire onto the world stage. They favoured a

global market minimally regulated, which would create the conditions for its own

flourishing. On the other side, social democrats argued the need for global institutions to

manage global markets in the interests of social justice, poverty reduction and

environmental protection. But the specifics of these positions were rarely spelt out.

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Globalisation has given rise to two problems, which should never have been swept under

the carpet. The first was that the ‘gains from trade’ are unevenly divided, thus violating the

condition of justice in exchange. The second is macroeconomic volatility, which violates the

requirement of reasonable stability. Let us consider these in turn.

One of the chief arguments for economic integration is that free trade promotes peace by

creating a ‘harmony of interests’. In the pure theory of free trade, everyone is better off,

though to an unequal extent. However, free traders acknowedge that, because of market

‘imperfections’, there will be winners and losers in the short-run, and there no reason a

priori to say that the gains will outweigh the losses. Free trade on its own cannot therefore

eliminate conflicts of interest between classes and states. However, aggregate welfare will

still be increased if the winners can compensate the losers and still be better off. For this a

state is needed. This is the main argument of contemporary free traders like Jagdish

Bhagwati, who urge free trade abroad and compensatory programmes (re-training,

subsidies, redistribution of wealth) at home. However, this argument is unlikely to persuade

the losers, because the losses are actual, while the compensation is hypothetical. Moreover,

no such compensatory mechanism exists in the international economy.

Since the 1990s, the chief gainers from globalisation have been the developing world

(especially East and South East Asia) and the wealthy elites of developed countries. The

main losers have been the rural poor in developing countries, unskilled and poorly skilled

workers of developed countries, and most of sub-Saharan Africa. Let us focus for a moment

on the developed world.

The specific fear in rich countries is job displacement and wage erosion. The argument is

that the new trading powers have become super-competitive by harnessing Western

technology but at much lower wages, thereby impoverishing workers in the West. The chief

gains from productivity growth (which include gains from globalisation) have been seized

by financial and business oligarchies, while systems of ‘compensation’ have been pared

down. Globalisation may be pulling up unskilled wages in China, but it is depressing them

in the United States and the depressing effect is faster than the pulling up effect. Retraining

programmes, even if implemented, are an inadequate answer. Practically all kinds of

employment that do not require physical presence can now be offshored. According to Alan

Blinder, this amounts to about a quarter of all U.S. jobs.4

The current Western effort to strengthen intellectual property rights is clearly a defensive

reaction to this perceived threat. The same can be said of the Western desire to link trade to

higher environmental and labour standards. These tensions explain the failure of the Doha

round of trade talks.

4Alan S. Blinder, ‘How many US jobs might be offshorable?’ Working Paper No.142 (March 2007), Center for

Economic Policy Studies, Princeton University.

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The problem of ‘super-competitiveness’ is exacerbated by a dysfunctional exchange rate

regime which followed the collapse of the Bretton Woods system in the 1970s. Under the

classic gold-standard regime, a deficit country like the United States would have been forced

to curtail its consumption in order to regain competitiveness. In the present system, it can

live for years beyond its means at the sacrifice of its competitiveness. This is because the

dollar is the world’s main reserve currency. America is in the happy position of being able to

write IOUs for the purchases of goods and services which destroy American jobs. The

system suits both sides. Americans get to consume much more than they earn, while East

Asian workers benefit from export-led growth. However, this happy phase of globalisation

was destroyed by the collapse of 2008. The conclusion is that if trade is to be left safely free,

there has to be agreement on reserve and exchange-rate rules between the dominant

powers. If no agreement is found, it seems inevitable that protection will cause trade to be

restricted.

The second problem with globalisation is that it is economically unstable. Deregulation of

the financial system rested on something known as the ‘efficient market theory’ – the belief

that risks would always be correctly priced and that therefore a system-wide financial

meltdown was impossible. However, conventional wisdom was blown sky high by the crisis

of 2008 which originated in the United States. Before 2007, few outside a small circle of

experts had even heard of collateralised debt instruments (CDIs) or credit default swaps

(CDSs) – defaults which dragged down the American economy. It is a perfect example of

how a financial storm can suddenly come up out of nowhere, destroying all those

sophisticated, pseudo-scientific techniques for ‘managing’ risk by which rational people try

to convince themselves that the world is more predictable than it can ever be.

Keynes understood that uncertainty and the disappointment of expectation were inherent,

not contingent, features of economic life. In Keynes’ economics, a loss of confidence,

whatever its causes, leads to an increase of ‘liquidity preference’, or a flight from investment

into money. This is what happened between 2007-09. The credit crunch in the United States

and the excess accumulation of reserves in East Asia were both signs of an increase in

liquidity preference. The need is not to search for new and ingenious ways to make financial

markets marginally more efficient but to provide a global macroeconomic environment that

reduces the chances of systemic shocks.

To sum up, there are strong arguments for the main economic ingredients of globalisation:

free movement of goods, capital, and labour. But they must not be pressed beyond the limits

of the consent available. Above all, it must not be assumed that the benefits of globalisation

are so obvious that opposition will simply fade away. There are undoubtedly practical limits

to globalisation. There may be normative limits as well.

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iii. Spontaneous Orders: Democracy

The dominant equilibrium theory of international relations has been that of the ‘balance of

power’. As we have suggested this is a long-run theory. The spontaneous operation of the

balance of power was much too crude to maintain a continuous balance. So it was

supplemented by a contractual view of international relations, deriving from the Dutch jurist

Hugo Grotius. This sought to construct order on the basis of international law and

institutions.5 The First World War discredited the idea that violence, once unleashed with

modern weaponry and involving whole populations, could be limited, as had the ‘cabinet’

wars of the eighteenth century. The League of Nations and its successor, the United Nations,

were set up to give institutional expression to the contractual view.

The key idea of balance of power theory is that when a power seeks to upset an existing

power equilibrium, other powers combine to thwart its ambitions. However, in the absence

of adequate deterrence, such a method of maintaining the balance of power necessarily

involved numerous wars. After 1945, a bipolar balance between the United States and its

allies and the Soviet Union and its allies avoided major war because nuclear weapons

provided decisive mutual deterrence. With the collapse of the Soviet system in the early

1990s, a key expectation was that the most important parts of the world would ‘naturally’

become democratic’; that democracy itself was a peace-preserving system, since

‘democracies don’t go to war with each other’, and that therefore the need for a balance of

power system would disappear. This has been shown to be false. Russia and China, the two

most important communist states of the Cold War era, have not embraced ‘western’

democracy; other centres of world affairs, especially in the Middle East, are not democracies

in any form western countries would recognise.6 Finally, the advocates of universal

democratisation grossly underestimated the costs of establishing democracies in troubled

areas of the world. To what extent the ‘Arab spring’ of 2011 has shaken up this kaleidoscope

is as yet unclear.

Underlying the belief that the world would be peaceful if only all, or at least the important,

countries were democratic is a proposition that, while extremely influential in international

relations theory, is poorly grounded both theoretically and empirically: namely, that the

external behaviour of states is determined by their domestic constitutions. What is wrong

with this proposition theoretically is that it assumes that the structure of the international

system as a whole exerts no influence on the behaviour of states. This is equivalent to the

proposition in economics which derives macroeconomic outcomes from the behaviour of

5 The chief Grotian principle was pacta sunt servanda: promises and treaties are to be adhered to. Grotius

also argued that no was could be just if purely aggressive, and hence only acts of defence and retaliation

could be justified. 6 Farid Zakaria, The Future of Freedom at Home and Abroad,2003, has spoken of the rise of ‘illiberal’

democracies like Iran, captured by nationalism or religious fanaticism. He points to the notion of ‘thin’ or

‘immature’ democracies as a potent source of disorder, pp.115-7.

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atomic, but self-interested and super-rational individuals. In both cases, the behaviour of the

whole is read off from the attributes of the parts. Both ignore the influence of the ‘system’ on

the parts. This is a point to which Kenneth Waltz, in particular, has drawn attention.7 His

contention is that the ‘international anarchy’ conditions the behaviour of states more than

the behaviour of states creates the international anarchy. This ‘world system theory’

approach to international relations is particularly useful in the period of globalisation,

which can be defined in terms of the growing impact of the whole on the parts.

Waltz’s argument, in a nutshell, is that you need to look to the system of inter-state relations

to ‘predict’ how individual states will behave, regardless of their domestic constitutions. In

international relations, the structure of the system affects the characteristic of states which

comprise it – their aspirations, their choice of means, even their internal organisation. It is

the ‘enduring anarchic character of international politics *which+ accounts for the striking

sameness of the quality of international life through the millenia’, despite the huge variety of

domestic political regimes.8

The well-known claim that ‘democracies don’t go to war with each other’ confuses an

empirical relationship with the causal proposition that it is the fact of their being

democracies which makes them peaceful. But one can just as well argue that it is peace

which causes them to be democracies. Is it democracy which has made Europe peaceful

since 1945? Or did the US nuclear guarantee, the fixing of borders by the war victors, and

Marshall Aid fuelled economic growth after 1945 make it finally possible for non-communist

Europe to accept democracy as their political norm?

In defending NATO intervention in Kosovo in 1999, the British Prime Minister, Tony Blair,

asserted that ‘the spread of our values makes us all more secure’.9 Because of the

misconception that western democracy is the ‘natural’ form of government, and through

drawing superficial comparisons with the ‘success’ of enforced democratisation in post-war

Germany and Japan, Blair grossly underestimated the difficulties of installing democracies

in societies which lacked western constitutional traditions. Iraq and Afghanistan are current

fruits of their efforts.

Liberal internationalism is trapped in a contradiction: where it doesn’t exist, democracy has

to be imposed by force. So liberal internationalism turns out to offer ‘war to end war’. We

may well find it tested to destruction in Iran and Pakistan.

7 Kenneth Waltz, The Theory of International Politics, 1979. 8 Ibid.,64. 9 Speech in Chicago, May 1999.

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iv. Surrogate Sovereignties

Globalisation can be viewed as the latest attempts to create world order without world

government. Its partial breakdown has reinvigorated the search for political foundations for

global peace and prosperity. Addressing the G-20 Finance Ministers in London on 4

September, 2009, then British Prime Minister Gordon Brown talked of the need

for an ‘economic government of the world’. The common point in these responses is that

central power – some sort of power – is needed to keep the world orderly. The main

questions are how is it to be supplied, and what rules are needed. Three broad answers

have been given.

The first is to create a world sovereign. States should relinquish their right to make war in

return for the protection the sovereign provides. This world state would set the ‘rules of the

game’ for economic and political intercourse in exactly the same way that a state sets the

rules for the domestic economy.

No one imagines that a world state will or can be created overnight. But advocates of this

approach argue that the United Nations and its ancillary organisations can over time become

sufficiently legitimate and effective to establish the rules of the game for a global society.10

This is the area of ‘governance’ or ‘quasi-sovereignty’ – that murky domain between markets

and states inhabited by the United Nations and its functional bodies, as well as by those

multinational corporations, regional organisations, and NGOs which are sometimes

thought to be part of an emerging ‘world civil society’. The concept of ‘soft power’ is much

invoked to describe their modus operandi. Advocates of soft power do not believe that it can

completely replace ‘hard power’. But hard power would be a residual, like the police force in

domestic jurisdictions.

After first Gulf War, President Bush Senior spoke of the ‘new world order’, supposedly

based on the United Nations Charter. This idea was eagerly taken up by Russia and China.

But the UN was soon overwhelmed by ‚the sheer explosion of civil wars, ethnic and

religious violence, massive violations of human rights, breakdowns of authority and

humanitarian emergencies‛. 11 On top of this came Al Qaeda’s suicide attacks on the

American Trade Centre and the Pentagon in 2001, and the ensuing ‘war on terror’. These

were deviations from traditional patterns of disorder against which states and peoples had

learnt to guard, and which the UN had been set up to quell. The Yale-Ford Foundation

report on the UN in 1995 noted that of the nearly 100 armed conflicts in the world since 1989,

all but five were domestic. If this was war, it was a war apparently without precedents, and

therefore rules. Moreover, the human rights agenda espoused by advocates of the ‘new

world order’ is a

10 Eg Peter Singer, One World, , 2003 11 Paul Kennedy, The Parliament of Man: The Past, Present and Future of The United Nations, 2006, p. 66

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potential source of disorder, since it rates justice above order (though claiming that in the

long run, order depends on justice.) Intervention in the domestic affairs of sovereign states to

protect human rights doesn’t square with a state-centred system of international relations.

The UN was therefore unable to overcome the stasis which afflicted it in the cold war era.

All projects for UN-based governance meet the crippling objection that no major state in

the foreseeable future, will cede an independent power of coercion – which might

conceivably be used against itself – to a body which it does not control.

Those who believe that international public goods need to be externally supplied have been

attracted by the more hard-nosed project of a Pax Americana. In the absence of a world

government, the locus of power has to be a predominant state. Britain to some extent

fulfilled this role in the 19th century; today only the USA is in a position to do so, and more

effectively than Britain because its relative power is greater. The American neo-conservatives

and neo-liberals who have most ardently championed this view claim that such an American

imperium would be, unlike all previous imperia, an ‘empire of values’ rather than territorial

conquest.

The unipolar idea of world order made strong headway under President George Bush,

disguised as a new doctrine of national security. The right of self-defence, authorised by

Article 51 of the UN Charter, was replaced by Bush’s potentially unlimited doctrine of ‘pre-

emptive action’, which gives the United States the right to strike at will against all its

potential enemies This means that the United Nations Charter is no longer considered

binding by its most powerful member. Might confers right. As Michael Byers writes:

‘Whenever the US government wishes to act in a manner that is inconsistent with existing

international law, its lawyers regularly and actively seek to change the law’. 12

Although empire is a political concept, it has its analogue in Charles Kindleberger’s idea of a

‘leader’ whose function is to provide the public goods necessary for maintaining a free

economy. What Kindleberger did was to generalise the common assertion that the gold

standard in the late nineteenth century was a ‘British managed’ standard into the conclusion

that ‛for the world economy to be stabilized, there has to be a stabilizer, one stabilizer‛. 13

Kindleberger’s chief public good is free trade. All countries gain from its existence, but

individual countries can get an advantage by protection. This being so, the free trade will be

undersupplied, unless a leading country is willing to underwrite its cost by offering other

countries special inducements to stick to it. The main inducements are free access to its own

capital and markets. Kindlberger’s most important point is that the management of the

inducements must be centralised. If they are competitively provided, the tendency will be

either for countries to evade the rules by playing off one provider against the other, or for

the system to split into sub-systems or blocs. In the absence of a world government,

12 Michael Byers,<.p.64 13 Charles Kindleberger, The World in Depression, 1977, p. 305

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centralising the underwriting function can come about only through the existence of a

country whose own economic ‘weight’ in the system is so large that it is able and willing to

provide the inducements necessary to maintain it. Kindleberger cites France as the main

example of a free-riding country, whose lack of support for the hegemon helped bring both

the British-managed gold standard crashing down in 1931, and end the American-

dominated Bretton Woods system in 1971, both collapses ushering in a period of unstable

‘non-system’.

The most obvious criticism of the Kindleberger thesis is that Kindleberger stresses the

services the leader provides much more than the benefits the leader receives from providing

them. In essence he describes a benevolent leadership, which suits the self-image of both

British and American elites. The Kindleberger picture, like its political parallel the Pax

Americana, ignores the elements of self-interest in hegemonic exertion, and thus the extent

to which its claims to provide global public goods are bound to be contested.

The practical question, regardless of merits, is whether the United States has either the

inclination or the ability to exert the kind of leadership demanded by the advocates of a Pax

Americana. The end of the cold war left the United States as the world's only super-power,

but it also unleashed the forces of religion and ethnicity bottled up by the cold war.

The United States’ power has been effective in dampening down major inter-state conflict.

We can rule out wars in the foreseeable future between the major powers. But large parts of

the non-European world remain violently unstable –particularly the Islamic crescent and

most of sub-Saharan Africa. Moreover, experience following the fall of communism has

shown that the writ of the United States cannot readily be made to run at anything below

the nuclear level.

The demographic and economic basis of western control over the political structure of world

is shrinking. Globalisation has created a group of ‘rising’ powers, the so-called BRICS –

Brazil, China, India, (post-Communist) Russia and South Africa: this is what ‘catch up’

means. This changed configuration will be a source of potential conflict, economic and

political. The changing power balance, though, is not just the result of globalisation.

Countries have adopted globalisation as a development strategy precisely to challenge the

West. Globalisation replaces military weapons by economic weapons in the age-old struggle

for power and influence: the economic race has become the functional equivalent of the

arms race; with the danger that it may well produce an arms race too.

The third option which lies somewhere between the first two can be summed up in the word

‘hierarchy’. This holds that the conditions of order must be secured by a hierarchy of states.

It comes in two versions. The first of these contends that it is not necessary that all states be

democratic, only that the most important ones are. These important states will agree on

‘rules’ which can, in practice, be enforced on the weaker states through a variety of facades

and sticks and carrots. This is the optimum form of hierarchy. A second version states that

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hierarchy is a necessary and sufficient condition for world order, irrespective of the internal

structure of states, a necessary qualification given the fact that some of the most important

states like China and Russia are certainly not democratic in the Western sense. Those who

believe in a democratic hierarchy tend to see it as coalescing round the United States in a

‘league of democracies’. They are sceptical about the possibilities of robust agreements on

the ‘rules of the game’ between different centres of power which do not share the same

values.

The non-democratic version of hierarchy argues that the self-interest of all the important

states will be sufficient to secure agreement on the basic rules of interstate relations,

provided the democratic states do not seek to impose their values on the rest. This is the

position of both China and Russia, and the United States has reluctantly accepted it.

It has some sanction in game theory. Game theory suggests that there are pay-offs from

inter-state cooperation. Whereas breaking one’s word may yield good pay-offs in the short-

run, keeping promises is much the better strategy in repeated games. Treaties, which are

long-run commitments, are usually kept; agreed rules are not flagrantly broken by most

states; cross-border networks proliferate; institutions are set up to monitor rule-keeping and

impose binding adjudication of disputes. This behaviour does not depend on the domestic

constitutions of the participants, only on their self-interest. However, it will be difficult to

stop a multipolar world whose members lack any inherent disposition to agree from

degenerating into a ‘balance of power’ world which, whatever its historical merits, did not

succeed in averting numerous wars to ‘restore the balance’.

These responses fall within the paradigm of globalisation. They accept that the economic

integration of the planet is a good, or in some versions an inevitable thing, and that the main

problem is to create the political conditions to enable it to continue unimpeded, and without

dangerous regress.

However, there is another response which comes from outside the paradigm of

globalisation. This would deal with the inadequacy of political foundations by abandoning

or modifying the programme of globalisation itself. Globalisation, this argument goes, is not

an imperative, it is a choice, and one which should be conditioned on its political

acceptability. The anti-globalist response has many roots, but an important one is the strong

commitment of anti-globalists to national sovereignty. The right of a people to decide its

own future cannot be transferred to higher authorities, for the simple reason that these

authorities can never be invested with the legitimacy which comes from the democratic

process itself. Democracy is an attribute of states, and cannot be transferred upwards. If

globalisation conflicts with democracy, then globalisation must be curtailed to what

democracies will accept. Talk about it being an inevitable process is misleading, and usually

a cloak for the interests of multinational corporations and others who clearly benefit from it.

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v. The Situation Today.

With austerity in the ascendant, the world recovery is petering out. Europe is on the edge of

a precipice, in a feedback loop from bank insolvency to an explosion of sovereign debt to a

second round of bank insolvency. The United States is in better shape, largely as a result of a

massive bout of quantitative easing, but its fiscal policy is paralysed, with the risk of a

Japanese-style recession.

Latin America, the Middle East and Russia are benefiting from a commodity boom. Of their

main markets, however, the US and Europe are hardly growing, and China is slowing down

as Beijing tries to rein in an inflationary bubble in real estate, and because its export-led

growth depends on the continuing increase in American and European demand. If China’s

voracious appetite for commodities slows, growth in Latin America, the Middle East and

Russia will grind to a halt, which in turn will limit demand from them for Chinese goods. So

the circle of pain widens, as each misfortune feeds back on itself.

The plain fact is that there is too little aggregate demand in the world, and the net effect of

all the policies being pursued is to reduce it further. So, what will the future bring?

We know what happened in the 1930s: the world economy broke up. The conventional

wisdom is that this is impossible today under any circumstances. The cliché has it that

economic integration is irreversible; that the revolution in information and communications

is ineluctably turning the world into a ‘global village’. However, this benign prospect

ignores the possibility of great crises and collapses. People were saying exactly the same

thing in 1914. Historically, globalisation has come in waves, which recede under the impact

of crisis and catastrophe as economic life retreats to the relatively safe haven of national

jurisdictions.

We have reached the end of that phase of globalisation in which we dealt with the problem

of permanently mispriced currencies by means of recycling mechanisms that pumped up

speculative bubbles. But what follows it?

The first hypothesis is Disintegration. As we fail to solve our problems globally, the global

economy will start to fragment. At present, domestic demand is being suppressed both by

countries that depend heavily on export-led growth and by countries that are trying to

reduce their current account deficits. What this signals is that the global authorities are

engaged in a simultaneous effort, for different reasons, to reduce aggregate demand.

This is completely the wrong policy. Christine Lagarde, the new managing director of the

International Monetary Fund, is right to argue that fiscal retrenchment in the teeth of a

recession is suicide. The break will come when the deficit countries, unable to endure any

further ‘bleeding’, start to resort to currency depreciation and protectionism. The eurozone

has won a breathing space by building an enormous firewall. But if it fails to organise

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growth policies, Greece and possibly other eurozone countries will resume their monetary

and trade independence. Currency and trade wars will erupt across the globe: indeed, these

wars have already begun.

The second hypothesis is what Gordon Brown calls a ‚G-20 growth compact‛. Essentially, he

is calling for a revival of the spirit of international co-operation which produced the stimulus

of 2009 and halted the slide into another Great Depression.

Elements of such a compact would include a reform of the global monetary system, aiming

to end the era of current account imbalances; a reform of the financial system, aiming to

avoid the excesses of bank lending that triggered the crisis; and macroeconomic policies that

aim to boost world demand in the short run.

Progress has come on the second item. Basel III has accepted the need for the banks to hold

more capital against their liabilities. Individual countries have also begun to beef up their

regulatory systems. In the United Kingdom, the Vickers report has proposed splitting the

retail from the investment functions of banks. The European Union has proposed a

transactions tax. Some countries have reinstated capital controls. These are tentative steps to

rein in financial power.

On the other two items, there is no progress to report at all. Reform of the world monetary

system needs be based on a grand bargain, mainly between China and the US, on reserves

and exchange rates, but there is no sign yet of any serious attempt to achieve this. As for the

third item, the only macroeconomic co-ordination is in the direction of cutting down, not

building up, the world economy. There is no investment in growth.

Yet the world economy cannot cut its way out of recession: it has to grow its way out. If the

bond markets force deficit reduction programmes on highly indebted governments, states

must look to alternative instruments – such as national or regional investment or

infrastructure banks – to mobilise private savings going to waste for want of confidence.

Sovereign wealth funds and pension funds would invest in growth if there was any growth

going on. As it is, they invest in government debt, which carries low yields but is at least

relatively safe. The former US deputy Treasury secretary Roger Altman has made the point

that historically low yields on long-term government debt in the US, the UK and Germany

can be explained only by anticipation of ‘negligible demand for capital’.

The crucial question is whether the political foundations for the ‘global compact’ can be

established in time to prevent disintegration. Perhaps voluntary cooperation by the great

powers, acting in their own self-interest, will be sufficient to secure the public good of global

peace and prosperity. But disintegration is the more likely. This is not just because political

leadership is not up to the job of forging a global compact, but because the adjustments

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required of our current national economic models are too great to be undertaken voluntarily.

Americans will need to consume less and export more; China and Germany will have to

consume more and export less. Such change requires a fundamental rethinking of ways of

living into which all three countries are locked. The likelihood of such rethinking is

extremely low in present conditions.

The two scenarios – Disintegration and Global Compact – have in common that they

presuppose more reliance by countries or groups of countries on domestic sources of

growth, and less on foreign trade; that is, a more balanced world economy. The sole question

is whether the retreat from the wilder shores of globalisation will be orderly or disorderly:

whether we drift into the bloc economics of the 1930s, or whether we have the wisdom to

build a managed and modified form of globalisation, free from the illusion that everything

can be left safely to the markets.

At this point, we need to confront the palpable inadequacy of global institutions. There is no

‘economic government of the world’, much less a ‘political government’, and the era of

‘surrogate’ sovereigns is over. There either has to be a quantum leap in the ability of the

great powers to cooperate and implement cooperative solutions, or the political economy of

globalisation will start to fragment.