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The System is Working

MEDFORD, MASSACHUSETTS – As the latest G-20 meeting of finance ministers starts in Cairns, Australia, the Legion of Gloom is at it again. Their conventional wisdom is that “the system” – global governance structures ranging from the World Trade Organization and the G-20 to the major central banks – is badly broken and in desperate need of repair. In fact, the global economic order has worked remarkably well since 2008.

True, the first year of the Great Recession was more severe than the first year of the Great Depression. But, despite this initial shock, the system responded in a surprisingly nimble fashion. Compared to previous global downturns triggered by a financial crisis, the global economy bounced back robustly. Trade and output levels exceeded pre-crisis levels in most countries a few years ago, and global poverty continues to decline rapidly.

One key to this rebound was that, in contrast to the 1930s, the global economy maintained existing conditions: trade barriers remained low, as did restrictions on foreign direct investment, and cross-border exchange continued to spread with the Internet.

As the McKinsey Global Institute noted, with the exception of cross-border finance, global flows are just as robust now as they were before the crisis. There has even been a partial revamping of key global institutions, from the rise of the G-20 to reform of the International Monetary Fund. Indeed, the resiliency of markets to geopolitical tensions in Ukraine or the South China Sea has begun to worry some Fed officials.

By any reasonable metric, multilateral institutions and great-power governments did what was necessary to preserve the global economy’s openness. So why the widespread misperception that the system failed?

Here, we run into a dirty little secret of world politics: many commentators on international politics do not know much about economics or economic policy. International-affairs professionals frequently talk about “high politics” and “low politics,” and they usually relegate economic issues to the latter category.

This ignorance matters when political commentators try to write about the global economy. They will naturally rely on the most accessible facts as their guide.

To be fair, some of the most obvious data have indeed suggested fragmentation of the global economic order. The dormancy of the Doha Round of WTO talks, the public deadlock of some G-20 summits, and stalemates at the United Nations Security Council seem like sufficient evidence to proclaim that the status quo is imperiled – even if facts beyond the headlines belie that consensus.

Consider the kerfuffle over “currency wars.” In 2010, the Fed began hinting at a second round of quantitative easing, or QE2. One of the policy externalities of QE – the Fed’s purchase of long-term financial assets – was a depreciating dollar. Fearing domestic asset-price bubbles and upward pressure on their currencies from an inward rush of capital, many emerging-economy leaders complained loudly about what Brazilian Finance Minister Guido Mantega called an “international currency war.”

Lost in all of the hype was the fact that neither markets nor financial analysts were terribly perturbed about excessive exchange-rate volatility or the possibility of an actual currency war. After the autumn of 2008, exchange-rate volatility slowly receded toward pre-crisis levels.

Another common reason for the collective misperception is misplaced nostalgia. Former US National Security Adviser Brent Scowcroft encapsulated the post-crisis conventional wisdom in 2012: “The postwar leaders set up the International Monetary Fund, the World Bank, and the General Agreements on Tariffs and Trade to develop rules of the road. The new G-20 is but a pale reflection of that once-brilliant institution building.”

But past efforts at building a global order have had their share of futility. Anyone familiar with the history of the Bretton Woods institutions knows that they experienced as many misses as hits. Compared to the past, the current order performed well above average.

Perhaps the deepest explanation for the Legion of Gloom’s strength is where they live. According to the Economist Intelligence Unit, the OECD economies averaged annual GDP growth of 0.5% from 2008 to 2012, whereas non-OECD economies averaged 5.2% growth.

This matters because analysis of the international order remains anchored in the West. It is a general rule of political science that a faltering economy causes greater distrust in institutions. A weak economy feeds perceptions that the system is broken, and that those in authority are not to be trusted. So greater skepticism about all levels of governance in the OECD economies is not surprising.

Analysts might be looking first at their local circumstances, and then extrapolating from that to their assessments of global institutions. Pessimism about slow national recoveries in the developed world is causing analysts to conflate poor domestic and regional governance with poor global governance.

But the primary causes for domestic economic weakness in Japan, the US, the United Kingdom, and the eurozone are not global in origin. Japan’s economy had been stagnating for almost two decades when the 2008 crisis erupted. Likewise, domestic policy stalemates and political uncertainty acted as a significant drag on the US recovery from the Great Recession.

Does the system’s remarkable resiliency since 2008 mean that it can withstand the next crisis? In theory, yes – many of the post-2008 reforms have been designed to add shock absorbers to the global economy. But, in international relations, collective misperceptions can create their own reality. If pundits continue to insist that the system failed, wonks will devote time and effort to figuring out how to fix what is not broken.

Moreover, it is extremely difficult to correct misperceptions once they ossify – particularly if the topic in question is outside a pundit’s range of expertise. Ironically, the only thing that might stop the system from continuing to work is the low confidence of its greatest proponents.
Daniel W. Drezner, Professor of International Politics at the Fletcher School at Tufts University, is the author, most recently, of The System Worked: How The World Stopped Another Great Depression.

Project Syndicate

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