Global Rebalancing and Financial Statecraft: Toward an Analytical Framework[1]
Leslie Elliott Armijo and SaoriKatada
February 1, 2013
Abstract
Governments may seek treasure by conquest, but also use loans to create dependence.
“Financial statecraft,” or the use of monetary levers by creditor—and sometimes debtor-- states for both international economic and political advantage, has a long history. A neorealist, zero-sum framing of international monetary relations is not inevitable, yet casts a persistent shadow, especially during periods of prospective interstate power transitions, when previously peripheral countries find themselves with unexpected new capabilities. To frame the collection of papers in this special issue, our paper opens with a briefreview ofthe theoretical tradition of studies of economic statecraft. We then reformulate the analytical framework to focus on the contemporary use of two types of financial statecraft by large emerging economies.Our approach highlights two dimensions: defensive financial statecraft, or interventionist regulatory policies designed to prot198ect the domestic economy and polity against contagion or pressure coming from global markets, and offensive financial statecraft, or the use by governments of national financial capabilities to achieve larger international policy goals. The paper continues with an overview of developing countries’ attempts to exercise (mostly defensive) financial statecraft during the 1980s through the mid-2000s, setting the stage for the set of case studies, which analyze the most recent period. We conclude with brief summaries of our colleagues’ findings in the collected papers, and of our own thoughts on continuing significance of this line of inquiry.
Global Rebalancing and Financial Statecraft: Toward an Analytical Framework
During the late 20th century, the emerging economies in Lain America and Asia struggled to implement market-oriented economic reforms while protecting themselves from imported financial crises. Meanwhile, yet largely escaping the radar of the foreign policy communities of the dominant advanced industrial countries, an underlying shift in the global interstate distribution of capabilities was occurring. The nature and the direction of interstate rebalancing are having a substantial influence on the national and regional financial statecraft of these rising powers and regions. Ultimately, such rebalancing has had and will continue to have fundamental although perhaps incremental implications for the global financial architecture. Hence, in this special issue, we focus on questions such as these: Which countries have emerged with financial capabilities strong enough to project influence? What instruments of financial statecraft have appealed to their governments and why? What are the major obstacles and challenges to the use of financial statecraft, and what might be the implications of the use such levers for the future evolution of global governance? This framework paper introduces the main sources and instruments of financial statecraft around the Pacific Rim, and begins the inquiry into how they might be employed in the course of global rebalancing, particularly in the post Global Financial Crisis (GFC) world.
In this project, we define “financial statecraft” as the intentional use, by national governments, of domestic or international monetary or financial capabilities or conditions for the purpose of achieving on-going foreign policy goals, whether political, economic, or financial. With our study, we begin to address three major theoretical and empirical gaps of the exiting body of literature. First, we complement the large body of existing work on economic sanctions that have thus far primarily focused on asymmetric economic relationships through which the strong impose conditions and sanctions on the weak. We instead explore the use of financial statecraft by rising powers. Second, we expand the definition of international financial statecraft to go beyond its narrow use as a synonym for financial sanctions intended to alter the behavior of a specific foreign state, generally one branded as an outlaw or rogue nation by the sanctioner. Instead we focus on an important class of situation: an increase in the relative material (including financial) capabilities of an emerging economy such that state leaders decide to employ financial or monetary levers in novel ways as conscious tools for general international policy ends. Third, we are particularly interested in two dimensions of financial statecraft, which we call respectively the “shield” – or the defensive use of financial statecraft in order to protect the status quo and domestic economic and political autonomy of the user from external threats, and “sword” – or the offensive use of financial statecraft in the hope of altering the international status quo or creatingnew leverage for international influence. These two set of goals are interrelated and some financial statecraft instruments demonstrate a dual character. We think it worthwhile, nonetheless, to begin to sort out instances and instruments of financial statecraft according to the types of influence hoped for by their users.
The paper’s first section discusses the emergence of how new powers in Asia and Latin America consequent on an underlying shift in the interstate distribution of capabilities. We suggest that the governments of many emerging powers have taken this as their cue to engage more actively in the exercise of financial statecraft. Section two theorizes the concept of financial statecraft and discusses our theoretical contribution. The third section provides illustrations of the use of financial statecraft as shield and swordin recent Latin American and Asia history as a backdrop to the papers collected here. Our fourth section introduces the range of empirical findings and author assessments contained in this set of papers. We conclude with brief comments on the implications for future global financial governance.
I. The 21st century’s shifting interstate distribution of capabilities
First and foremost, how do we know that the emerging market economies are really “emerging” with higher relative capabilities and potential to influence others and the global system? The use of international financial statecraft by new global and regional players rests on the assumption that an underlying shift of capabilities, and thus eventually of global influence, is indeed in process.
Measuring shifting power is not simple. The field of international relations splits between strict “realists” (Waltz 1979; Mearsheimer 2001) who conceptualize power principally in terms of the distribution of material capabilities (power potentials) among like units in an ungoverned (“anarchic”) interstate systems, and those, including liberal institutionalists, who understand power as inevitably relational and thus inhering only in situations in which one state is able to persuade or dissuade another away from the target state’s default path (Barnett and Duvall 2005). Our theoretical stance is closer to that of the “neoclassical realists,” who ground their analyses in the material balance of power potentials among states, yet we also would explicitly allow for the possibility of foreign policy choices being shaped, in addition, by policymakers’ responses to domestic or transnational institutions, interests, and ideas (Rose 1998; Kitchen 2010). The classical balance of interstate material capabilities sets limits on plausible state choices, and thus matters, particularly when it is in flux.
Most observers agree that currently the United States disposes of more “power” resources (that is, material capabilities that might be translated into global influence) than any other single country. Ikenberry, Mastanduno, and Wohlforth (2009) find that today’s interstate system is not hegemonic, but is certainly unipolar. Yet other states are increasing their presence. One quantitative snapshot comes from the Composite Index of National Capabilities (CINC) developed by the “Correlates of War” project and calculated continuously since 1820 (Singer, Bremer, and Stuckey 1972). The index averages national shares of world totals of six objective capabilities thought to be particularly relevant to the ability to wage war: population, urban population, iron and steel production, energy consumption, military personnel, and military spending. Table 1 shows the results for 1955, 1990, and 2007, the most recent year available. According to this index, the U.S. alone accounted for about 23 percent of all international “hard power” capabilities in 1955, which shrunk to only about 14 percent in 1990, then held steady through 2007. The decline in the share of capabilities controlled by the remaining major advanced industrial countries—the G6 of Canada, France, Germany, Italy, Japan, and the UK—was smaller and more gradual, falling from 18 percent in 1955 to 13.5 percent in 2007. Between 1955 and 1990 the relative shares of countries not included in the table (the rest of the world, ROW) expanded by about 20 percent, from around 41 to 51 percent of world capabilities—but then fell back to less than 43 percent in 2007. The share of China, India, and Brazil (BIC) grew slowly from about 15 to 17.5 percent in 1990, then exploded to nearly 30 percent of the world total in 2007, mainly due to the growth of China. Yet these results are questionable, as they suggest that today China has greater material capabilities than even the U.S.
[Table 1. Relative Material Capabilities of States about here]
One might instead construct an alternative Contemporary Capabilities Index (CCI) more appropriate to measuring relative capability in our own era (Armijo, Muehlich, and Tirone 2012). In contrast to the CINC, the CCI incorporates the total size of the economy, two proxies for technology, and a measure of financial capability, but no longer assigns positive valence to high energy consumption or urbanization per se. The CCI is calculated as the mean of national shares in global totals of: national income (GDP at PPP rates), population, telephone subscriptions (both fixed and mobile), industrial value-added, foreign exchange reserves, and military spending. By the CCI, as recently as 1990 the U.S. had 21 percent of global capabilities, which had shrunk to 17 percent by 2007-9. The share of the remaining six major advanced industrial countries (G6) meanwhile fell from about 26 to 19 percent. Most of the expansion occurred in China, India, and Brazil, but mainly in China, which went from 5 to 14 percent of total global capabilities. With only two components in common (population and military spending), the trends in the CINC and CCI are broadly similar, the main difference being that the CINC, using arguably anachronistic indicators, shows the advanced industrial democracies declining sooner and farther.
Similarly, a newly-inaugurated World Bank annual report, Global Development Horizons (GDH) 2011, begins with the following remarkably bold assertions:
“The inaugural edition of GDH addresses the broad trend toward multipolarity in the global economy“ (p. xi)… “By 2025, the most probable global currency scenario will be a multipolar one centered around the dollar, euro, and renminbi” (p. xii)… “ [In the postwar era,] in exchange for the United States assuming the responsibilities of system maintenance, serving as the open market of last resort, and issuing the most widely used international reserve currency, its key partners, Western European countries and Japan, acquiesced to the special privileges enjoyed by the United States— seiniorage gains, domestic macroeconomic policy autonomy, and balance of payments flexibility” (p. 2)… “[Today] three conventional pillars” [of global economic governance] need to be reappraised: the link between economic power concentration and stability, the North-South axis of capital flows, and the centrality of the U.S. dollar in the global monetary system” (2) (World Bank 2011).
This underlying transition is particularly apparent following the GFC initiated in the U.S. in 2007. The GFC has been a significant blow to the global influence of the neoliberal economic paradigm and of leading advanced capitalist democracies, as these countries have exposed their underlying fiscal and banking fragilities, which have continued to roil markets and unseat incumbent governments. Hence, “the old notion of rich countries funding poor countries is no longer appropriate, as emerging markets rise in economic clout and are as much sources of development cash as they are recipients” (Politi 2012). In short, the distribution of global capabilities is shifting, and we judge that this shift has impacted and will continue to impact the debates over national foreign policy choices and global financial governance. Governments of many of the larger emerging economies perceive in current conditions the opportunity to exert themselves more actively in international affairs, including via financial statecraft.
II.Theorizing financial statecraft
States often have deployed economic and financial instruments to achieve their foreign policy goals. “Economic statecraft” has traditionally been defined as the employment by the state of economic levers as a means to achieve foreign policy ends. For instance, trade sanctions may be imposed on a foreign country with the aims of pressuring its government to end human rights violations against its citizens or cease construction of a nuclear weapon. Conversely, military or diplomatic allies may receive subsidized loans or trade preferences. Consistent with this usage, “financial statecraft” would refer to a national government’s use of monetary or financial regulations or policies to achieve foreign policy ends. Thus Steil and Litan (2006:4) refer to financial statecraft as “those aspects of economic statecraft that are directed at influencing [international] capital flows.” Their interest is in the use of these capital flows mainly for traditional security and foreign policy goals, and mainly against a specific foreign target state. Steil and Litan list these examples of financial statecraft instruments: capital flow guarantees and restrictions, financial sanctions on state and non-state actors, and government decisions to underwrite foreign debt in a currency crisis, create currency unions, or opt for dollarization. Other recent scholars have examined the relations between financial power and financial statecraft through currency relations (Kirshner 1995; Kirshner 2003; Helleiner and Kirshner2009) or through the politics of finance (Maxfield 1990; Woo 1991; Haggard and Maxfield 1996; Walter 2008) or financial crises (Noble and Ravehill 2000; Wade 1998; Aggarwal 1996).
The notion of economic and financial interests enlisted or involved in foreign policy goes back to the early times of the globalizing economy and modern nation-state. The peace preference of the haute finance, argues Polanyi (1944), contributed significantly to the one-hundred-year relative peace in Europe under the rapidly globalizing market economy of the late 1800s through World War I. Adopting a more realpolitik tone, Hirschman (1945: xv) examines how “quotas, exchange controls, capital investment, and other instruments” can be used to engage in economic warfare, especially through establishing a country’s potential for economic sanctions. Focusing on the use of economic means to achieve foreign security policy goals, Baldwin’s (1985) seminal work on economic statecraft highlights the way in which economic instruments, particularly trade and other economic sanctions, can be deployed in support of state security objectives. In the last twenty years, a cottage industry on economic sanctions has investigated both the domestic political foundations and the effectiveness of such sanctions.[2]
This body of work has a strong large country bias, however. Authors’ research interests focus on the wealthy democracies, particularly the United States, the state which imposes most of the sanctions. Work by Hufbauer et. al. on economic sanctions imposed between 1914 and 2006 statistically analyzes the characteristics of the home and target of the sanctions as well as the indicators of success.[3] These scholars propose that the size differential between the home state (which imposes the sanction) and the target state (the sanction’s recipient) has to be at least 10 to 1 for the sanctions to be minimally feasible, and that the sanction must amount to at least 1 percent of the target’s GNP for it to be effective. By setting the bar for potential real-world significance so high, most previous research has limited the studies of financial statecraft by emerging economies, even of those possessed of substantial economic and financial capabilities.
Moreover, their focus on targeted sanctions may have led researchers to underestimate the intentional political content of more broadly-based international financial and monetary policies. For example, the provision by the United States of the world’s dominant transaction and reserve currency for decades has been conceived of by U.S. policymakers and academics either as a technical matter devoid of political implications or as a public good provided to the global political economy—rather than as an “exorbitant privilege,” enabling the issuer to further a range of non-financial international policy goals (Eichengreen 2011).This special issue moves beyond both the large-country bias and the narrow focus on sanctions of much of the existing literature.
Our analytical framework nonetheless builds on existing research. Paying closer attention to monetary dynamics beyond the strongest states and focusing on the cost of monetary adjustment, Cohen (1966) was ahead of his time in suggesting that there are two types of negative results from monetary adjustment: continuing costs and transitional costs. Cohen (2006) later developed these concepts into “the two hands of monetary power”; power to delay (that is, to postpone the continuing cost of adjustment) and power to deflect (that is, to avoid the transitional cost of adjustment). Large countries with high levels of liquidity and borrowing capacity, along with diversified economies, always have higher power to delay and deflect, but small countries typically lack both. Andrews (2006; 18-19) analyzes the use of monetary statecraft in both currency and financial relations, and identifies both internal and external aims of key instruments or techniques. For example, he notes that manipulation of currency values has the internal objective of insulating domestic monetary policy, but also the external target of promoting exports or exacting concessions on other issues.
Agreeing with Cohen (2006:49-50), who argues that international monetary relations have tended to be hierarchical, our project pushes the envelope by considering the choices available to countries striving to ascend this hierarchy. How do emerging economies protect themselves from the pressures of globalized finance and strive to transform existing modes of global financial governance in order to provide themselves a more secure position within it?