From capital controls to capital mobility: How the state orchestrated its own subjugation to the financial markets

Transcription

1 From capital controls to capital mobility: How the state orchestrated its own subjugation to the financial markets Question 3: The power of the state has withered under the force of globalisation. Discuss this perspective in relation to theories of International Political Economy and one or more aspect of the international political economy. Final exam International Political Economy December 2016 Copenhagen Business School International Business and Politics Christian Mathias Brynjolf Bohn. 19 December 2016 STU count: Total pages: 10 (14 including front page and bibliography) 1

2 Today, international flows of money dwarf the cross-border trade of goods, and their impact on states' ability to govern autonomously has only increased through the last four decades by their growing speed and global reach. Whether the power of the state has actually withered under the force of globalisation is undoubtedly one of the most controversial and highly discussed topics in IPE. Since the very fundamentals of democratic governance in contemporary societies are at stake, it is also a question of great importance to scholars and politicians alike. However, the answers arising are many and differ to a high degree depending on how the terms involved are defined and understood as well as which theories are employed to interpret the mechanisms and implications of the question. The two sides that disagree the most are probably the neorealists, who argue that the state to this day is still in control and preserve full policy autonomy, and the critical theorists, especially the neo-gramscians, who argue that the state by supporting and promoting financial globalization has in effect subjugated itself to the market. This paper will side with the latter and through thorough arguing and providing empirical evidence prove that the neo-gramscians are in fact correct in their view and that the neo-realists are wrong. This paper therefore argues that the globalization of financial markets has eroded the power of the state since the collapse of the Bretton Woods Order. In addition, this paper argues that this has paradoxically happened with the support of the state itself, which has in effect turned it into a "policy-taker" subjugated to the market. This argument will be supported through multiple steps. First, the specific meaning of the terms state, state power and globalization in the context of this paper will be clarified and clearly defined. Secondly, the theories of the neorealists and neo-gramscians will be elaborated and contrasted. Thirdly, it will be shown how the state through capital controls had power over the market during the time of the Bretton Woods Order. Fourthly, the way economic globalization has taken place and how the state acted has against its own interest by supporting it will be detailed and supported. Fifthly, empirical evidence with a particular focus on the 1997 East Asian financial crisis will be provided in support of the view that the power of the state has in fact been eroded by the liberalization of financial markets. Lastly, this paper will sum up and make a conclusion in relation to the theoretical perspectives employed throughout the paper. 2

3 Having traditionally constituted the main actor focus in IPE, the state is not only of great importance in the views of scholars in an academic context but also for politicians in their understanding of its policy-making capabilities. In order to discuss whether the power of the state has truly withered, it is necessary to clarify what exactly is meant when referring to the state and its power throughout this paper. The classical understanding based on international law in the 1933 Montevideo Convention is that states are entities that have: "(a) a permanent population; (b) a defined territory; (c) a government; and (d) a capacity to enter into relations with other states" (Dixon 2007: 115). Just as important in the modern conception of the state is the concept of sovereignty, which according to Reus-Smit forms one of the foundational institutions that "define legitimate statehood and rightful state action" (Reus-Smit 1997: 558). Together, these descriptions form the picture of the state as a sovereign entity that governs its population within a defined territory. State power is based on the concept of state agency, which refers to the so-called agential power of a state to "purposively exercise influence in a specific realm of action." (Broome 2014: 49). In the specific context of IPE and this paper, state agency therefore refers to the international power of the state as its ability to "determine policy and shape the international realm" (Hobson 2000: 6). According to this definition, state power is understood as the previously defined sovereign entity's ability to be a "policy-maker" in the global political economy, which in turn means being able to create its own policies without being coerced by other states or forced by market forces to follow a specific path. In contrast, if a state loses its power and effectively its ability to exercise much agency over global rules, norms, principles and market processes, it is defined as a "policy-taker" (Broome 2014: 49). This paper therefore investigates to what degree the state has moved from being a policy-maker to a policy-taker in the global political economy because of the financial globalization that has taken place since the collapse of the Bretton Woods Order. Having defined what is meant by the state and its power, it is now just as crucial to establish the meaning of globalization in this paper. The broader understanding of the concept is conceived to be multidimensional across the cultural, political, ecological, military, and social domains. However, in IPE 3

4 globalization is taken to be synonymous with a "process of intensifying worldwide economic integration" (McGrew 2014: 226). This understanding of globalization as an inherently economic process that dissolves the separation of the world into discrete national economic units is taken as the starting point for this paper. More concretely, it entails the increasing patterns and trends of world trade, capital flows, and transnational production taking place across borders. Hirst and Thompson describe it very fittingly for this paper as "a global economy in which distinct national economies and, therefore, domestic strategies of national economic management are increasingly irrelevant" (Hirst and Thompson 1999: 1). It is difficult to pin down exactly when this economic globalization started to take place, since the process is constantly evolving and increasing the interdependency and interconnectedness of the global economic actors. However, the breakdown of the Bretton Woods Order in 1971 marks a point in time where governments went from upholding legislative barriers to the movement of capital and therefore being able to control cross-border private financial flows to a continuing liberalization of those same barriers and an embrace of free capital mobility (Helleiner 2014: 180). Since this paper will be putting a particular focus on the globalization of finance and its impact on the power of the state, the analysis will therefore take its departure in a comparison of the time before and after the breakdown followed by empirical evidence proving the erosion of that power and supporting the perspective of the neo-gramscians. After the clarification of the central terms of this paper, the conflicting theories of neoralism and neo- Gramscianism will now be elaborated respectively. Beginning with the former, the neorealist approach first and foremost understands the state as the central and dominant actor in the global political economy. It is the rational pursuit by states of their national interests that drive international dynamics, and in the absence of an overarching authority, which could constrain the states, they compete against each other in order to maximize their own interests (Broome 2014: 20). In this view, the economy is clearly subordinate to the needs of the state, not the other way round, and economic globalization is a process controlled and promoted in the interests of the states. In other words, "globalization has been made by states, for states, particularly dominant states" (Heywood 2014: 12). This means that, according to the neorealists, 4

5 developments such as an open trading system, global financial markets and the advent of transnational production were all put in place and continuously supported to advance the interests of states. Neorealists therefore strongly disagree with the statement that the power of the state has withered under the force of globalisation. Quite to the contrary, they believe that the market and the private market actors, like major commercial banks, transnational corporations (TNCs) and credit rating agencies are to this day subordinate to the state. Among others, Robert Gilpin argues that "national governments still make the primary decisions regarding economic matters; they continue to set the rules within which other actors function, and they use their considerable power to influence economic outcomes" (Gilpin 2001: 18). However, this paper argues that the state has in fact acted against its own interests by supporting and promoting financial globalization and the liberalization of financial markets, since this has effectively subjugated it to the market. That is exactly what the neo-gramscians believe, which this paper will now elaborate on further. In contrast to the neorealists, the neo-gramscians do not view the state as the dominant actor in the field of IPE, but instead understand capitalism as the main driving force of the global economy. They argue that the capitalist elite is not only dominating the state because of the economic and political power of the former, but also because of the ideological hegemony of capitalist ideas and theories (Heywood 2014: 75). This is core to understanding why states have themselves promoted economic globalization, believing that they were serving their own interests, but actually acting irrational because they were in effect subjugating themselves to the market. Economic globalization is therefore understood by the neo-gramscians as the establishment of a global capitalist order, and they generally regard the increase in economic integration after the collapse of the Bretton Woods Order as a shift in the relationship between the state and the market. According to this view, "states have lost power over the economy, being reduced to little more than instruments for the restructuring of national economies in the interests of global capitalism" (Heywood 2014: 18). According to the neo-gramscians, this loss of power is genuinely threatening the economic sovereignty of the state and continuously eroding its ability to regulate the capital elite. In the words of those same theorists, the support of economic globalization by the state has given rise to a capitalist 5

6 hegemon, which in effect has transformed the state from a policy-maker to a policy-taker. Susan Strange formulates it like this: "Where states were once masters of markets, now it is the markets which, on many crucial issues, are the masters over the governments of states." (Strange 1996: 4). Having clarified the positions of the theorists, the next part will focus on proving that the neo-gramscians are right in their view of the global political economy and that the neorealists are wrong by providing thorough empirical evidence. In order to prove that the power of the state has actually been eroded by financial globalization after the collapse of the Bretton Woods Order, it is necessary to determine how the state had power over the market before. After the Second World War, the Bretton Woods order was established in order to rebuild an integrated international monetary and financial order. It was shaped by the fear that an unregulated international economy is inherently unstable and that markets therefore has to be managed. It can therefore be seen as an attempt to establish a Keynesian-style regulative framework for the international economy. Since this international economic order acknowledged only the limited benefits of market competition, John Ruggie has described it as a form of embedded liberalism, as opposed to "pure" liberalism (Ruggie 1998). This embedding of the commitment to economic openness also reflects the economic ideas, which at the time had come to be widely shared amongst policy-making states. More concretely, the Bretton Woods Order gave the states the right to regulate all capital movements across borders in order to enable them to "control speculative and 'disequilibrating' private financial flows that could disrupt stable exchange rates and national economic policy autonomy" (Helleiner 2014: 178). This power of the state to regulate the capitalist elite effectively secured two decades of sustained economic stability in the global political economy. This is reflected in the fact that during the 25 years of the Bretton Woods Order, "only" 21 financial crises in industrial economies and 16 in emerging markets took place, while those numbers rose to 44 and 96 respectively in the 25 years of financial globalization coming after (Bordo and Eichengreen 2002). However, this period of economic stability during the time of the Bretton Woods Order due to the power of the state over the capitalist elite did not last. 6

7 The question is of course how this change and increasing globalization of financial markets came about, and how it has affected the power of the state today. The former will now be elaborated with a focus on how the state itself promoted and supported this economic globalization through liberalization, because it believed this change to be in its own best interest. However, as the neo-gramscians argue, it was in fact undermining its own capabilities and giving rise to a capitalist hegemon in the process. There is not one single explanation for the increased economic globalization that took place after the collapse of the Bretton Woods Order, and it is important to mention the growth of global telecommunications networks that enabled money to move around the world much more easily and cheaply than in the past as a precondition for this globalization (Helleiner 2014: 180). However, most importantly was the political choices by states to support the emergence of a more liberal environment for cross-border financial flows. (Abdelal 2007). Already in 1957, the creation of the 'Euromarkets', encouraged by the UK, provided a means for private financial actors to buy and sell US dollars in unregulated 'offshore' markets to get around those national controls put in place at the establishment of the Bretton Woods Order (Helleiner 1994: 71-72). The 1970s then saw the rise of the so-called stagflation, in which economic stagnation and rising unemployment was linked to high inflation. In 1971, the USA therefore decided to abandon the system of fixed exchange rates, which in effect signalled the collapse of the Bretton Woods Order. This also meant that a system based on embedded liberalism now gave way to one based fully on neoliberalism (Heywood 2014: 471). This liberal evolution was led by the USA and the UK through the abolishment of their national capital controls in 1974 and 1979, respectively, but they were soon followed by other OECD countries. By the 1990s, almost all the wealthy states of the world had embraced the liberal economic ideas, which in effect gave market actors a degree of freedom in cross-border financial activity unparalleled since the 1920s (Helleiner 2014: 180). Many poorer states also chose to abolish capital controls in order to offer their territories as locations for 'offshore' international financial activity via loose regulatory environments (Palan 2003). Today, there is "considerable evidence" that capital controls have declined significantly since the 1970s for OECD states and the 1980s for most developing states (Obstfeld and Taylor 2014: 165). This 7

8 support for financial globalization has been explained by Helleiner to be a product of the increasing influence of a more neoliberal ideology among the policy-making states after the collapse of the Bretton Woods Order. The idea that emerged was that capital controls interfered with individual freedom and prevented markets from efficiently allocating capital internationally (Helleiner 2014: 180). The neorealists explain the state support for economic globalization as rational behaviour because of their interest in escaping the stagflation of the 1970s, and they point out that the liberalization was driven especially by the strongest states, the USA and the UK. On the other hand, the neo-gramscians argue that it was actually the hegemony of capitalist ideas the neoliberal ideology that made the states believe that they were acting rationally and in their own best interest when they were liberalizing capital controls, but that they were in fact accelerating their own demise. This paper will provide the empirical evidence proving the latter. Before showing the impact of the liberalization of financial markets and how it has eroded the power of the state, it is important to assess the empirical evidence proving that financial globalization has actually taken place as a result of the former. And the evidence is staggering. First of all, the enormous growth in TNCs since the Second World War is reflecting the rise of the capitalist elite operating across borders and financial markets. It has now become a key actor in the global political economy, and it was estimated that 82,000 TNCs by 2009 were controlling more than 810,000 subsidiaries (UNCTAD 2009: 18). Secondly, in the same period foreign direct investment, FDI, increased more rapidly than either production or international trade, and by 2011, the global stock of FDI amounted to about $20 trillion (Ravenhill 2014: 15). Looking to international finance, the exact same picture becomes apparent. Daily turnover on foreign exchange markets more than doubled, from $590 billion in 1989 to $1,210 billion in 2001, then increased to $3,500 billion in 2008 and peaked in 2010 at $4,000 (BIS 2001). Comparing it to world merchandise trade, annual foreign exchange turnover in 1973 was equivalent to twice the value of annual world trade, but by 2008 it was equivalent to more than sixty times the value of annual world trade and "significantly exceeds other global financial flows" (Held and McGrew 2002: 48). As a last piece of proof that financial globalization has in fact taken place, it is noted that global capital flows fluctuated between 2 and 6 per cent of world GDP 8

9 from , but stood at 15 per cent of world GDP by 2006 and at $17.2 trillion were three times the gross level of 1995 (IMF 2010). This paper will now elaborate on the implications of this on states. It is now time to provide the empirical evidence proving that the power of the state has in fact been eroded by the financial globalization that the state itself has been part of promoting and supporting. First, though, in relation to the definitions given in the beginning of this paper, it must be established how exactly the state has lost power to the market. The biggest way, in which the power of the state has been eroded, is how financial globalization has severely undermined national policy autonomy by giving the capitalist elite an 'exit' option to exercise against states that stray too far from its preferences. More concretely, it is the way that the shift from capital controls to capital mobility has boosted the significance of private financial actors and increased their power as a 'disciplinary' force that constrain the scope of states' capacity to choose their own economic policies, like high taxation, expansionary macroeconomic policies that risk inflation or having large budget deficits. According to Mosley, this has restricted states' 'room to move' in terms of autonomously choosing their policy options (Mosley 2000). At the same time, this has imposed severe economic consequences on states that are deemed to have lost 'policy credibility' by private financial actors (Grabel 2000). These new constraints that states now face because of the rise of this capitalist hegemon has been called the 'Golden Straightjacket by Thomas Friedman (2000) and are said to explain why states stay away from those previously mentioned policy options. There are plenty of examples how the Golden Straightjacket has reduced the state from a policy-maker to a policy-taker among more wealthier or stronger countries as well as poorer or weaker countries. Among others, these involve the UK, which was forced out of the European ERM by financial speculation against the pound in 1992, and Mexico that sparked a currency crisis by its sudden devaluation of the peso against the US dollar, which resulted in an international financial crisis ignited by capital flight in However, southern states are generally seen to be more vulnerable to the discipline of global financial markets than their northern counterparts are. Especially the 1997 East Asian financial crisis is a clear example of the 9

10 negative effects that liberalized capital flows can have on states' economies when things go wrong. The rapid growth of loans denominated in foreign currencies following the liberalization of financial markets increased the risk associated with a depreciation of East Asian currencies. In 1997, the Thai baht came under speculative attack, which caused private financial actors to pull out as much of their capital as possible based on the conclusion that "it was time to get out and to get out fast" (Bello 1999: 40). This caused international financial institutions to cut all credit to borrowers, including otherwise profitable firms with low debt to equity ratios that would actually benefit from currency depreciation. All that capital leaving the country, which put pressure on the Thai baht, effectively forced the Thai state to officially devalue the exchange rate peg to the US dollar (Broome 2014: 177). That is how generalized fears of a devaluation of the baht became self-fulling, which caused the panic to spread. This prompted a regional liquidity crunch, and soon capital flew out of South Korea, Indonesia, and Malaysia as well. Like that, the capital flight was now exacerbated by the panicked reactions of private financial actors globally. This shows how the forces of economic globalization can have huge consequences for states and their populations, and it exemplifies how the liberalization of financial markets has effectively subjugated the state to the market and reduced the power of the state and its ability to control the capitalist hegemon. This in effect proves that the neo-gramscians are right in their beliefs, while the neorealists are wrong when they assert that states "continue to set the rules within which other actors function" (Gilpin 2001: 18). Another clear example of the state's reduced power is that of the financial crisis of Without going into all the details of the causes and consequences of the crisis, it highlights how the four decades of economic globalization and the integration of financial markets have developed beyond the control of the state as a financial regulator. It shows how the crisis in one country, in this case the private US-mortgage crisis, can develop into a global crisis because of huge volumes of capital flows crossing borders, complex financial instruments linking TNCs and banking institutions all around the world, and the interconnectedness of capital markets, and how this can have severe consequences for states and populations alike. Wigan points out how the capitalist elite following the crisis effectively determined the 10

11 policies of the state, and how the response of the state in turn "reflects both its impotence in the face of financial innovation and the concomitant subjugation of public interests to private imperatives." (Wigan 2010: 122). This also exemplifies how the transnational character of the capitalist elite presents an overarching challenge for the state, simply because the state is bound to its own territory. Since many financial activities of the capitalist hegemon takes places across borders, the power of the state is reduced even further because it cannot legislate in other territories than its own. Cerny puts it like this: "Without the development of transnational regimes capable of regulating global financial markets, the structural basis of the national state itself is being undermined" (Cerny 1994: 319). However, neorealists argue that the state still possess the policy-making sovereignty to control the capitalist elite, which is the exact reason that no international agency has been put in place to regulate international capital flows, simply because the state is not willing to give up its sovereignty (Pauly 2014: 206). The neo-gramscians, on the other hand, believe that this has reduced the state to little more than a policy-taker subjugated to the needs of the capitalist hegemon, which it paradoxically has created itself. And judging from the evidence, they are right. This paper has argued that the power of the state has that the globalization of financial markets has eroded the power of the state with the support of the state itself, which has turned it into a policy-taker subjugated to the capitalist elite. In effect, this paper has sided with the neo-gramscians that are concluded to be right in their belief that the state in its support of economic globalization has in fact given rise to a capitalist hegemon, which the state now has no way of controlling. This conclusion has been reached by 1) showing the power that states had before the collapse of the Bretton Woods Order because of their ability to regulate mobile capital, and 2) how the influence of neoliberal ideas made them believe they were acting in their own best interest when they liberalized financial markets. 3) By providing the empirical evidence for the economic globalization that has taken place during the last four decades and through concrete examples proving the erosion of state power over the capitalist elite, the neorealist has been shown to be completely wrong in their belief that the state is still in control over the financial markets. 11

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