International Political Economy Final Exam 2016 IDEAS VS. INTERESTS Alexander Gamerdinger XXXXXX-XXXX 19.12.2016 Bsc. International Business and Politics Copenhagen Business School, Tutorial Class: XX Word Count: 3298 Page Count: 9,9 STU Count: 22.742 0
Introduction The debate between the role of ideas versus the role of interests in determining different actors behavior and their outcomes, is a contemporary issue within International Political Economy (IPE). Their mutual relationship is particularly crucial in understanding change, as this conveys which of the two drives outcomes more predominantly. I, in this essay, will argue, that ideas are shaping the interests of actors and thus deliver a better understanding of change through determining behavior of actors in IPE. Exemplified by the globalization of finance, I seek to explain how ideas, by shaping interests, changed state actors, international institutions and market actors behavior from encouraging capital controls to legitimizing their liberalization. Hereby, I will employ constructivism as the cornerstone of my theoretical analysis claiming the superiority of ideas and neo-realism as well as liberal institutionalism advocating the priority of interests. Directing the attention to the essay s structure, I will first address the theoretical framework, outlining the analysis of interests/ideas. Secondly, I will briefly summarize the emergence of global finance from the Bretton Woods (BW) to the post-bw system. Thirdly, I turn to the empirical part by showing 1) how neo-realists explain states behavior change of liberalizing capital controls 2) and how constructivists give a more in-debt explanation for that. Fourthly, I will address how the European Community (EC) and the Organization for Economic Cooperation and Development (OECD), codified liberalization opposed to state interests and thus contributed to change. Lastly, I outline how market actors through their investment decisions brought change to the BW system. Theoretical framework Neo-realism Neo-realism is a state-centric theory, arguing that due to the anarchic state system and associated power relations, states primary concern is their own survival (Broome, 2014: 34). International organizations are not adjudged particularly significance but rather are assumed to be incumbent upon states and their interests, only deemed to endure if a hegemonic power fosters this development through penalties and benefits (Ravenhill 2014:65). The theory strongly emphasizes the self-interest of the actor, which in the state s regard amounts to protecting the state s physical, political and cultural identity against encroachments by other nations (Morgenthau, 1952:972). Moreover, the self-interest should lead to utility maximizing, cost avoiding actions, which are rankable in preference 1
or i.e. express rational behavior relying on rational choice theory assumptions (Broome, 2014: 34 ;Ravenhill 2014: 32). As Geuss demonstrates, these rational 1 assumptions can only hold water if actors have access to full information (Geuss in Blyth, 2002:28), presenting a weak point that will be asserted by constructivists later on. As hitherto demonstrated, neo-realists articulate actors behavior and thus change through rational reactions to situations by solely drawing on their self-interest, neglecting the importance of ideas in their decisions. Liberal Institutionalism Liberal institutionalism incorporates self- interested individuals, groups, firms and states in its unit of analysis, stressing the fact that actors are rational and risk adverse (Moravcsik in Broome, 2014:35). As Keohane emphasizes, self-interested states attain their interests collectively through cooperating within international institutions, particularly if problems cannot be solved individually (Brome, 2014:34). Moreover, international institutions are favored by states as they lower transaction costs, provide information and thus reduce uncertainty, (Ravenhill 2014:65-6) yet serving the interests of the member states. Liberal Institutionalist stress that actors behavior is largely driven by their interests. Despite acknowledging that ideas matter, liberal institutionalists do not award them the power to effect interests, and can therefore be subsumed under neo-realism (Wendt, 1999:19). The only point of distinction between the two theories is whether states engage in absolute or relative gains. Hence, this essay will treat neo-realist and liberal Institutionalist perception of interests equally 2 since both theories are undersocialized in the sense that they pay insufficient attention to the ways in which the actors in world politics are socially constructed (Wendt, 1999:4). Constructivism Constructivism, which is illustrated rather as a conceptual toolbox than a theoretical paradigm, seeks to understand dynamic roles played by ideas, norms, values and identities in political processes and outcomes (Broome in Palan, 2013:193,199). As the reality for constructivists is socially constructed (rejecting positivism), ideas are crucial in shaping interests and therefore actors behavior. Moreover, ideas are intersubjective constructs that constitute both the identity of an actor, as well as his or her interest (ibit.). Especially during change and more generally in times of 1 Rationalist approaches in IPE are originate in IR, pointing out the material nature of the actors self-interests, which is perceived to be the unit of analysis in neo-realism (Broome, 2014:35) 2 they both are referred to as rational theory also incorporating rational choice theory. 2
uncertainty, Frank Knight highlighted that actors are unable to calculate all available possibilities of their actions and therefore need to rely on shared social constructions of how the world works in order to cope with these situations (Broome in Palan, 2013: 195). This notion of Knightian Uncertainty is used to debilitate rational theory by declaring perfect information as rather implausible and thus comes to the conclusion that ideas and interests cannot be separated (Blyth, 2002:28). Rather, ideas are prior to interests in determining behavior. This can be seen as the main issue 3 between constructivism and neo-realism/liberal institutionalism, that will guide the overall paper. Now I will turn attention to the globalization of finance and start with a chronological summary of this process. Globalization of Finance: From Bretton Woods to Post-Bretton Woods After the second World War, the in 1944 founded BW system appeared on the world stage, being broadly visible through 4 features: capital controls 4, fixed exchange rates with adjustable pegs to the dollar, state monetary autonomy and the creation of international institutions such as the International Monetary Fund (IMF) and the International Bank for Reconstruction and Development (World Bank) (Ravenhill, 2014). The systems aim of monetary stability, achieved through capital controls, was seen as legitimate by states, contrary to floating exchange rates, which were starkly associated with beggar- thy-neighbor policies and speculative financial flows (Ravenhill 2014:178). Furthermore, BW was undermined by the Euromarket, which emerged 1957 shortly before all European states restored their current account convertibility in 1958. The Euromarket, which was an unregulated, international offshore 5 money market trading in US dollars, created, apparently spontaneously by merchant and overseas bankers based in London (Burn, 2006:4), permitted private market actors to freely move short term financial flows without constraints and thereby increasing financial speculation. Gradually emerging, the Euromarket experienced its heydays in the 1970s following the oil crisis in 1973 (Ravenhill 2014:180). 3 this issue is referred to as the three-cornered debate by Wendt, where due to the similarities between neo-realism and liberal institutionalism (as part of neoliberalism), they are treated as one rational theory (Wendt, 1999:4). 4 Ravenhill defines capital controls as: restrictions placed by governments on private [market] actors moving funds into or out of the territories they control. (Ravenhill: 2014:399) There are short and long run capital flows. Especially short run capital- or speculative financial flows was seen as dangerous during BW. 5 Palan defines it as a set of juridical realms marked by more or less withdrawal of regulation and taxation on the part of a growing number of states (Palan, 2003:19). 3
Turning the view to the US, the country experienced enormous problems with its current account balance, which has, due to the fact that the US acted as a world bank, turned into a account deficit in 1959 (Eichengreen, 2007). As dollars were invested abroad, extra dollars were printed causing the value of dollars to decrease which threatened to break the dollar-gold par of 35$ per ounce. This lead to the introduction of the Interest Equalization Tax (IET) in 1963 intentionally decreasing profitability of foreign investments by American firms, to counteract the dollar outflow. Here, the Euromarket hindered the IET from succeeding as American market actors took advantage of the deregulated market to pursue their investments. Continuing the vicious cycle, the dollar value inevitably misaligned with the gold-peg (dollar overhang), increasing speculative activity and finally closing the Golden Window in 1971. (Blyth, 2002; Eichengreen, 2007:10). This marked the end of the BW system. States such as the US and UK did not fully liberalize their capital controls before 1974 and 1979 respectively. (Helleiner, 1994:8). In the 1980s, the liberalization of capital controls was codified by the EU and the OECD, obligating member states to end capital controls. Consequently, there has not been an ultimate political authority regulating capital flows in the post BW era (Ravenhill 2014:206), which has been characterized by an increasing number of crisis through private financial speculation, even though increased stability was promised. (Wigan, 2016). The Liberalization Process and States From a neo-realist perspective, international competitive dynamics have forced states to liberalize capital controls and therefore change is explained through states acting in a rational manner, aligned with their self-interest. Starting at the source, the liberalization process was initiated by 1) the national interests of the US and UK to support the creation of the Euromarket and 2) by financial as well as technological innovation minimizing costs of market actors (Ravenhill, 2014:180). The prime interest of the US, in supporting the Euromarket was to gain foreign investors to finance its account deficit, whereas the UK was primarily concerned with re-establishing London as a global financial hub by taking legal actions to create an offshore money market, attracting private investors (Burn, 2006:8; Ravenhill, 2014:180-1). The market, being completely deregulated, lured international capital and business into London, while capital controls were still existent. Even the US Federal Reserve and the Treasury encouraged American Banks to move their assets to London. (Helleiner, 1994:89). This offshore opportunity in Britain initiated competitive pressure for other states to deregulate their 4
markets as domestic capital and business threatened to move their assets to London. (Helleiner, 1994a:301). Neo-realists call this situation a collective action problem, since a group of states that could gain from market regulation (e.g. higher taxes) would never counteract deregulation due to the high costs involved. As an increasing number of states, due to arguably competitive pressure, liberalized capital controls (US 1974, UK 1979), the costs of implementing more effective capital controls was too high since international capital has already spread transnationally. (Ravenhill, 2014:181). Consequently, the competitive dynamics continued until the BW system and capital controls collapsed. Instead of international competitive dynamics pushing states to liberalize capital controls, constructivists argue that neo-liberal ideas, which have been in the back-head of decision-makers for an enduring time, redefined the interest of states to pursue this action. But what were these ideas and how could they emerge? Neo-liberal ideas broadly argued against Keynesian ideas (dominating during BW) in that they advocated state deregulation, so capital could move to locations where it could be utilized most effectively, reducing risk (Helleiner, 1994a: 310). Moreover, ideas included floating exchange rates and liberalizing capital flows in order to address external imbalances more smoothly than it could with a fixed exchange rate. (Chwieroth, 2010:71). Ideas shift especially in times of crisis 6, when there is uncertainty and doubt in the effectiveness of the current system. In this case, the 1970s economic downturn caused problems such as stagflation, which existing ideas and institutions seemed unable to address (Blyth, 2002:5). This situation, due to general uncertainty, forced state actors (decision-makers) to rely on current shared social conceptions (Knighting Uncertainty), which during this time were largely neo-liberal in thought. At this point, other questions arise such as how did the ideas shape states interests and to how is this explanation more convincing than the realist one? Blyth adds here, that ideas can be used as weapons to delegitimize existing institutions (Blyth, 2002:35). In the case of the US, Helleiner adds that the alteration of policy was largely influenced by advocates of neoliberal thought who attained vital positions in the US Treasury and other institutions (Chwieroth, 2010:141). Experts such as 6 another crisis, that could have been discussed here instead, leading to the same outcome, represents the exchange crisis in 1957 in London, which could arguably have lead to the emergence of the Euromarket through financial elites ideas. As Burn argues, the emergence of the Euromarket is an un-researched area, largely unsupported by facts, yet he suggests that financial elites had influenced the decision. (Burn, 2006: 7-9). 5
Milton Friedman and Gottfried Labeler e.g. shaped policy positions of the Nixon and Ford administrations through their ideas (ibit.). These ideas, connected with promises of a more stable and efficient world economy, shifted state interests from legitimizing capital controls to liberalizing controls and deregulating the market for the sake of a more effective world economy. Yet, these changes of interest did not occur simultaneously around the globe. The US and UK were one of the first states advocating neo-liberal ideas in the 1970s facing tremendous opposition by European and Japanese officials, which instead urged more stringent cooperative control measures (Chwieroth, 2010:138). Furthermore, some of these states demanded a new international economic order which placed emphasis on expanding state intervention and limiting private finance flows in the international market. However, by the 1980s, many have abandoned their calls and this phenomenon is dubbed the silent revolution (Boughton in Ravenhill, 2014:205). The last point demonstrates that the constructivist explanation is more convincing since some states opposed the liberalization for a long time. These states only legitimized capital controls through force by international institutions, which will be addressed later. If the realist argument had been true, the race to the bottom would have continued until markets were completely deregulated. The Liberalization Process and International Institutions Liberal institutionalists, to review, see institutions as a tool for states to decrease their cost and increase information through cooperation and thereby acting within the state interest. Here, I will demonstrate how ideas are able to change the attitudes of institutions, and thereby disregarding the self interest of member states. Despite capital liberalizations of formerly mentioned states US and GB the liberalization process until the 1980s can be described as uneven, since many governments still deliberately employed capital controls (Abdelal, 2006:3). Here, two international institutions EC and OECD went a step further than states and de-legitimized capital controls on short term capital flows through codifying the liberalization of capital for all the member states. Even though it commonly is perceived (realists) that the US Treasury, Wall Street or the Euromarket fostered the legalization of capital movements, the European policy makers and the OECD made a more significant contribution even acting against American realist national-interest 7 (Abdelal, 2006:3). Constructivists argue that reality is constructed in the minds of decision-makers (Ravenhill, 2014:66) 7 The realist national interest of the US (and others) would have never allowed to give power to institutions and infringe sovereignty. (Abdelal, 2006:3) 6
and place, in this case emphasis on how two neo-liberal agents Jacques Delors and Henri Chavranski altered the EC s and OECD s perception of capital controls in times of uncertainty. Hereto, Delors as a French pioneer pushed capital liberalization on the EC agenda in the belief that it would 1) strengthen the Mittelstand of Europe 2) follow liberal thought and 3) benefit the European Market and identity. (Abdelal, 2006:7). By infiltrating the institution with neo-liberal ideas and using his powers of expertise and agenda setting, Delors sought to persuade other policy makers to legitimize capital flows. After several failed proposals, the directive was finally adopted in 1988 facing opposition from especially southern European member states. In a similar fashion, Chvranski pushed the development in the OECD, which was successfully implemented in 1989, even though some member states were opposing. (Abdelal, 2006;Howarth & Sadeh, 2011:640)). Consequently it has been shown how institutions, through ideas rather than interests contributed to financial liberalization, disregarding some national-interests of member states to continue capital controls. The Liberalization Process and Market Actors The emergence of the Euromarket in 1957 has assigned significant power to private market actors by permitting their financial flows to move without regulation. Broadly, this power shift has not only lead to financial instability through speculative short term flows, but also weakened the states in their effort to keep capital controls (Broome, 2014:104). Arguing from a constructionist view, market actors have contributed to state capital liberalization as they promoted and enacted neo-liberal ideas weakening the legitimacy of the BW system. These ideas included the belief that bubbles, crisis and market failures do not exist in a liberalized market as the investors possess all available information (Chwieroth, 2010:80). Furthermore, it was believed that speculative financial flows are not harmful to the economy but rather stabilizing (Chwieroth, 2010:73). An unregulated market was seen as a stable and efficient market. In the time of stagflation and increasing uncertainty as well as economic downturn, private market actors were able to influence the states with these liberal ideas. Furthermore, they pressured states through speculative flows against their exchange rates, forcing them to liberalize. Subsequently, I will show that the intentions of neoliberal ideas and their assumption of full available information cannot be achieved. 7
Market actors believed to act rationally aligned with their self-interest, as neo-liberal ideas pledged. Yet, I will illustrate, how every single investment decision is shaped by these neo-liberal ideas rather than pursued rationally according to the self-interest, as rationalists argue. Let s go back to the market situation in the 1970s. As the market became increasingly unstable through speculative flows, investors diversified their assets internationally to reduce their overall risk. (Ravenhill, 2014:180) Moreover, through economic downturns at the time (stagflation), the market perception was characterized by uncertainty. When investors made a decision, they faced 1) incomplete information as the size of international financial market was enormous and 2) uncertainty of what decision to pursue. Therefore, market actors had to rely on shared social conceptions of how the market works in order to understand the situation and to pursue their next actions (Knightian Uncertainty) (Chwieroth, 2010:66). Since the market environment was represented by other neo-liberal thinkers, investment decisions were merely re-enacting these beliefs. Actors thus neglected to realize that the intentions of neo-liberal ideas stable and effective market were not achieved. In contrast, the market after post-bw, which can be considered neo liberal (floating exchange rate), has been more instable as ever before (Ravenhill: 2014:190) leading to several crises. 8
Conclusion To conclude, this essay has shown that ideas deliver a more robust understanding of change than interests, as they shape interests and therefore actors behavior in the first place. This overall claim has been confirmed by enlightening the predominance of ideas in three core issues concerning the globalization of finance. First is has been shown that states liberalized capital controls not due to international competitive dynamics following their national-interest, but due to ideas shaping their interest of liberalizing controls in the first place. Secondly, it has been displayed how international institutions furthered this development by codifying the liberalization of capital controls for states. This development has also been primarily pushed by ideas through agency redefining the interests of these institutions rather than complying to the national interests of the state. Thirdly, I showed that market actors were contributing to the liberalization process of states, through speculative flows undermining the BW system as well as being subject themselves to neo-liberal ideas rather than acting with self-interest in every investment decision. These arguments have been backed up by constructivism arguing for dominance of ideas and well as neo-realism and liberal institutionalism arguing for the importance of interests. Even though dominant neo-liberal ideas enabled change from BW to post BW, it does not mean that these ideas were true. Placing power in the hands of private market actors, which continue to believe they are acting rationally although facing incomplete information, did not create a stable market. In contrast, it is a dilemma leading to increasing crisis and instability at the expenses of the state and the taxpayer. How can states allow that to happen, when they should distribute wealth equally among their inhabitants? One might argue, that they are not seeing the clear picture through these neo-liberal ideas. But there is hope, as social conceptions are constantly changing, especially during times of uncertainty as shown throughout this essay. Maybe, Keynesian ideas will return. 9
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