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

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. Keyness 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 overissue of dollars by the U.S. Federal Reserve, made possible by the dollars role as the worlds leading reserve currency. This enabled Americans to live beyond their means and to spend

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 banks purchase of U.S. Treasury bills which allowed the United States to become the worlds 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.

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 Hobbess 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

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

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 3

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

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.

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.

Alan S. Blinder, How many US jobs might be offshorable? Working Paper No.142 (March 2007), Center for Economic Policy Studies, Princeton University.

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 worlds 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.

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 dont 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

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. Waltzs 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 dont 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 doesnt 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.

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

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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 Qaedas 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 11

Eg Peter Singer, One World, , 2003 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 doesnt 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 Bushs potentially unlimited doctrine of preemptive 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 Kindlebergers 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 Kindlebergers 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. Kindlbergers 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 13

Michael Byers,<.p.64 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 Americandominated 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 ones word may yield good pay-offs in the shortrun, 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 Chinas 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 clich 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.

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