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10 Sep 08 Essay for conference on subprime crisis, University of Warwick, Coventry, Sep 18-19 08, organized by James Brassett, jamesbrasset@yahoo.com, and Lena Rethel, lena.rethel@warwick.ac.uk. Not for quotation.

THE FIRST-WORLD DEBT CRISIS IN GLOBAL PERSPECTIVE Robert Wade This essay pulls back from the financial specifics of the current crisis, and puts it in broader perspective. 1 It begins with the sectoral and state interests at play in the globalization works growth model of the 2000s, and the ideas which justified it. It then describes the series of mirror crises now ricocheting around the world. It shows how the crisis has exposed weaknesses in both the justifying ideas (the efficient market hypothesis) and in the regulatory regimes of transactions-orientated financial capitalism, and draws a parallel with the 1920s. Finally, it argues that the sectoral and state interests at play in the build up to crisis will probably ensure that little more than regulatory bandages are applied (beyond some high-profile bail-outs), even though confidence in the justifying ideas has been temporarily -- eroded. In other words, no Polanyi double movement. There is, however, a silver lining at the end. 1. BUILD UP TO CRISIS The East Asian/Russian/Brazilian crises of 1997-98 prompted an outpouring of debate about a new international financial architecture.2 There was even talk of a second Bretton Woods conference. But this response evaporated as the High Command of global finance saw that the crises were contained in the periphery and not spreading to the heartland. Analysts came forward to show that the crises could be safely explained in terms of faults in the affected countries. (The findings suggest that these countries did not follow International Accounting Standards and that this likely triggered the financial crisis. Users of the accounting information were misled and were not able to take precautions in a timely fashion, opined a World Bank study of 2001. 3). The High Command breathed a sigh of relief and devoted its attention to creating global standards of best practice in such domains as data dissemination, bank supervision, corporate governance and financial accounting, and enlisting the IMF to judge the extent of compliance.
See also Wade, The first-world debt crisis of 2007-2010 in global perspective, Challenge, July/Aug 2008, 23-54. 2 Wade, A new global financial architecture?, New Left Review, July/Aug 2007, 113-29; Choking the South?, New Left Review, Mar/Apr 2006, 115-27. 3 T. Vishwanath and D. Kaufman, Towards transparency, World Bank Research Observer 16, 1, 2001, 44, emphasis added.
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Little was done at national or international level to place additional constraints on financial firms such as on the amount of debt they could incur, or the kind of products they could sell. Indeed, the Basel 2 negotiations, starting in 1999, moved in the opposite direction, away from the external regulation of Basel 1 and towards self-regulation selfregulation of entities which were well aware that in the event of crisis they would be seen as too interconnected to fail and hence had a good chance of government bail-outs. The shift from Basel 1 to Basel 2 violates a basic principle of regulation, that entities confident of bail-outs must be regulated externally. But finance in the driving seat pushes for self-regulation plus bail-outs, for this combination permits it the best of all worlds, where it can socialize losses and privatize profits (with the justification that it produces lots of value, even though the productivity of finance is never actually measured). Once the 1997-98 crisis was seen to be confined to the periphery, the consensus settled back into to use John Stuart Mills phrase the deep slumber of a decided opinion: that global capital markets and the US, UK and other regulatory regimes in the North were in good shape, and that globalization was working to spread material well-being ever more widely a message promoted by Martin Wolf of The Financial Times in his manifesto, Why Globalization Works (2004). Since the East Asian crisis the world economy has grown fast on the basis of a global growth model in which the US plays the role of locomotive. US consumers (assisted by British, Spanish, Irish consumers) have binged on consumption financed by debt and rising house prices. Hence the US has run large trade deficits with every major industrial region of the world, and these trade deficits -- readily financed with its national currency because the national currency doubles as the international currency -- have fuelled the rest of the worlds growth. But the deficits have also made the rest of the world very dependent on access to the US economy, and strengthened the US hand in negotiating the proliferating regional and bilateral trade agreements with developing countries. On the face of it, this is a crazy model. First, it relies on recession being temporarily averted by expanding the consumption of already very rich populations in the US and the rest of the North considerations of fairness and climate change notwithstanding. Their rapidly rising consumption is financed by rising levels of external debt, public and private considerations of financial stability notwithstanding. Second, capital is flowing (net) uphill, from South to North, from poorer countries to richer countries; and paradoxically (for neoclassical

economics), countries which export more capital tend to grow faster and invest more than those exporting less. 4 Third, the Chinese governments wish to keep the export machine in high gear and therefore slow down the appreciation of the yuan against the dollar has led it to incur huge costs in accumulating ever more foreign exchange reserves (estimated at as much as one seventh of GDP during the first half of 2008).5 The central bank has invested a large part of its reserves in US securities, much of them bonds of Fannie Mae and Freddie Mac and even AAA-rated asset-backed private securities containing US mortgages. Thus the central banks return flow to the US helped to turbo-charge the US house market during the 2000s, directly contributing to US financial fragility as well as to fast US growth. 6 Fourth, land-abundant developing countries in Africa and Latin America have increasingly specialized in commodity exports, in line with static comparative advantage, as their manufacturing sectors shrink or remain unborn under competition from imports from China. Chinese door makers are even able to outcompete domestic doormakers in the capital city of landlocked Mali, after incurring the costs of shipping doors ___ kilometres from Shanghai. International development agencies like the World Bank celebrate this shift back into these regions sectors of historic comparative advantage; but from the perspective of Schumpeterian/Kaldorian/increasing returns economics it is a disaster for their long-term development. Now, a decade after the East Asian crisis, the deep slumber of a decided opinion has again been disturbed. In June 2007, the normally cautious Bank for International Settlements rang the alarm bell as loudly as it could in its Annual Report:
Years of loose monetary policy have fuelled a giant global credit bubble, leaving us vulnerable to another 1930s slump.

More than a year after the BIS gave this warning the crisis has moved into a slow-burning second stage and is still (September 2008) gathering pace, spreading around the world. Most of the OECD is growing at less than 1% a year and many developing countries slowing to 3-5%. The chances of another 1930s slump (in terms of big falls in output and employment) look very small.
4 UNCTAD, Trade and Development Report, 2008: Commodity Prices, Capital Flows and the Financing of Investment. 5 Keith Bradsher, Bailout likely to increase long-term Asian worries about U.S., International Herald Tribune, Sep 8 2008.

Wade, , The financial crisis: burst bubble, frayed model, openDemocracy, 1 Oct 2007, http://www.opendemocracy.net/article/the_end_of_neo_liberalism

But the chances that it will be worse than any developed country crisis since the early 1990s are high. The current crisis has a peculiar twist, which adds a whole new aspect. Previously, the phrase debt crisis went with third world. Now it goes with first world. Hopes are being pinned on growth in developing countries to rescue the world economy, and on capital injections from developing countries to rescue troubled banks in the US and Europe. The crisis thereby dramatises the ascendance of several developing countries in the global hierarchy. 2. MIRROR CRISES

The crisis is also peculiar in that it is the conjunction of several events each of which might warrant the word crisis, creating complex patterns of interference. It is analogous to what happens when stones are thrown into a still lake, and the ripples from each stone interfere with all the others. We can call them mirror crises. World growth crisis: Throughout 2008 forecasts of US, European and world growth made one week have been torn up the next and generally revised downwards. Weaker than expected is the recurring phrase (except for the US economy, where reports on the second quarter of 2008 are peppered with better than expected). The hoped-for decoupling story that the high growth developing countries would continue to grow fast thanks to domestic demand, and their high growth would help to soften the slowdown of the US and Europe turns out to be a hope. The synchronised decline story now looks more plausible. The crisis will probably cast a long shadow over world growth, depressing it until 2010 at the earliest. (Which might or might not be good for climate change.) The one apparent bright spot is Sub-saharan Africa, where growth may reach 7% in 2008, a historic high. The relatively high growth results in large part from high commodity prices, and in particular, high oil prices. But oil exports are concentrated in only a few countries, so the regional average is misleading; and in those countries, oil is an enclave, whose growth in revenues has little spillover into broad-based development, making averages even more misleading. The credit crisis: The credit crunch is now global in its reach, though impacting most in the US and the UK and least in Japan and most developing countries, with continental Europe in between. The housing crisis: House prices in the US have fallen in the past two years by more than in the Great Depression. The property market continues to

crash in several OECD economies, including the US, the UK, Ireland, Spain, and New Zealand. The crash feeds back into the credit crisis as financial firms remain uncertain of the value of their and their counterparties assets, and are unwilling to lend except at a high premium. The food crisis: The food crisis is partly a price crisis. The rise in food prices is due in significant part to speculation, driven by financial speculators retreating from finance to commodities. For example, the last year has seen the growth of a market in rice futures for the first time. The food crisis is also a shortage crisis. It comes on top of the news that pre-crisis -- the world extreme poverty headcount, using the World Bank measure, was already substantially higher than earlier estimates, thanks to the results of the latest (2005) international price comparison from the International Comparison Project (ICP). The new estimates raise the extreme poverty headcount for China from about 100 million people to 300 million people, for example. While food prices and supply remain at anything near current levels, even more people are unable to meet basic calorific requirements than in the upwardly revised World Bank/ICP estimates for 2005. 7 Energy crisis: High energy prices feed through into rising prices for many consumer goods. Farmers in developed and developing countries who benefit from higher food prices are having their gains wiped out by higher energy and fertilizer prices. Exchange rate volatility crisis: Not only are the major exchange rates jumping all over the place, swinging unpredictably, it is not clear what the true directions should be. For the decade prior to mid 2007, largely free capital markets were driving many exchange rates in the wrong direction, making current account deficits and surpluses bigger rather than smaller. (Iceland was an extreme case: over the past several years, double digit external deficits [24% of GDP 2006, 17% 2007] were accompanied by rapidly appreciating currency thanks to the carry trade from low-interest Japanese yen and Swiss francs to high-interest krona. 8) The US dollar has fallen sharply in the past year, a fall which, in the words of The Financial Times, has cushioned the US slowdown and exported US weakness overseas 9 to the dismay of those overseas governments. One toxic interaction between crises involves commodities (food, energy) and assets. The US, UK and several other OECD economies are now
7 8

REFERENCE Wade, Iceland pays the price for financial excess, Financial Times, 2 July 2008. 9 Krishna Guha, et al., All in this together?, Analysis, Financial Times, 8 Sep 2008.

subject to a dangerous combination of consumer inflation and asset deflation.10 As asset prices fall, everyone tries to sell the depreciating assets at the same time. The result is that many individuals and businesses, which bought assets on borrowed money, end up with more debt relative to assets than before. This is Irving Fishers debt deflation with a vengeance, and it puts inflation-targeting central banks in a near-impossible position. As though this is not enough, the world is also experiencing a broader crisis of interstate cooperation, also known as a crisis of US hegemony, discussed later. 3. CONFIDENCE IN THE ANGLO-SAXON MODEL OF FINANCIAL CAPITALISM This section examines several effects of the crisis, which have in common that they disturb the deep slumber of a decided opinion. Confidence in the efficient market theory of finance In the words of Martin Wolf,
What is happening in credit markets today is a huge blow to the credibility of the AngloSaxon model of transactions-orientated financial capitalism. 11

Paul Volker, the former chair of the US central Bank, recently remarked that
The bright new financial system, with all its talented participants, with all its rich rewards, has failed the test of the marketplace. 12

The great wave of financial deregulation going on around the world from the 1970s was justified by the philosophy of Milton Friedman and his Chicago School colleagues. They formulated it in the form of the efficient market hypothesis, which says that unhindered competition, as distinct from regulation, is the best way to discipline financial market behaviour, because financial markets are flexible, reach equilibrium by themselves, clear continuously, and price risk and return correctly. The implication is that competitive asset markets cannot become substantially over- or under- valued in relation to fundamentals. Any proposed policy intervention to curb asset price booms is dismissed, from this perspective, as financial repression, an automatic boo word.

Paul Krugman, The power of deflation, Int. Herald Tribune, 9 Sep 2008. Wolf, ___, Financial Times, 12 Dec 2007. 12 Quoted in Aditya Chakrabortty, Capitalism lies in shambles, and the left has gone awol, Guardian, Aug 7, 2008.
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These arguments came increasingly to prevail after the breakdown of the Bretton Woods arrangements in the early 1970s (as Samuelson said, Chicago is not a place, it is a state of mind). The world moved towards an optimal financial model with three pillars of responsibility: central banks keep inflation at a low level using short-term interest rates; regulators ensure that individual financial firms act prudently; and capital markets determine asset prices and investment allocation on their own, without government intervention. The current financial crisis is the first time this architectural division of responsibility has come into serious question, because all three pillars have malfunctioned. Indeed, the crisis provides a natural test of the efficient markets hypothesis. The US underwent a dramatic financial liberalization in the 1990s not a de jure liberalization but a de facto liberalization, as barely regulated entities, such as mortgage brokers, came to play a much larger role in the financial system. In particular, the sub-prime mortgage market was the least regulated part of the American mortgage market, and was celebrated as such by many economists, including Alan Greenspan, chair of the US central bank. Thanks to practically no regulation, they said, the sub-prime mortgage market generated all kinds of desirable financial innovation, and enabled Americans with no incomes, no jobs, no assets to buy their own homes. We now see, on the contrary, that the crisis began with loose and negligent lending into the sub-prime market by banks and Wall Street. Their behaviour was driven by lack of regulatory oversight, combined with an incentive system that rewarded management and mortgage brokers for maximizing the quantity of loans regardless of prudence. 13 Re-regulation is in the air. Some mainstream voices are even calling for the re-introduction of measures like the Glass-Steagall Act, the Depressionera regulation which separated US banks and securities traders, repealed in 1999. Globalization champions like Alan Greenspan are deeply alarmed. Greenspans recent op-ed in The Financial Times was titled, The world must repel calls to contain competitive markets (5 Aug 2008). Confidence in the globalization consensus The current crisis reinforces existing doubts about the globalization consensus, as in Dani Rodriks recent declaration that the globalization consensus is dead. 14 How do we measure consensus? One way is through
Wade, The first-world debt crisis., Challenge, July/Aug 2008; Thomas Palley, Scapegoating regulation, 9 Aug 2008, www.thomaspalley.com. 14 Dani Rodrik, ____. REFC
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surveys to find out what economists agree and disagree about. Surveys of the views of members of the American Economics Association in or around 1980, 1990, and 2000 show a high degree of consensus around both positive and normative propositions about openness. For example, Tariffs and import controls lower economic welfare: agree, agree with qualifications, disagree. This statement elicited more agrees in the 1980 survey than any other, at 79%; and similar high consensus in the 1990 and 2000 surveys. (Continental economists have from the beginning shown less consensus. Only 27% of French economists in 1980 agreed to the above proposition.) 15 One way to test the globalization consensus is dead hypothesis is to compare results from the survey of 2010 with those from the earlier surveys. I predict we will see significantly lower consensus around globalization works propositions. Even a narrative as well protected by vested interests and formalization as the efficient market theory and the globalization works story is vulnerable to facts. The big and underreported fact about the globalization consensus is that its expectations have not been borne out, according to several important measures. Consider the following three charts. They show the trend line of average income in the third world (developing countries excluding transitional countries) as a fraction of average income of the North (North America, western Europe, Japan, Antipodes); and average income in developing regions (Latin America, etc.) as a fraction of that of the North. If globalization works, and if we accept that policy regimes around the world have shifted to favor openness, deregulation, liberalization and privatization since around 1980, we expect to see a trend towards rising ratios towards catch-up growth after 1980. What we actually see depends on whether we convert incomes at market exchange rates or at purchasing power parity (PPP). If we use purchasing power parity conversions, the trend lines for most regions are downward sloping (divergence) or flat (chart 1). 16 The PPP trend line for the third world as a whole is upward sloping (convergence) after the late 1980s (chart 2); but the trend for the third world minus China is flat from the 1980s, upticking after 2004 with the commodity boom. If we use market exchange rates (chart 3), the trend is flat after the 1980s, whether China is in or out. CHARTS In short, with this set of measures of global development, globalization (whether as policy regime or as cross-border market integration) only works
REFERENCE Wade, Globalization, growth, poverty, inequality, resentment and imperialism, in John Ravenhill (ed), nd Global Political Economy, 2 ed., Oxford University Press, 2008.
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to produce catch-up growth for the third world when incomes are converted at purchasing power parity and China is included. When China is excluded, PPP incomes do not tend towards convergence; and market exchange rate incomes do not tend towards convergence whether China is in or out. Martin Wolf in Why Globalization Works does not report these trends. Note that the above data on PPP incomes comes from before the recent PPP revisions based on the 2005 ICP price survey. The revisions yielded some of the biggest ever revisions to major international statistical indicators, including a near 40% cut in the PPP GDP of China and India. It is not yet clear how the revisions affect the globalization story; but they probably weaken its empirical support even more. Confidence in the US and UK financial regulatory regimes The crisis has exposed what should have been glaring weaknesses in the US and UK regulatory regimes. The US regulatory regime grew up bit by bit, without any grand plan, and each new financial product tended to get its own regulator. As a result, well over 100 authorities now keep watch over different and overlapping segments of the countrys financial marketplace.17 Many of the authorities get fee revenue from the regulatees (an obvious conflict of interests). The system leaves large cracks between regulated segments. Important segments have been left free of regulation, including the markets for sub-prime mortgages and over-the-counter (OTC) derivatives. Moreover, banks operating across international borders receive only partial regulation of their cross-border operations, partly due to the weakness of cooperation between national regulatory authorities. The UK regime seems to be more unified, with less built-in conflicts of interest. Yet it too has failed spectacularly so two types of transactionsorientated financial regulatory regime have failed, not just one. The British regulatory agency, the Financial Services Authority (FSA), was formed as recently as 1997, at the same time as the Bank of England was given semiautonomy in monetary policy. (The USs SEC, by contrast, was created in the Great Depression.) The FSA has sweeping jurisdiction over the British financial sector; yet it regulates diffidently. At the time of its formation the UK financial sector was extremely powerful, and the incoming New Labour government was only too anxious to please it. So the FSA was established in order to meet the theory of three financial pillars, but it was mainly for display: its budget, staffing, salaries, standard operating procedures and culture were designed to ensure that it did not do much to restrain the behaviour of financial actors. As Howard Davies, the FSAs first chairman, said recently,
17

Joanna Chung, Multi-layered patchwork will be tough to unpick, Financial Times, Apr 24, 2008, 13.

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The philosophy of the FSA from when I set it up has been to say, Consenting adults in private? Thats their problem, really. 18

Hence the FSA allowed UK banks and insurance companies to run with much less capital than similar American organizations. It came as near as it could to allowing financial firms based in Britain to continue on with self-regulation, as before. It has less than 10% the number of enforcement agents of the SEC ( 98, compared to 1,111) for regulating British financial markets one third the size of the US financial market. The consequences of its approach are seen in the case of the aggressive mortgage lender, Northern Rock, which became the first British bank to be nationalized since the mid 19th century. Confidence in the global regulatory structure The crisis has equally exposed the overcomplicated and ineffective character of the global regulatory structure, which is dominated by North American and western European states and non-state entities. The structure has an incontinent number of bodies and obscure relationships between them.19 New committees and working groups are continually added, and few are taken away. There is no locus of leadership, as seen in the fact that the G7 finance ministers have paid little attention to issues of financial volatility since they created the Financial Stability Forum in 1999. The composition of its governing bodies reflects the post-Second World War balance of power. For example, the G20 grouping of developed and developing countries was selected by the US Treasury official in charge of international economic affairs (Timothy Geitner) in a transatlantic telephone conversation with his German counterpart (Ciao Koch-Weser). They had in front of them a long list of countries and went down them one by one, yes or no, to end up with the chosen 20.20 Then they presented the list to the other G7, who agreed. Then they issued invitations. The Basel Committee on Banking Supervision (established in 1974) reflects the post-war power structure in even more distorted form. It comprises 13 member states, of which 10 are from Europe, including Belgium and mighty Luxembourg. Japan is the only Asian state. China and India are not members, nor any state in the southern hemisphere. Although charged with supervising the worlds banking system it is accountable to the G10 (in practice 13) of central bank governors, a majority of whom have either no bank supervisory responsibilities or only marginal ones. In countries where banking supervision is organized separately from the central bank, the heads of banking supervision are not officially involved in the committee.
18 19

Jesse Eisinger, London banks, falling down, www.portfolio.com/views/comments/wall-street/2008/08/13. Howard Davies and David Green, Global Financial Regulation, Polity, 2008, especially 33. 20 From a source who requested anonymity.

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Again, in the International Organization of Securities Commissions (IOSCO), which is to securities markets what the Basel Committee is to banking, the key Technical Committee, where standards are set, is a selfperpetuating body which includes two Canadian representatives but none from China or India.21 4. The wider interstate political crisis Confidence in the global economic and security regimes The financial crisis has hit at a time when interstate cooperation across many economic and security domains is particularly fragile. The G7 states have been notably uncooperative in their response to the crisis. As one observer remarked, We are witnessing one of those instances when the monetary authorities are not cooperating with each other. He went on to suggest that the US Fed was needlessly creating hardships for Europe by the speed and scope of its monetary easing delaying taking more direct action to recapitalize or close banks, thereby delaying the day of reckoning and exporting the USs problems by adopting policies that weaken the dollar.22 The IMF is in deep trouble, almost bankrupt and facing big staff cuts. The WTOs Doha Round is on life-support. The US and the EU are competing to form regional/bilateral trade and investment agreements, by-passing the WTO and twisting the arms of their partners to get them to accept trade and investment liberalization and intellectual property protection much more stringent than could be negotiated through the WTO, trying to restore the old hub and spokes trading system. The UN is even weaker than before, thanks to the efforts of the US in replacing Kofi Annan, who sometimes stood up to the US, with a Secretary General who could be relied upon not to. Meanwhile, the G8 states are trying to have their cake and eat it too by incorporating major developing countries at the top table of world governance, but in a second-class citizen kind of way. This is the formula known as the G8+5, where five leading developing countries (Brazil, India, China, South Africa, Mexico the list was drawn up by the G8) are invited to participate at the G8 summits in a limited way. Their heads of government are invited to fly half way around the world in order to join the G8 heads over a lunch followed by a few hours of discussion, and then go on their way. The formula is not viable. The USs capacity to lead in multilateral fora has been seriously compromised by the wars in Iraq and Afghanistan, which have plunged its
21 22

Davies and Green, Global Financial Regulation, 60-61. Charles Wyplosz, The Fed is delaying the day of reckoning, Financial Times, 13 Mar 2008, 37.

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moral authority to rock bottom in much of the world. Economically, the USs fundamentals are much weaker than in, say, 1990, due to excessive borrowing and excessive spending. The US is now vulnerable to countries on the other end of the US trade deficit coordinating the application of financial pressure on the US for strategic purposes. Washington foreign policy circles are full of talk of a new Cold War, of Russia as a threat to the US and Europe and of a Russia-China axis looming in the background.23 Overlooked in Washingtons rush to resurrect the Cold War is the extent to which, in much of the rest of the world, the US is now seen as the worlds only expansionist ideological power, aggressively pushing everywhere, promoting and even invading for democracy, moving far beyond its traditional sphere of influence in the Caribbean, Central America, and Latin America, anchoring itself in about 1,000 military bases across the globe. (The rest of the world generally understands that neither Russia nor China are any longer ideological powers, even if Washington does not.) In short, the international financial crisis is occurring at the same time as the international political-economic framework seems to be weaker than it has been for a long time, producing a feedback loop from political to economic conditions, making concerted interstate responses more difficult. In particular, the kind of cooperation demonstrated in the framing of trade rules through the WTO is conspicuously lacking in the even more important domain of monetary and exchange rate policy, where in the absence of interstate rules mercantilist strategies have free rein. Parallels with the 1920s The fragile condition of the global financial regulatory regime and the larger framework of inter-state cooperation suggests parallels with the situation in the late 1920s, which brings us back to the BISs apparently exaggerated bracketing of current events with the 1930s slump. The big question about the Great Depression is why an ordinary downturn in 1929 became a Great Depression. 24 Economic historians have tended to locate the reasons in economic factors, such as the growth of unregulated banks in the US during the 1920s followed by a wave of bank runs in 1930 and 1931, combined with adoption of mistaken monetary and trade policies as the downturn worsened.

The Russia-China friendship is not just driven by elites. Many Russians now see China as their closest partner, and the number of Russians who see China is a friend is more than double the number who feel the same about the US. Jonathan Steele, The Sino-Russian embrace leaves the US out in the cold, Guardian 12 October 2007. 24 Robert Boyce, The Great Interwar Crisis: Why There Were Two World Wars, Not One, and Why Understanding the Crisis May Help Us Avoid a Third, manuscript, London School of Economics, Jan 2008.

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This explanation short changes international political factors. During the 1920s no state or coalition of states was providing the sort of public institutions for the world economy which Britain had provided before World War I (via the Bank of England, Lloyds, the City, and the Royal Navy) and which the US provided after the onset of the Cold War. At the same time, the global security framework had become flimsy to non-existent by the late 1920s. The League of Nations was hobbled (the US declined to join). These conditions played into the hands of nationalists and imperialists, producing a climate of jittery insecurity in the major states, which deterred them from cooperating in international economic institutions and encouraged them to subordinate economic policies to national security concerns. One indicator of this is that trade treaties made in the 1920s were of much shorter duration than previously. There is no metric with which to compare the strength of the international political framework in the 1920s and early 1930s with todays. But it seems plausible that a similar dynamic is at work today as in the earlier period, whereby a frayed international political framework makes it more likely that the worst is yet to come. 5. Beyond bandages to Polanyi? There is no shortage of ideas about new forms of regulation and new global financial norms. The US Congress, the US Treasury, the UK Treasury, the IMF, the Financial Stability Forum, the G20 and others are all actively discussing reform proposals. And some dramatic steps have been taken, most notably the nationalization of Northern Rock, and Fannie Mae and Freddie Mac. But what are the chances that anything beyond regulatory bandages will be applied to the private sector? What are the chances of a Polanyi double movement, whereby the disruptions of the let the market work era generate sufficient political support for the state to become more active in managing investment and constraining finance? Recall what happened in the wake of the Asian crisis of 1997-98: as the crisis stopped threatening the heartland the encroaching forces of complacency ensured that the High Command did little beyond formulating a raft of new international standards of good practice; it placed few additional constraints on market participants. This time, too, the financial industry will use its formidable power over legislatures and regulators to ensure that few additional constraints are placed on it. The industry benefits hugely from an architecture of floating exchange rates, free capital movements and the Dollar Standard, and from the rotating supply of asset bubbles around the world. Bubbles make for

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expanding opportunities for profitable arbitrage, and thereby for continuous increase in the share of capital income relative to labour income. So Wall St will continue to insist that the line of solution is more standards of good practice and more pledges of good behavior, but not more constraints on leverage, on new financial products, on incentive pay for executives, and the like. Analysts celebrate every bounce of the stock market as the light at the end of the tunnel (rather than the approaching train), in the hope that policymakers will be dissuaded from getting serious about re-regulation. Within the UN system, UNCTAD is the only source of clearly heterodox arguments and prescriptions, especially through its annual Trade and Development Report. But the US representative on the UNCTAD governing body actively tries to rein in the TDR team. The TDR budget is tiny compared to the World Banks budget for the World Development Report. (The TDRs have print runs of about 12,000 in English and another 78,000 split between the five other UN languages, compared to the WDRs print runs of about 100,000 in English, not to mention the other languages. 25) In the wider international policy community in the North, many would agree with the Financial Times journalist who declared, The world would loose nothing if UNCTAD disappeared.26 This is how the antibodies work to marginalize arguments that challenge the globalization consensus. The US interest in the financialization of China With the crisis having questioned the stability of even well institutionalized financial markets, the financial industry is worried that developing countries may draw the lesson that they should slow down the momentum towards full financial opening (as UNCTAD suggests). The US state is equally worried. It gives high priority to persuading China to take steps that would amount to giving up the developmental state, in which, domestically, Chinese state-owned banks support Chinese industry, and externally, China builds a renmimbi bloc in East and South East Asia and special political-military links with major commodity suppliers. This developmental state model interrupts the USs primary competitive advantage, which is the ability of its financial firms to insert themselves into positions which break the domestic finance-domestic industry link, and redirect flows of profit back to the US. Over the 1990s the US was able to contain the threat of this kind from Japan and South Korea (in Korea by encouraging the government to break the finance-industry link in the name of free market economics); but China is a bigger challenge and a richer prize.

Wade, US hegemony and the World Bank: the fight over people and ideas, Rev. Int. Pol. Economy 9, 2, 2002, 201-229. 26 Personal communication.

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Tensions will rise as the US presses China to open its financial system at the same time as the US experiences a political backlash against sovereign investment funds, including Chinas. Sovereign investment funds will be searching for other US assets than low-yielding Treasuries or dubious assetbacked securities. Their purchase of US icons will further fuel anti-trade sentiment in the US. The move towards a multi-polar world order For those who look forward to a new world order in which the US and the G7 have less power to set the agenda of global business on their own (even while the US remains the indispensable nation), the crisis has a silver lining. The fact that it is the first crisis in history where hopes are pinned on growth in developing countries to rescue the world economy, and the first time that troubled banks in the US and Europe have been rescued by capital injections from developing countries, should jolt the US and the G7 out of complacency about their own leadership and about the truth of market fundamentalism. The crisis may be a stealthy bridge-building event towards incorporating China and several other emerging market states as equal partners at the top table of global economic governance, 27 and towards a new approach to the role of political authorities in governing the market,28 and even towards loosening the grip of finance and the military on the US government. But the immediate sharp question the Keynesian demand question -is whether developing countries will try to break away from their commitment to export-led growth as their exports to the US economy slow, and instead develop internal demand to compensate for falling demand in the North.29 If they did it would be a sure sign of the weakening of the globalization consensus, with its supply-side emphasis. But to do so they would have to take steps to curb soaring income inequality, especially top incomes relative to the median, and redistribute income downwards. So deeply has the globalization consensus eclipsed concern about income inequality, worldwide, that it hardly features on the public policy agenda except in the reduced form of poverty reduction. When a small group of World Bank economists proposed to write a World Development Report on income inequality and development, Executive Directors from two countries in particular were adamant that the Bank could not touch the subject, because inequality was political and the Bank was a non-political organization. Who were they? They were the EDs from Russia and China. They eventually gave their consent after the economists pledged that they would focus on how to expand opportunities to earn income (equity), as distinct from the distribution of income per se. The World Development Report was written under the title,
27

To soften the representativeness-colleagiality tradeoff, some current top table states would have to be invited to merge their representation with others. Several European states are obvious invitees. 28 Robert Wade, Governing the Market, Princeton University Press, 2004. 29 Thomas Palley, Decoupling vs. the concertina effect, 8 Sep 2008.

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Development and Equity [CHECK], 2006, The story is a useful reminder that wider representation at the top tables of global economic governance will not necessarily make for more progressive global policies. END