Defining Global Financial Orders

When we refer to global financial orders (GFO), we refer most explicitly to the rules, norms, and procedures that govern cross-border money and finance. GFOs foster common expectations and focal points about what constitutes international money, what cross-border transactions can be legitimately conducted, and the appropriate forms and modalities to regulate national financial sectors. Elements of any global financial order include the rules and arrangements governing currency convertibility, exchange rates, payments and settlements, banking regulation, supervision of non-banking financial institutions, accounting standards, and so forth.

Global financial orders consist of formal rules, informal rules, and meta-rules designed to create stable expectations about behavior as well as to handle deviations from expected behavior. The codified rules, such as the IMF Articles of Agreement or the Basle Core Principles, are self-evident. GFOs also include informal norms and procedures governing the financial sector. Examples would include the US “strong dollar” policy of the late 1990s, or the tradition of an American presiding over the World Bank and a European presiding over the IMF.Footnote ¹⁵ Finally, GFOs also include either explicit or implicit understandings for how to regulate, preserve, and defend challenges to the system. The current process of IMF quota reform or the creation of the G-7 to manage the post-Bretton Woods exchange rate system would be examples. Simply put, the global financial order consists of the rules themselves and the meta-rules about how to deal with violations and dynamic changes in world capital markets.Footnote ¹⁶

Global financial orders can vary across several dimensions. First, GFOs vary in terms of their degree of scope. Are the various rules and informal rules and practices widely agreed on and mostly followed by participants? A second important dimension is in the area of adjustment. How is adjustment carried out?Footnote ¹⁷ Are the costs of adjustment highly skewed or widely shared across all actors in the system? Do private or public actors bear more of the burden? If public actors, what is the pattern around which states adjust? Does adjustment lead to a period of stability to keep the system on an even keel, or trigger of crisis and upheaval? A third important dimension is the embeddedness of the global financial order within the rest of the global economy. In terms of maintaining the status quo, to what extent does finance have priority over other dimensions of the global economy? Do the rules and practices governing the financial order prohibit or embrace the active management by public actors, be they national or international?

Applying these criteria helps to distinguish the Bretton Woods order of “embedded liberalism” from the “Washington Consensus” of the post-Cold War world.Footnote ¹⁸ In terms of scope, the Bretton Woods system was concentrated primarily among the core OECD economies, whereas the Washington Consensus was truly global in scope. In terms of adjustment, both orders shared the principle that it was incumbent on countries running balance of payments deficits to take corrective action in response to crises. During Bretton Woods, for example, it was assumed that states facing balance of payments crises would respond with a mixture of domestic macroeconomic adjustments and external assistance from the IMF.Footnote ¹⁹ In terms of embeddedness, the Bretton Woods system was set up such that global finance was subordinated to trade integration and domestic policy autonomy. Under the Washington Consensus, however, capital market openness had greater priority over domestic macroeconomic policies.

This conception of global financial order is consistent with both the standard international relations concept of an international regime, and the more recent concept of a “regime complex.”Footnote ²⁰ This definition also covers the more recent economic debates over the future of the international financial architecture.Footnote ²¹ Furthermore, these are the arrangements that have occupied the attention of mainstream IPE scholarship over the past two decades.Footnote ²²

Empirical work in economic history demonstrates the tendency of financial orders to drift towards credit overexpansion, speculative financial bubbles, amassing of public debt, and eventual collapse.Footnote ²³ Charles Kindleberger famously described financial crises as “hardy perennials” in his telling of the cycles of manias, panics, and crashes that occur with monotonous regularity, even if spectacular in each individual episode and devastating to many.Footnote ²⁴ Yet political scientists have not done as much to fill in the gaps of why and how policymakers, investors, and citizens keep believing that, in Reinhart and Rogoff's words, “this time is different.” One of our starting assumptions is that no global financial order can conceal its internal contradictions indefinitely. All global financial orders experience a life cycle of emergence, dominance, and collapse.

Power in All Its Forms

Power and ideas are foundational to understanding the sources, cycles and workings of global financial orders. Such a statement seems intuitive, perhaps, but to a striking extent recent work in international political economy (IPE) has not, in fact, placed these issues at the center of analysis. IPE has produced a rich literature on the sources, mechanics, and consequences of international financial markets.Footnote ²⁵ Recently, however, the subfield has been strangely silent about some of the macro issues of the international financial and monetary system. Instead, an “open economy politics” (OEP) approach has dominated IPE scholarship for the past generation.Footnote ²⁶ David Lake accurately summarizes the OEP approach as follows:

In other words, open economy politics privileges domestic interests and institutions as the source of actor preferences and constraints, and essentially “brackets” everything else. By starting out at the domestic level, interactions between the domestic and systemic levels—or purely systemic factors—are excluded.Footnote ²⁸ In this way, OEP is a “reductionist” approach.

By looking at the constellation of domestic interests and institutions, this paradigm has developed sophisticated models of structure-induced equilibria at the national level.Footnote ²⁹ In adopting a reductionist view of the workings of markets and politics, however, the open economy politics approach has also developed significant blind spots in analyzing global financial orders. As Thomas Oatley has observed, this paradigm accords “no explicit theoretical role to macro-level processes,” which limits the ability of OEP scholars to study how systemic processes like financial contagion or hegemonic coalitions affect national economic policies.Footnote ³⁰ Authors reflecting on the subfield of IPE have lamented the failure to consider the “big questions” posed by events of the past decade.Footnote ³¹ Some scholars have gone so far as to label current IPE as a “monoculture” because of OEP dominance.Footnote ³² Indeed, the OEP approach was responsible for more than three-quarters of all IPE articles published in International Organization and the American Political Science Review between 1996 and 2006.Footnote ³³

It is not a coincidence that the OEP approach reached its zenith during the Washington Consensus era. The global distribution of power and interests were essentially treated as constants during this period, with shifts in domestic institutions as the key causal variable. The “Great Moderation” in the United States made it appear that ironclad laws of proper policymaking had been discovered. Topics like the geopolitical consequences of global macroeconomic imbalances or the choices of reserve currencies—in other words, questions about economic power—did not receive sustained study by IPE scholars working in the open economy politics tradition.

We view economic power as a critical but often neglected factor shaping the global financial order. The concept of economic power falls in the interstices between economics and politics, and neither discipline has fully grappled with the topic. It has traditionally made economists and political scientists uncomfortable, albeit for different reasons. Economists are generally reluctant to talk about the idea.Footnote ³⁴ Notions like “market power” and monopoly power” certainly exist in the literature, but economists tend to focus more on the ways in which markets erode temporary agglomerations of power.Footnote ³⁵ Political scientists are far more comfortable with the notion of power, but they are much less comfortable with economics. Economic power therefore remains an understudied concept.Footnote ³⁶

IPE scholars have studied the role that various dimensions of power have played in shaping global financial orders. Daniel Drezner, Herman Schwartz, and Carla Norrlof have explored the ways in which America's market power has determined the global governance of finance.Footnote ³⁷ Ngaire Woods has examined how China has used its development aid to win influence in Latin America and sub-Saharan Africa. David Bach and Abraham Newman have looked at the ways in which the capacity of national and international regulators has affected governance outcomes.Footnote ³⁸

We contend that to explain the sources and consequences of the shifts in the global financial order requires a tight focus on the role of power, not only in a material geopolitical sense, but in the social construction of macroeconomic policy models, as well as the social construction of financial markets themselves. The ways in which different economic metrics of good housekeeping, such as debt loads or trade balances, are interpreted have profound implications for the distribution of geopolitical power. The rules that govern the integration of global financial markets are drawn up by self-interested actors, whose ability to get those rules adopted and complied with is always and everywhere partially informed by the various types of power resources that they hold and exercise. In turn, the rules themselves and the institutions that arise around them, reverberate back onto the relative power positions of the actors, national or otherwise, in a dynamic process of power creation and diminishment. For example, shared understandings among economists about the Great Depression led to a temporary embrace of Keynesianism in the fall of 2008. The negative market response to mounting levels of sovereign debt in Greece led to a re-evaluation of the merits of fiscal expansion, however. Rather than understanding that market-policy response as given and unchanging, we view it as dynamic and based on interpretations by the human beings that make up markets and policy circles, always in the context of power.

Periods of crisis, such as the post-2008 years of turmoil, present a particularly opportune moment to examine these dynamics of power and social construction. When the global financial order is stable and relatively conflict-free, participants and observers tend to take for granted established rules of thumb, without overtly acknowledging the underlying processes of social construction and power that reproduce that stability on a daily basis. With crisis, however, the underpinnings of the system become visible, questioned, and potentially up for grabs. In periods of crisis, this contingent nature is painfully revealed as a paycheck might suddenly be worth much less when hyperinflation erodes its purchasing power before it clears. Uncertainty about the future heightens the stakes for winners and losers from the pre-crisis system to engage in fights about what constitutes the correct rules, policies, institutions, or market positions.

In periods of stability, we forget the contingent nature of money as it takes on the status of a stable social fact. Periods of stability likewise often mask the exercise of political power within these markets. As Peter Gourevitch observed twenty-five years ago:

The US-centered global system of the early post-Cold ar era was one in which the US was materially the most powerful nation.Footnote ⁴⁰ The lock-in of international institutions such as the IMF or the Basle Committee on Banking Supervision, and the emergence of important national actors such as China and India have conspired to make less prominent the role of the US in providing the material, political, and ideational infrastructure for the expansion of global markets and the norms and rules governing them. Economic and political power is more contested than it has been in decades, providing us with an opportune time to examine these dynamics.

Ideas in All Their Meanings

The previous sections should make clear that we reject the false dichotomy between power and ideas, between material interests and social relations. The financial realm offers a particularly overt set of empirical evidence for the role that ideas, perceptions, norms, and culture play an inescapable role in the operation of markets. Modern money, after all, is the ultimate social construct. Fiat currency obtains value only in social interactions among human beings. Be it a printed piece of paper or an electronically represented number, money only has value to the extent that those using it can agree upon that value. Intersubjectively constructed, it does not exist unless symbolically represented, and depends upon shared understandings and ongoing practices for its existence and valuation.

What is challenging for policymakers, and deeply interesting for social scientists, is the dynamic construction of financial value. Rules, norms, and prices are determined through practice, and therefore always have the risk of instability as actors interact and change their views over time. Indeed, the history of GFOs demonstrates the wide swings that occur in the beliefs about what constitutes value in market terms, whether it is tulip bulbs, collateralized debt obligations, or Wenzhou real estate.Footnote ⁴¹ A financial bubble is intrinsically defined by a collective shift in actor perceptions about the value of an underlying object. Beliefs about what constitute appropriate government macroeconomic policies have likewise shifted over time and place, sometimes dramatically as in the shift to Keynesian demand management of the early postwar periodFootnote ⁴² to the price stability emphasis of the late twentieth century.Footnote ⁴³ Ideas about the costs and benefits of financial regulation have evolved over time as well, in ways that have had a huge impact on the unfolding of the current crisis.Footnote ⁴⁴ Scholars of international money and finance have long focused on how these ideas have become institutionalized in bodies like the IMF.Footnote ⁴⁵ When one set of beliefs takes hold and fundamentally reshapes the very ways that actors and values are constructed and categorized dependent on the broader worldview, we can understand a process of productive power to be at work.Footnote ⁴⁶

Financial markets can reward or punish state actions in dramatic ways, but we cannot predict much without an appreciation for the underlying cultural or ideational context within which those markets are acting. In the 1990s run-up to Europe's Economic and Monetary Union (EMU), states, such as Italy, that were very far from the target of a three percent budget deficit were able to come close to meeting that goal because financial markets became convinced that Italy and others were serious about cutting budgets and raising taxes. As interest rates came down, lowered debt payments contributed a substantial portion of the savings allowing for ultimate entry into the new euro.Footnote ⁴⁷ In the wake of the 2008 financial crisis Ireland has slashed its budgets by a much larger percent but cannot convince markets of its stability, creating a vicious cycle rather than a virtuous one. The beliefs private actors hold, constructed in interaction with other and public actors and situated within larger social institutions, become reality, even if the functional determinants may not clearly indicate which way these dynamics will go.Footnote ⁴⁸ As power is exercised through more structural and social contexts, the role of ideas becomes ever more salient. Attractive and politically expedient ideas can attract key supporters, subtly altering the balance of power in an emergent global financial order.

Constructing Financial Orders: A Life-cycle Model

We propose the following life cycle for understanding the recent global financial disorder and its theoretical implications. This analytical framework could be applied to other IPE or domestic policy arenas, but there are also some elements that seem particularly salient to the financial realm because of its subjectively constructed and thus particularly fluid nature. In its attention to the importance of taking a fine-grained approach to the question of how power is constructed and exercised, it could provide an example for other emergent areas of international concern.

In our suggested approach, the specific cycle of global financial transformation starts with a period of perceived stability, where actors broadly assume that the difficulties and troubles of the policy arena have been largely worked out. There is little overt contestation of ideas, and the distribution of winners and losers from the enshrined set of policies, regulations, and market activities has been institutionalized and is no longer the source of significant political conflict. There is a relatively pervasive sense that cause and effect relationships have been worked out, and that there are no viable or workable or desirable alternatives to the dominant paradigm. It should be stressed that these hypothesized relationships are not necessarily accurate in their causal mechanisms. Like Ptolemaic astronomy, however, so long as the predicted outcomes match reality closely enough, the causal mechanisms are accepted as true, allowing convergent expectations to form across the financial system. This stability of the global financial order can provide a political mask to contestation, and keep policies and market arrangements in place that might have extensive private and public negative externalities. During this period there is “apparent consensus” among experts. This phase mirrors the Kuhnian “normal science” phase of paradigmatic development in science, or the notion of John Stuart Mill's “dead dogma” in the case of political rhetoric.Footnote ⁴⁹

In the prior global financial order, the accepted wisdom of the Washington Consensus was that open, lightly-regulated, internationally-integrated financial markets would provide the best engine of growth for the global economy. It rested on a set of ideas that had been developed over the previous half-century.Footnote ⁵⁰ Motivated by economic ideas but also entrenched in material interests and promoted by powerful proponents, this conventional wisdom also viewed adjustment in global imbalances as occurring primarily through market actions. In this “end of history” style telling, the 1990s ushered in a period of almost unanimous agreement that booming markets and economies around the world were best promoted by a “hands off” attitude to financial sector firms so that they could best and most efficiently use the market logics to distribute capital efficiently throughout the economy.Footnote ⁵¹The efficient market hypothesis concluded that state regulation was essentially unnecessary, since all information about any financial asset was encapsulated in its price.Footnote ⁵²The constellation of interests arrayed around this particular form and content of the global financial order were relatively stable as well, resting solidly and not coincidentally on the role of the US as the unipolar power of the post-Cold War system whose financial markets and financial services firms dominated the era of the open-market ideology and ever-growing global capital flows.Footnote ⁵³ The scholarly literature in the field of international political economy analyzed this spread of the more neoliberal policies,Footnote ⁵⁴ but tended to spend little time anticipating the potential tensions in the “disembedding” of the market that came with those policies.

The next phase in the Kuhnian life-cycle is one of stresses and transformations, both material and ideational. These stresses open up a space for political reconsideration of the particular arrangements and rules governing the international financial order. Of course, this reconsideration is really a political contestation. Actors and interests that believe the current global financial order cannot sustain itself will lobby for wholesale change. Those that are convinced that the system is sustainable will propose more modest reforms or fixes to the system. The Asian financial crisis would represent an example of this kind of contestation during the Washington Consensus. Although there were actors who pushed for a wholesale change in the global financial order, the system was reinforced. In the process, however, the decision by the Pacific Rim economies to “self-insure” against a future crisis—rather than rely on the IMF—helped sow the seeds of the Great Recession a decade later.

As time passes, endogenous effects are likely to cause the original animating ideas to lose explanatory power over time. As time passes, foundational ideas become obscured by absolutist ideology, caricature and ad hoc efforts to explain away emerging anomalies. The longer that a particular idea appears to explain its particular domain, dynamics emerge that guarantee its future applications will be a poorer fit. Intellectuals have an incentive to engage in ideational arbitrage and apply the idea to more disparate phenomena, increasing the likelihood of policy failure. Propagandists have an incentive to simplify the content and causal mechanisms of the idea, eroding the ability to falsify it. As Angus Burgin documents, the laissez-faire ideas that started in the Mont Pelerin Society were far more complex than how those ideas appeared a generation or two later.Footnote ⁵⁵

As previously noted, we assume that no global financial order can be indefinitely maintained. The longer a theory stays in circulation, the greater the likelihood of underlying conditions shifting to the point where the original model's empirical claims do not hold up. The accumulation of stresses and strains occurring over time eventually triggers a breakdown in the consensus around a particular set of policies and interests. This dynamic has been explored by a variety of authors in the field of international relations and comparative politics.Footnote ⁵⁶ At this stage, power and ideas interact in the context of uncertainty over what is the “correct” model of growth and stability in an expanding global financial order. New strategies, templates and exemplars get generated, and the role of geopolitical, bureaucratic and other types of powers in promoting a particular vision of how the global financial order should be run.

During the crisis stage, the ideational discussions around the “correct” economic policy model pay close attention to the ways in which power both feeds in and shapes the ultimate outcome of policy recommendations, but also to how those ideas, once institutionalized in rules and practices, then feed back and empower some actors while disempowering others. During this contestation period, actors promulgate ideas that define the key problems that triggered the crisis. These ideas, in turn, create constraints on possible policy solutions.

Actors can draw upon multiple sources for new ideas—and try to advance them through a variety of power mechanisms. Some ideational agents choose to rely on historical analogies to define the problem and possible solutions.Footnote ⁵⁷ Since the 2008 crisis, for example, the interwar era has been closely examined to see what mistakes can be avoided and what lessons can be learned.Footnote ⁵⁸ Other actors can also point to the actors that have best weathered the current crisis as geopolitical exemplars that offer a policy template for others. Discussions of the Beijing Consensus follow this route.Footnote ⁵⁹ During times of crisis, economists can also innovate and offer new models for policy guidance. Keynes wrote The General Theory during the Great Depression; the rational expectations revolution emerged during the stagflation crisis of the 1970s; the 2008 crisis accelerated the scholarly trend towards behavioral finance.

Actors can use multiple power mechanisms to advance their preferred set of ideas. The winners and the losers from a transforming economy are highly motivated to shape the debates and outcomes over the rules of the global financial order, and will certainly use ideas tactically as “hooks” to move forward their preferred policies.Footnote ⁶⁰ But ideas are not just strategic resources wielded by self-conscious actors. They also can take on structural power, generating blowback on strategic actors, reconstructing their interests in ways unlinked from conscious framing or manipulation by those actors.

Ideas become structurally powerful when they diffuse widely, gain acceptance and constrain alternative thinking. For example, the battle over defining exactly what caused the financial crisis in the first place is central to framing debates for the next global financial order, and whether it will stress the greater embeddedness of capital markets. Defining the problem as a failure of regulation, a failure of financial markets to assess risk properly, irresponsibility on the part of greedy homeowners overleveraged in debt, or Chinese over saving and capital inflows into the US all create different potentially politically-salient policy solutions. Contestation over defining the problem in a period of financial crisis will in part determine the type of policy responses, transformative or not, that then are possible.

Why We Need to Re-embed Markets in International Relations

The above analysis offers an approach that is fundamentally different from the analysis offered by much of current IPE scholarship. For example, one aspect of the financial system instability—speculative attacks—is the subject of work in the Open Economy Politics tradition.Footnote ⁶¹ Attacks on national currencies are often modeled as a function of financial market actors' expectations about government policies (left or right) and the likelihood of a particular government surviving elections. Markets are modeled as reacting most strongly in the event of an unexpected collapse of a right wing government, as they are hypothesized to fear capital controls or other regulations that might dampen profits with the arrival of a new leftist government.

However, as a casual observer of any financial crisis—including the ongoing Eurozone mess—would note, contagion is a large part of the dynamic of any financial crisis. Contagion is by definition a process that occurs across actors at the systemic level, as individual national currencies, or bond markets, or banking systems, are linked in traders' minds and categorized as risky because they are either geographically proximate, as in the Asian Financial Crisis, or linked by a currency, as in the Eurozone crisis. While there are clearly domestic level attributes that will impact traders' evaluations of the sustainability of a currency or national bond, contagion can be important in determining the outcome national financial crises.Footnote ⁶² Peer group effects—the ways in which private markets categorize countries together when evaluating the sustainability of financial assets—are one such contagion dynamic that may be determinate in explaining the path and severity of a financial crisis across multiple states.Footnote ⁶³

Such contagion processes across states are intrinsically captured in the model of global financial orders that we suggest. By looking to the systemic level of interactions across national orders, and by characterizing those interactions as a combination of market logics, geopolitical power, and ideas, critically important phenomena like contagion become theoretically legible and empirically tractable, even as they escape the view of the domestically-focused OEP approach.

When instability in the global financial order occurs, global financial markets can unravel remarkably quickly, as in the autumn of 2008.The severe dislocations caused by the crisis cast the “Washington Consensus” policy template into doubt more broadly. The delegitimization of this global financial order has brought about a period of genuine uncertainty about the correct path towards stabilization and ultimately, reconstruction and revitalization in the global economy. While non-Western states never fully embraced in word or in deed the strictures of the Washington Consensus, they also have not generated a clear and compelling alternative model of development and growth. Contrary to popular perceptions, there is no “Beijing Consensus” on matters of international finance.Footnote ⁶⁴ Or, to put it more bluntly, what the Washington Consensus and Beijing Consensus have in common is that they were both invented in Washington. As multiple scholars have observed, China has actually adhered to most of the major planks of the Washington Consensus.Footnote ⁶⁵ Chinese officials have been exceedingly reluctant to recommend their development model to other countries. Indeed, there is a striking lack of consensus within China about the relative merits of the Beijing Consensus; it is therefore not surprising that they have not proselytized it elsewhere.Footnote ⁶⁶ So the overall impression of observers of the collapse of the US economy and the global financial system is that its reconstitution is occurring without a clearly agreed upon or articulated template.Footnote ⁶⁷

Our approach suggests a new avenue forward for thinking about the global financial order, opening conceptual and analytical doors. In his review essay on the 2008 crisis, Eric Helleiner concluded that “the development of a more comprehensive understanding of the political economy of the underlying causes of global-scale financial crises remains an important task for future IPE researchers.”Footnote ⁶⁸ In developing a better understanding of global financial orders, we urge our colleagues in IPE to take up Helleiner's challenge. We suggest here ways to think about the concept of global financial orders, tracing out how power is exercised and manifested in tandem with ideas, building on a Kuhnian life-cycle model.

International political economy needs to be resituated within the context of the study of international relations more broadly. Economists increasingly acknowledge the role that political power and ideas play in determining national and global prosperity;Footnote ⁶⁹ it is time that IPE scholars were willing to be as bold. The analysis of financial markets needs to be re-embedded within broader debates about the nature of international politics. Greater attention to security, power transitions, and non-state actors can offer an enhanced view of the study of the politics of international economics.Footnote ⁷⁰ This is a pragmatic, not ideological, choice. We view this re-embedding as a necessary step for unlocking the challenges that confront scholars and policymakers alike in the area of international finance today.