Reconceptualizing Interstate Power Relations

From an interstate perspective, the crisis has coincided with, and reinforced, a diffusion of power in global finance, thus challenging analysts to move beyond their past focus on the United States and the EU as dominant powers in international regulatory politics. In the late 1990s and early 2000s, developing countries were the main targets of the international standards project but they played little role in influencing the agenda of the United States and EU.Footnote ²² A decade later, China and other emerging powers within the developing world seized the opportunity of the crisis to demand a greater role in discussions about the future of international financial regulation to match their growing weight in global financial markets. Their new influence came less from the hosting of attractive financial markets than from the increasing significance in world markets of their investments and financial institutions. This significance was apparent at various stages of the crisis when cash-strapped U.S. and European institutions pleaded for financial support from investors and financial institutions from many of these “emerging-market” countries. The fact that many of these investors and institutions were state-owned (as in the case of sovereign wealth funds, central banks holding large reserves, or state-owned Chinese banks) only reinforced the power of their governments at that moment.Footnote ²³

U.S. and European recognition of their dependence on these new centers of wealth in the world economy helped pave the way for a widening of the “clubs” involved in international standard-setting. The demands of emerging powers for greater representation were initially met through the creation of G20 leader summits whose first meeting was focused almost exclusively on international regulatory issues and which immediately took over the role of agenda-setting in this policy area from the G7. With the encouragement of the G20 leaders, the membership of key international standard-setting bodies—such as the BCBS—was then quickly widened to incorporate more emerging powers from the developing world. The membership of the FSF was also expanded at the April G20 summit in London to include all G20 members, and this body was transformed into a more robust institution—the Financial Stability Board (FSB).Footnote ²⁴

These developments were important not just because they highlighted that international regulatory politics could no longer be viewed as what Posner calls the “Euro-American regulatory condominium.”Footnote ²⁵ At a theoretical level, these developments also revealed the limitation of past scholarship's focus on relative market size as the key source of power in international financial regulatory politics. International regulatory power can stem not just from the hosting of attractive financial markets but also from being the home country for internationally important investors and institutions. This different kind of “market power” of a number of emerging-market countries has, if anything, been augmented by the crisis. Investors and financial institutions from many emerging powers have weathered the crisis better than most American and European firms. Banks located in emerging-market countries have also taken advantage of the massive losses experienced by American and European institutions to climb the charts of the largest banks in the world (the three largest banks in the world in 2009 by market capitalization were Chinese).Footnote ²⁶ This has given their home governments growing clout in international regulatory politics. Understanding the significance of this different kind of market power, and how it might be used in the coming years, needs to be an important subject for future research.

The crisis revealed one further limitation in precrisis conceptions of interstate power. Before the crisis, scholars focused primarily on “power-as-influence”; that is, how the hosting of important markets provided power to shape international rulemaking through changing the behavior of other countries. Since the start of the crisis, some flexing of power in international regulatory politics has had a different objective that is closer to what Cohen has called “power-as-autonomy.” Cohen describes this form of power as the capacity “to exercise policy independence—to act freely, insulated from outside pressure in policy formulation and implementation.”Footnote ²⁷ This form of power has been particularly apparent in the EU's regulatory response to the crisis. In addition to trying to influence the behavior of other countries through the G20 international regulatory discussions, European policymakers have acted unilaterally to reduce Europe's dependence on, and vulnerability to, U.S. regulatory practices in a number of areas. They have flexed this “power-as-autonomy” by insisting that international private financial entities operating in Europe be subject to a greater degree of “host country control” by European regulatory authorities than in the past. This attempt to create what some commentators have called a “New Fortress Europe”Footnote ²⁸ has been particularly apparent in the derivatives sector where an initiative is underway to force American derivative dealers to clear their EU contracts through a central counterparty located, regulated, and supervised in Europe for the first time. In the realm of the credit-rating agencies, European policymakers have also forced American rating agencies to have their ratings endorsed by a European subsidiary subject to European regulation.

Future theoretical work needs to explore the nature of this “power-as-autonomy” in international regulatory politics. Its importance has been apparent not just in Europe but also in emerging powers such as China. At the same time that Chinese investments and institutions are becoming more prominent within international markets, the country's domestic financial markets are growing in size and diversity. Chinese domestic markets are hardly able to challenge New York or London in terms of their attractiveness to foreigners yet, not least because the Chinese government limits foreign access to them.Footnote ²⁹ The growth of Chinese markets, in other words, is not boosting its power-as-influence in international regulatory politics. But it is reinforcing China's power-as-autonomy by lessening the dependence of Chinese firms on U.S. and European markets. This growing ability to carve out an independent regulatory path can also be seen in other emerging countries such as Brazil and India whose domestic financial markets are increasing in size and sophistication. Whether officials in these countries take advantage of their rising capacity to adjust domestic regulatory policies without reference to the outside world and to withstand external pressures should be another future research topic. If policymakers do set down that route, their countries' growing power-as-autonomy may turn out to have an even more important impact on the trajectory of international regulatory politics than the power-as-influence gained through their new membership in the “clubs” that set international financial standards.

Changing Domestic Politics in Core States

The crisis also revealed domestic political dynamics in leading advanced industrial countries that are difficult to reconcile with Singer's model. To begin with, the crisis challenged his assumption that “the main actors in international regulatory harmonization are regulatory agencies.”Footnote ³⁰ The severity of the crisis and the politicization triggered by massive bailouts of financial institutions in the United States and Europe put significant domestic pressures on elected policymakers in these core states to become directly involved in international regulatory politics. This was apparent in the way U.S. and European leaders used the G20 leaders process from November 2008 to lay out unprecedentedly detailed priorities and timetables for their own officials and international financial technocrats to follow.Footnote ³¹ This development marked a striking reversal of precrisis trends, which Singer had (correctly) summarized in the following way: “the rules of global financial governance are increasingly the creation of international committees of regulators and private actors rather than heads of government acting in concert.”Footnote ³²

The U.S. Congress and legislative bodies in Europe, especially the European Parliament, also influenced the direction of international regulatory change in a more direct way than simply threatening to curtail the autonomy of regulators (as in Singer's precrisis model). The crisis triggered intensive legislative debates in the United States and Europe on previously obscure topics such as the regulation of credit default swaps or reforms to accounting standards, generating detailed legislative initiatives that in turn influenced the direction of international regulatory agreements. Members of the U.S. Congress even engaged in diplomatic missions to interact directly with members of the European Parliament on this issue.Footnote ³³ The role of legislative bodies in shaping the direction of international reform was also enhanced by the ambition of the postcrisis international regulatory reform agenda that left regulators dependent on major legislative action at home to implement commitments reached internationally. This dependence has undermined Singer's assumption drawn from the precrisis experience that “regulators who initiate international negotiations over harmonization do not face a ratification requirement and therefore can conduct themselves in a relatively opaque and seemingly apolitical environment.”Footnote ³⁴ These new direct roles assumed by leaders and legislators from leading countries in international regulatory politics require an in-depth understanding of the preferences of a wider set of public actors—leaders and legislators—toward international regulatory issues, as well as the domestic pressures they face.

The crisis has also challenged the way that many precrisis domestic-level analyses dealt with the role of domestic societal actors in shaping international financial regulation. Like other analysts, Singer highlighted how the range of domestic societal actors engaged in policy debates about international financial regulation was usually much narrower than in international trade or exchange rate politics because of the complexity of financial regulatory policies and their more indirect and less obvious costs and benefits. While Singer noted that financial crises generated domestic political pressure on legislators to act, his model does not explore the specific roles of societal actors beyond the financial industry in much detail. The recent crisis encourages scholars to focus more attention on the role and preferences of a broader range of domestic societal actors in core states. The politicization of financial regulatory issues during and after the crisis triggered the mobilization of corporate actors outside the financial sector as well as citizens' groups, who found in the U.S. Congress and European Parliament new ways to influence U.S. and European positions toward international regulatory reform. We need more detailed knowledge of how the mobilization of these groups beyond the financial industry can influence the direction of state policy toward international regulatory standards indirectly through legislatures, as well as through direct lobbying of regulators and the executive branch.

The crisis also highlighted the limitations of models that depict the financial industry in leading powers as a cohesive group in regulatory debates with uniform preferences that stem from international competitive concerns. During the financial crisis, quite sharp divisions emerged among different parts of the private financial sector, divisions that reduced the sector's overall influence. Banks demanded tighter regulation of credit-rating agencies against these agencies' wishes. Accountants and banks strongly disagreed with each other about the need to reform mark-to-market accounting. Investors and exchanges criticized the reluctance of derivatives dealers and brokers to accept tighter regulation of over-the-counter derivatives. In some cases, these divisions reflected efforts by individual sectors to shift the blame for the crisis and the regulatory burden upon other sectors. In other cases, certain parts of the financial industry recognized material gains they could realize from regulatory tightening in specific areas. The disagreements also reflected different lessons learned from the crisis and distinct judgments about the long-term interests of the financial industry. These developments suggest the need for future theorizing to disaggregate the industry into its constituent parts and to embrace more context-specific analyses of financial industry preferences.

More detailed attention should also be devoted to the entire question of private “capture” of financial regulatory policymaking. Johnson has played a particularly important role in provoking debates on this topic with his argument that the crisis was caused in large part by the “river of deregulatory policies” sponsored by the private financial sector in the United States.Footnote ³⁵ Johnson has argued that the financial sector's disproportionate influence over regulatory policies came not just from campaign contributions but also from the prestige and cultural capital the sector amassed during the boom years as well as from the “revolving doors” between regulators and financial industry members that allowed the latter to have their preferences internalized in the policymaking process.Footnote ³⁶ Britain's top regulator, Lord Turner, has also talked about “regulatory capture through the intellectual zeitgeist” of the dominant belief among regulators in market efficiency during the years leading up to the crisis.Footnote ³⁷ Other analysts have highlighted how regulators face particular pressures during financial booms not to rein in excessive financial growth from the financial industry and others who argue that “this time is different.”Footnote ³⁸ This dynamic suggests the need for more cyclical theories of private influence in which booms encourage deregulation, followed by crises and reregulation.

One final area for future theoretical innovation relating to the domestic context in “core” countries relates to the diffusion of interstate power we described earlier. Like other prominent precrisis analyses of the domestic origins of international financial regulation, Singer models the relationship between independent regulators and their domestic political system drawing on the experience of advanced industrial countries. This approach was understandable when the United States and Europe were the principal dominant powers, but it is now more problematic given the growing influence of policymakers from countries whose domestic political context is often radically different.Footnote ³⁹ For instance, the relationship between regulators, politicians, and financial industry groups is quite distinct in China where many of the most internationally active financial institutions are state-owned and regulators remain under more direct control of the executive.

The growing power of countries with quite different domestic political contexts highlights the need for more comparative analyses of the distinct domestic foundations of policies toward international financial regulation. Such analyses should address not just how national institutional arrangements influence state policy toward the design and implementation of international standards (for example, unitary versus federal political systems, single regulator versus different regulatory bodies etc.).Footnote ⁴⁰ Equally important are more structural analyses that explore how attitudes toward international regulation are influenced by distinctive “varieties of capitalism.”Footnote ⁴¹ Some recent scholarship has pioneered this approach by showing how the different roles of the financial sector in Anglo-American liberal market economies versus Rhenish-coordinated market economies can help explain disagreements between these countries concerning the role of credit-rating agencies within the Basel II negotiations, the adoption of international accounting standards, and the regulation of hedge funds.Footnote ⁴² The global nature of the crisis provides analysts with particularly favorable conditions to advance this kind of comparative research agenda by exploring how this simultaneous shock has generated convergent or conflicting responses in different countries.

In sum, the crisis has reinforced the importance of the overall insight that Singer and others have developed about the centrality of domestic politics for international financial regulatory developments. But the crisis has also revealed new domestic political dynamics in core countries that suggest the need for adjustments to precrisis analytical models. Many of our suggestions here are in fact similar to points taken up by Walter in his study of compliance in peripheral countries. As noted, he analyzes a wider range of public and societal actors, identifies the differentiated preferences of financial industry groups, and embraces insights from comparative politics. The crisis has revealed how these approaches are now relevant also to the study of domestic politics within core countries with respect to both the setting of international standards and their domestic implementation.

New Constraints on Transnational Politics

The crisis has also posed some challenges to the kind of transnationalist analytical framework put forward by Porter and others. To begin with, Porter and others in this tradition assume that transgovernmental networks operate quite insulated from their respective domestic political contexts and from interstate diplomatic pressures. These networks did demonstrate significant autonomy in the early stages of the crisis; indeed, it is striking how transnational regulatory bodies under the leadership of the FSF took the initial lead in formulating the comprehensive internationally coordinated regulatory response that was endorsed at the first G20 leaders summit in November 2008.Footnote ⁴³ But the ability of internationally networked technocrats to set the agenda soon became more constrained by the greater activism of the G20 leaders and legislative assemblies such as U.S. Congress and the European Parliament, which started to set detailed priorities and stringent deadlines for technocratic officials to meet.

The very feature of the networks that had been their strength before the crisis—their carefully cultivated autonomy—now became the subject of criticism from politicians who held the unelected international committees of technocratic officials at least partially responsible for the crisis.Footnote ⁴⁴ Faced with newly engaged political leaders and resurgent domestic political pressures, transnational networks of financial officials were increasingly forced to react rather than to lead the international regulatory reform process. This development highlights the need for future research in the transnational tradition to theorize the ways in which transnational political processes are nested within the domestic and interstate political contexts.

The crisis has also challenged Porter's assumption that transgovermental networks have a strong capacity to forge consensual technical knowledge. To be sure, this capacity was clearly on display right after the outbreak of the crisis when officials working within the FSF set the international agenda by reaching consensus on a detailed road map to strengthen existing international standards in various incremental ways. Even more impressive was the fact that by early 2009 they had developed a shared commitment to a new macroprudential regulatory philosophy that was aimed at preventing the accumulation of system-wide risk (as opposed to the microprudential focus of existing standards on protecting the stability of individual financial institutions, markets, and instruments). Since then, however, cracks in the ideational cement began to open, particularly vis-à-vis questions relating to the implementation of macroprudential objectives such as curtailing procyclicality in the financial system or developing differential treatment of “systemically important” institutions. Increasingly strong and public disagreements among financial officials from the leading powers eroded the cohesion, and thus the influence, of transgovernmental expert networks.

These disagreements partly reflected the growing external constraints on the autonomy of transgovernmental regulatory networks' emanating from domestic and interstate political contexts. But transgovernmental networks have also experienced challenges from within. The severity of the crisis badly shook confidence in the kinds of ideas and forms of knowledge around which technocratic consensus had formed during the preceding years. Walter documents in his book how the East Asian financial crisis of 1997–98 eroded the confidence of policymakers in that region and encouraged them to view and embrace an Anglo-American model of “regulatory neoliberalism” as a superior model.Footnote ⁴⁵ Because the post-2007 crisis originated in U.S. markets and quickly spread to the British financial system, the legitimacy of that model has been undermined and authorities from East Asia, continental Europe, and elsewhere have become more assertive in questioning U.S. and UK regulatory practices. In the absence of the old “intellectual compass,”Footnote ⁴⁶ the task of creating a focal point around which the reforms of different national regulators can converge has become more difficult. Scholars working in the transnationalist tradition need to research and theorize the politics of consensus formation and knowledge generation within the transgovernmental networks in this new environment.

Future researchers also need to explore whether the difficulties in reaching and maintaining technocratic consensus may be exacerbated by the inclusion of new members from emerging powers within transnational groupings. The latter reform, driven by political imperatives within the interstate political context, has increased the intellectual diversity in these groupings. In the past, developing country officials often presented quite distinct perspectives on international regulatory issues.Footnote ⁴⁷ These perspectives reflected not just development priorities but also the fact that their countries' financial systems, regulatory arrangements, and traditions were often quite different from those of advanced industrial countries. Are the new members of the “clubs” of international standard-setting thus likely to challenge the ideas and knowledge developed by advanced industrial states within these bodies, or will the transgovernmental bodies instead socialize the new members into the worldviews of the existing membership? Similarly, the fact that officials from new member countries such as China are more directly under the influence of their government's executive branch raises important questions about the capacity of transgovernmental networks to remain insulated from the exercise of power politics and the pursuit of national interest. Is their new membership further weakening the capacity of transgovernmental networks to remain autonomous? More generally, are emerging states as susceptible to being “disaggregated” in the way that transgovernmental network theory suggests?

A number of postcrisis developments are not easily reconciled with another important trend identified in the transnationalist analytical perspective: its focus on the growing power of transnational private interests in international regulatory politics. Faced with a crisis of such enormous scale, politicians seized back much of the regulatory authority they had delegated to private actors. Under attack for its unclear accountability, the poster child for “private authority” in international regulatory politics—the IASB—accepted public oversight of its activities for the first time in early 2009. G20 policymakers also committed to extending greater public control over those sectors where international regulatory responsibility had been delegated to the self-regulatory initiatives by transnational private actors before the crisis, such as over-the-counter derivatives, hedge funds, and credit risk management by banks. In addition, public authorities agreed to assume a greater role in monitoring and enforcing compliance in areas where these activities had previously been assigned to voluntary efforts, as in the case of credit-rating agencies. Lobby groups representing the international financial industry have opposed, but failed to stop, a number of these international regulatory reforms, as well as others such as the introduction of international standards on compensation.

The crisis has thus revealed how the power of transnational private actors is more contingent than some of the precrisis literature suggested.Footnote ⁴⁸ Before the crisis, the close relations between transgovernmental networks and the transnational financial industry drove many of the precrisis international regulatory trends.Footnote ⁴⁹ According to Tsingou, these elite officials and industry actors increasingly constituted a cohesive “transnational policy community” transcending the distinction between public and private, and dominating international financial regulatory politics.Footnote ⁵⁰ As the crisis shifted the political action more to the domestic and interstate contexts, this community became, in Tsingou's words, “under stress” and transnational private-sector groups found it less easy to capture the international regulatory agenda.Footnote ⁵¹

Moreover, while the precrisis literature often depicted transnational private financial interests in monolithic terms, this crisis has revealed the emergence of sharp divisions among transnational financial industry. Some fault lines reflected the same kinds of conflicts noted above at the domestic level. But intra-industry conflicts at the transnational level were exacerbated by developments in the interstate and domestic political context. In the aftermath of the bailouts, policymakers pressured their national banks to strengthen their ties and redirect the provision of credit toward their home economy. The heightened awareness that global banks are global in life, but national in death (as the governor of the Bank of England Mervyn King put it) has complicated the efforts to forge a coherent transnational private-sector voice.Footnote ⁵² The ability of transnational private groups to remain a coherent transnational political force may also be weakened by the growing status of financial firms from emerging powers, especially China. While state-owned Chinese banks are now members of the IIF, the ambiguity of their status may inform their perspectives on international regulatory issues and align them more with those of public authorities in their home country.

We are not suggesting that international private financial interests have lacked influence in postcrisis international regulatory politics. As memories of the crisis have begun to fade, transnational private-sector lobbies have also become bolder and more successful in their efforts to slow down and dilute many international initiatives to tighten regulation, often by exploiting policymakers' concerns about international competitiveness issues, and by highlighting the costs that regulation could impose upon the broader economy by stifling the recovery from the crisis. From the perspective of a number of observers, the enduring power of transnational private interests has been apparent in the fact that most international regulatory reforms today have been incremental rather than radical, even in the face of the worst global financial upheaval since the 1930s.Footnote ⁵³ These developments have kept the debates about private “capture” politically salient at both the transnational and national levels, and they highlight once again the need for scholars to devote more serious theoretical attention to this issue.

New Outcomes to Explain

What kind of international regulatory outcomes would need to be explained in a world of weakening official international standards? A number of the books reviewed here note that international market pressures and ideational diffusion may still generate informal regulatory convergence even in the absence of deliberate intergovernmental efforts to create international standards.Footnote ⁶³ Governments may be tempted to maintain a level regulatory playing field vis-à-vis other states to bolster the confidence of investors, to prevent mobile financial firms from shifting their activities to more attractive regulatory environments abroad, or to conform to what is regarded by markets as “best practices.” Porter also shows how the self-regulatory activities of private actors with transnational reach may lead to a convergence of practices despite the failure of international cooperation among national regulatory authorities.

But are these mechanisms of informal convergence strong enough to counteract the centrifugal forces we described which are pushing policymakers toward charting independent regulatory paths? Walter argues that the power of transnational market pressures to promote convergence varies across different sectors and should not be overstated.Footnote ⁶⁴ The possibility that informal regulatory convergence could be driven by a process of ideational diffusion also seems much less likely in a world where the credibility of the precrisis regulatory model has been weakened and there is much less consensus on optimal regulatory models. Finally, we have suggested that transnational private actors are weaker and more divided now than in the precrisis period, thus making it less likely that they will be able to create a united front capable of filling growing gaps that may be left by governments in international standard-setting through private international rulemaking.Footnote ⁶⁵

If transnational market pressures, ideational diffusion, and private rulemaking capacity are less influential, then a world of weakening official international standards is more likely to be associated with regulatory divergence. The implications of greater regulatory divergence, and the ways it can be governed, represent an important avenue for theoretical inquiry that has not been adequately explored by the precrisis scholarship, which was inclined to equate regulatory divergence with an unraveling of international cooperation. For instance, Drezner highlights how the absence of strong cooperation among Great Powers may generate either “rival standards” or “sham standards.” Singer provides examples of the former, while the latter is exemplified by Walter's focus on East Asian “mock compliance” with the international standards project.

These analyses are important but a move away from strong official international standards need not necessarily be associated with the absence of intergovernmental cooperation. What about situations in which effective international cooperation is explicitly designed to facilitate the co-existence of divergent national or regional standards? Drezner comes closest to acknowledging this possibility when he states that regulatory cooperation does not automatically imply policy convergence but could involve “the mutual recognition of other national standards.”Footnote ⁶⁶ In the postcrisis era, scholars need to give more serious attention to these kinds of outcome, particularly because they have become the subject of major debate within international policymaking circles.

In a widely discussed March 2009 article in The Economist, Rodrik argued forcefully for a new model of international regulatory cooperation along these lines. His case rested on a strong critique of the international standards project of recent years. In his view, the drive to create “one size fits all” global standards overlooked the fact that “desirable forms of financial regulation differ across countries depending on their preferences and levels of development.”Footnote ⁶⁷ It was also imprudent because policymakers could easily “end up converging on the wrong set of regulations,” a possibility that the crisis appeared to have revealed very starkly.Footnote ⁶⁸ Moreover, he questioned whether it was really politically realistic to expect that leading countries, such as the United States, would agree to “surrender significant sovereignty”Footnote ⁶⁹ in international standard-setting processes.

In place of strong harmonized international standards, Rodrik advocated a “Plan B for global finance” that would place the choice and responsibility for financial regulation and supervision much more squarely at the national level (or perhaps regional level, in a case such as Europe). Global financial firms would be supervised by host country authorities and abide by host country regulations relating to such issues as leverage and capital standards. Rodrik acknowledged that the international financial order would thus become somewhat more segmented, but he argued that “an architecture that respects national diversity does more to advance the cause of globalisation than ambitious plans that assume it away.” This move away from strong international standards would not be a world without international cooperation. To prevent “adverse spillovers,” he suggested that countries would need to agree to “an international financial charter with limited aims, focused on financial transparency, consultation among national regulators, and limits on jurisdictions (such as offshore centers) that export financial instability.” Regulatory arbitrage, in particular, would be dealt with by giving governments the “right to intervene in cross-border financial transactions—but only in so far as the intent is to prevent competition from less-strict jurisdictions from undermining domestic regulations.”Footnote ⁷⁰

The case for this more decentralized international regulatory order has been developed further by the Warwick Commission on International Financial Reform.Footnote ⁷¹ In addition to echoing Rodrik's arguments against detailed global standards, the commission added the case that nationally distinctive host country regulations would greatly simplify the implementation of the new “macroprudential” countercyclical regulations that the G20 and FSB have endorsed,Footnote ⁷² and also enable developing countries to better tackle distinctive risks associated with currency mismatches or procyclical capital flows. The commission also noted that countries would be better insulated from the collapse of a parent bank abroad if international banks were forced to establish subsidiaries regulated by host governments.

Like Rodrik, the Warwick Commission argued that host country rules would need to be coordinated internationally at the level of common broad principles to address competitive pressures and externalities stemming from poor regulation abroad and to prevent the use of host country rules for protectionist purposes. International assistance would also be needed to boost the capacity of smaller and/or poorer countries that may lack sufficient capacity to implement effective host country regulation. Equally important would be the task of strengthening the capacity of all countries to regulate at the national level through cooperative research, early warning systems for global risks, and extensive information sharing (relating to market developments, activities of large firms, regulatory initiatives abroad). The commission suggested that the new FSB might be well positioned to support these various cooperative tasks.

One other blueprint for a model of international cooperation designed to allow a more decentralized international regulatory order has come from Eichengreen. Unlike the proposals of Rodrik and the Warwick Commission, Eichengreen's plan would not rely on greater use of host country regulation. Instead, he suggests that an international organization “would establish principles for prudential supervision” but in a manner that allowed for national diversity. These principles would not “prescribe the structure of regulation in detail” and members would be able “to tailor supervision and regulation to the particularities of their financial markets.”Footnote ⁷³ To prevent the “destructive spillovers of poor regulation,” Eichengreen suggests that countries could block access to their financial markets to institutions that were chartered in countries that did not meet the broad principles. Judgments about this could be made by “an independent body of experts, not unlike the WTO's Dispute Settlement panels.”Footnote ⁷⁴ Eichengreen notes that an advantage of this proposal would be that private institutions seeking to operate abroad would have a clear incentive to lobby for tighter regulations at home. To perform these various tasks, Eichengreen proposes the creation of a new “World Financial Organization” (WFO) but the FSB might also be well suited to assume these roles.

These proposals highlight that effective international cooperation need not always be associated with creation and strengthening of strong harmonized international standards. We can think instead of a wider range of international regulatory outcomes, as outlined in Table 2. Under this framework, four possible outcomes exist, according to variations in both the level of interstate cooperation and the degree of regulatory convergence. As noted, existing scholarship has highlighted how regulatory convergence can be a product of not just interstate cooperation (the upper left-hand quadrant) but also international market and ideational pressures or the self-regulatory initiatives of the private sector (the lower left-hand quadrant). In our view, however, the issue that deserves more attention from future scholarship concerns the options on the right-hand side of the table. If we are heading for a world of greater regulatory divergence, the key question is whether this takes place within a framework of strong interstate cooperation or not. The latter would result in a more fragmented international regulatory order of the kind that Drezner's sham or rival standards describe (the bottom right-hand quadrant).Footnote ⁷⁵ The former would represent what we might call a scenario of “cooperative decentralization” advocated by Rodrik's Plan B, the Warwick Commission, or Eichengreen's WFO (the top right-hand quadrant).

TABLE 2.

Typology of international regulatory outcomes

Theorizing Regulatory Divergence

Under what political conditions is the scenario of cooperative decentralization likely to prevail over fragmentation? The answer will depend partly on the capacity of international regulatory bodies to facilitate that cooperation in the face of strong centrifugal political pressures. At first sight, these institutional capacities seem to be limited by the lack of a strong international organization with the power to monitor and enforce compliance among its members. The existing patchwork of transgovernmental regulatory bodies remains constrained by its loose network-based structures and weak enforcement mechanisms as well as the increasingly diverse membership of these bodies. The creation of the FSB has strengthened the structure of transgovernmental cooperation, but it has little formal power and acts more as a “network of networks” than a substantial international institution along the lines of IMF, World Bank, or the WTO.Footnote ⁷⁶

It is important to recall, however, that the institutional form that best facilitates international regulatory cooperation is not independent from the “content” of the cooperation being sought. The kinds of international cooperation required to sustain a scenario of cooperative decentralization are different from those supporting the creation of the strong harmonized international standards. While some assume that more international cooperation is inherently useful, advocates of cooperative decentralization highlight the benefits of scaling back the ambitious forms of cooperation that were embodied in the efforts to build strong official international standards. As Rodrik puts it, “the world economy will be far more stable and prosperous with a thin veneer of international co-operation superimposed on strong national regulations than with attempts to construct a bold global regulatory and supervisory framework.”Footnote ⁷⁷ According to the blueprints for cooperative decentralization outlined here, this “thin veneer of international cooperation” would be centered upon the development and promotion of broad principles-based international regulatory standards as well as activities such as information-sharing, research collaboration, international early warning systems, and capacity building. Network-based cooperation might suffice to sustain these more limited tasks since this “new internationalism” would not rely so heavily on detailed international commitments or enforcementFootnote ⁷⁸ Indeed, networks may even have some advantages since scholars have often identified the facilitation of these kinds of activities as among the main strengths of this form of governance.

One other cooperative activity outlined by some advocates of “cooperative decentralization” involves the process of penalizing jurisdictions that do not abide by minimum international principles. Under Eichengreen's proposal, an international institution would authorize the use of sanctions against such jurisdictions. Interestingly, the FSB has already moved quickly to assume this role, establishing a set of procedures that will allow its members to identify jurisdictions that are not complying with some international principles relating to cooperation and information exchange vis-à-vis the regulation and supervision of banks, securities, and insurance. Among many possible penalties for noncompliance is included the blocking of access to the FSB members' financial markets. This initiative signals a willingness of FSB members to see the organization combine “soft” networked governance with the use of “hard” power or “hierarchy.”

While the FSB members are willing to enforce compliance collectively vis-à-vis small outsiders, scholars have noted that networked governance is less well suited to punish members of the network itself. As Eilstrup-Sangiovanni puts it, networks are defined by their lack of a “legitimate organizational authority to resolve disputes among actors.”Footnote ⁷⁹ The FSB reveals this tendency as well. Its members have chosen to assign the FSB plenary the role of identifying noncomplying jurisdictions, rather than the kind of WTO-like dispute settlement panel that Eichengreen proposes. Because the plenary is governed by a consensus of all members, it is unlikely that sanctions would ever be applied against FSB member country. For the “insiders,” the pressure to comply will stem instead from softer forms of influence such as the new peer review process and periodic assessments of compliance with international standards by the IMF and World Bank. If those mechanisms prove insufficient to protect against poor regulation from other members, countries may be tempted to resort more to stronger host country regulation, either unilaterally (reinforcing the fragmentation outcome) or in a coordinated way, as suggested by Rodrik and others.Footnote ⁸⁰

Theorists thus need to consider seriously the hypothesis that the major international governance innovations emerging from the crisis are in fact pointing in the direction of the kinds of institutional capacities required to sustain a scenario of cooperative decentralization. While the crisis has not led to the emergence of a “World Financial Organization,” the creation of the FSB and the upgrade of the G20 grouping to the leaders' level have strengthened the kind of network-based forms of governance—combined with the collective use of hard power vis-à-vis outsiders—which may in fact be suited to support the types of international cooperation necessary for that scenario.

In addition to these institutional capacity issues, the unfolding of a scenario of cooperative decentralization—as opposed to one of fragmentation—will depend also on the incentives that national regulators and policymakers face to cooperate. We have argued that the financial crisis has created new pressures and dynamics pushing these officials in the direction of carving out greater degrees of national (or regional) regulatory autonomy. At the same time, the incentives to cooperate remain strong because of the high level of global economic integration. Despite the deepest financial crisis in more than six decades, there are very few signs of a collapse of global economic interdependence and the emergence of rival closed economic blocs comparable to the 1930s. In this context, national officials are still drawn to international cooperation to address the risks of both competitive problems and negative externalities that can arise from poor financial regulatory practices in other countries. Even if they find it difficult to create strong international standards for the reasons we've noted, policymakers will still be tempted to mitigate these problems through looser forms of cooperation such as principles-based international standards, information-sharing, research collaboration, international early warning systems, and capacity building. As outlined, enduring global financial interdependence also creates strong internationally oriented private-sector constituencies at the domestic and transnational level which pressure policymakers to support cooperative arrangements over the fragmentation scenario because of fears that they could encourage protectionism and complicate their cross-border operations.

Future scholarship needs to be alert to the possibility that policymakers may increasingly embrace an international regulatory order centered upon cooperative decentralization as a means of reconciling these competing incentives for greater national (or regional) autonomy within the context of still-integrated global markets. This reconciliation would share some similarities with the “embedded liberal” compromise of Bretton Woods where policymakers sought to construct a multilateral open world economy that was compatible with the desire for national policy autonomy.Footnote ⁸¹ While the Bretton Woods architects pursued this goal in the context of rebuilding a world economy after the collapse of the 1930s, today's advocates of greater decentralization are responding to pressures for greater national policy space within an already-existing global economy. Ruggie described how the initial embedded liberal compromise was a product of U.S. power and a shared transnational social purpose of embedded liberal values that combined during the unique moment of the Bretton Woods negotiations of the early 1940s. In the current period, a movement from the top left-hand quadrant of strong international standards to the top right-hand quadrant of cooperative decentralization would likely be a more incremental and experimental process driven by efforts of policymakers, working within dense transgovernmental networks, to reconcile the competing incentives outlined above.

In exploring the likelihood of this scenario vis-à-vis fragmentation, scholars also need to be prepared for one additional possibility: variance in outcomes across different financial sectors. The strength of transgovernmental networks is not uniform across these sectors. The incentives pushing towards cooperative outcomes are not either. The intensity of cross-border competitive pressures, for example, is uneven from one part of the financial industry to another. Inadequate foreign regulatory practices also do not generate the same levels of negative externalities in all sectors. The cohesion and influence of transnational private financial groups is also not uniform across each segment of the financial industry. These differences helped to explain why the precrisis trend toward the strengthening of international standards varied across financial sectors. In a similar manner, they may influence whether a scenario of cooperative decentralization, rather than fragmentation, unfolds if international standards begin to weaken.