Changes in the International Economic Order after the Global Financial Crisis

The global credit crisis of 2008-09 was the most serious shock to the world economy in 80 years. It was for the world what the Asian crisis of 1997-98 had been for emerging markets: a profoundly alarming wake-up call. By laying bare the fragility of global markets, it raised troubling questions about the operation of the 21st-century world economy. It cast doubt on the efficacy of light-touch financial regulation and, more generally, on the prevailing commitment to economic and financial liberalization. It challenged the managerial capacity of institutions of global governance. It augured a changing of the guard, pointing to the possibility that the economies that had been leaders in the global growth stakes in the past would no longer be leaders in the future. Given that the 2008-09 crisis was first and foremost a financial crisis, it is appropriate that analysis should start with an assessment of the causes of recent financial problems and the successes and failures of post-crisis financial reform. The author argues that the traditional separation of macroeconomic and financial policies – the “Tinbergen principle” of assigning monetary policy to the maintenance of price stability and regulatory policy to financial stability – is part of what caused the crisis, and that the development of a synthesis, which flies under the flag of “macro-prudential” or “macro-financial” policy, points the way to a solution. Another striking aspect of the crisis was the abrupt collapse of international trade, which declined even more precipitously than the production of goods and services. Why the impact on trade was so dramatic continues to be debated. Then there was the protectionist response, described in Chapter 3. A few governments responded to the crisis and recession with overtly protectionist policies, but more important was “murky protectionism” defined to include not simply import tariffs, quotas and export taxes but also subsidies, bailouts, preferential public procurement practices. The global crisis also deepened disenchantment with the structure and operation of the international monetary system. It was already a commonplace that a system in which the U.S. dollar enjoyed the “exorbitant privilege” of providing the vast majority of global foreign exchange reserves was dangerously prone to imbalances. Chapter 4 sketches likely future trajectories for the international monetary arrangements. The author is dismissive of far-reaching reforms ranging from a regime based on Special Drawing Rights on the one hand to restoration of a gold-based system on the other. But he is equally skeptical about the viability of a dollar-centric monetary system like that of the recent past. The remaining option being a system organized around several national currencies – not just the dollar but also the euro and the Chinese renminbi, the question then becomes how to ease the transition to such a system and to smooth its operation once it arrives. Among the notable long-term consequences of the crisis has been the emergence of the Group of Twenty (G20) as the de facto steering committee for the world economy, displacing earlier advanced-country-centered groupings, notably the Group of Seven/Eight (G7/8). But, institutionally, the G20 remains a work in progress. As explained in Chapter 5, it has no permanent staff or written constitution. It has no global mandate; why it includes the countries it does reflects the particular historical process out of which it emerged. The details of how the G20 will work with multilateral organizations such as the International Monetary Fund and Financial Stability Board when additional problems arise remain to be determined. As the growing prominence of the G20 reveals, another consequence of the crisis has been to enhance the weight of emerging markets in the world economy. Their economies held up best in the face of the shock, and they continue to grow robustly. Chapter 6 marshals a number of indicators showing just how fast the emerging markets have grown and how importantly they now figure in the world economy. At the same time, as the author explains, these countries face serious challenges in the post-crisis environment. Stagnation in the advanced countries is a challenge for their traditional strategy of export-led growth. Chapter 7 focuses more closely on the challenges facing the emerging markets of East Asia in particular. The global crisis of 2008-09 and, more recently, financial turmoil in Europe had relatively little impact on East Asia’s fast-growing economies. The emerging markets of East Asia, it was increasingly asserted, had successfully decoupled from the advanced-country world. The authors ask in the chapter whether this will remain the case going forward. As global liquidity strains rose again in the latter part of 2011, a number of East Asian currencies weakened substantially, highlighting the region’s continuing dependence on external financial conditions. But if the challenges that emerging markets will face in the new post-crisis environment will be formidable, they pale in comparison with those that will confront the advanced economies. The advanced economies as a group emerged from the crisis with large budget deficits and heavy debts. Winding down those deficits without derailing recovery and damaging the prospects for growth will not be easy. All this takes place against a gloomy demographic backdrop that implies rising old-age dependency ratios, heavy pension obligations and health care costs, and a declining share of the population participating in the labor force. Chapter 8 takes up these issues. The authors frame their analysis around a number of distinctions. Notwithstanding numerous differences among economies, medium-term fiscal challenges are daunting across the advanced-country world. Under any plausible projection of the evolution of macroeconomic variables, current policies are not sustainable. Difficult decisions are unavoidable. The global financial crisis has cast a long shadow. It has profoundly affected the advanced economies, emerging markets and the balance between them. The implications for the international trade, the monetary and financial system, and global governance are far reaching. Drawing out those implications and beginning to comprehend what they mean for the future is the task the authors take up, collectively, in this volume.