International Financial Governance – Time for a radical institutional transformation and economic reorientation (by Henning Schmidt) PART 2

110811girouxPart II An article on the neoliberal reaction to the global financial crisis in 2007/8 and its severe long-term effects: Harsh austerity policies, an ongoing recession and mass unemployment.

Part 1 (4th of June 2015)

Part 2 (5th of June 2015): Rejecting Drezner

a) Shared sets of belief:
Responsible for the immediate turnaround to austerity which caused the ongoing economic recession

b) Global governance mechanisms and the new financial architecture:
Precursors of the economic crisis

Part 2

Yesterday’s blog post illustrated Daniel Drezner’s claim that the global (financial) governance institutions worked in a sense that they prevented a severe economic depression in 2007/08. Today’s Part 2 demonstrates several great weaknesses of his thesis.

a) Shared sets of belief:
Responsible for the immediate turnaround to austerity which caused the ongoing economic recession

This part emphasizes on the institution ‘IMF’ and sticks to the ideational reasons for which the IMF (and similarly trained central bankers) have been able to act that decisively, according to bail-out and stimuli policies. However, it makes exactly this ability responsible for the long lasting recession and suffering of advanced industrialised as well as developing countries.

As early as in 2005, Momani examined IMF’s recruitment policies and internal debates on organizational diversification. She showed that the IMF staff proposed common policy solutions to economic adjustment thanks to their Anglo-American dominated educational background (see Momami 2005: 185). Moreover, the analyses of 15 years of IMF documents on staff recruitment and several interviews revealed their internal organisational dynamics. The leadership actively produced an ideologically monolithic organisation with “agreement on the appropriateness of conservative macroeconomic approaches” (183) when it comes to the recruitment of PhD graduates. Correspondingly, no former staff member or executive director did suggest alternative economic paradigm. Therefrom, it is not surprising that Nelson (2014) illustrated how IMF lending has been ideologically determined during his observation window (1980 – 2000). Loans became “less onerous, more generous, and less rigorously enforced” (297) to the higher degree that borrowing governments conformed with neoliberal convictions – and vice versa. This is reasonable from both rationalist and culturalist approaches of organizational theory since the IMF has somehow to assess the probability that borrower fully implement the programs and pay back their loans. The former approaches are pointing to cost-effective calculations that maximise payoffs, the latter to the identity of decision-makers: officials may fall back on social scripts that guide their choices instead of implementing IMF’s austerity measures (see 303 ff.).

Admittedly, this excurse is not directly linked to the IMF crisis-reaction. However, it shows the strict ideological enforcement of aid programs for countries that attempt to recover from crises. In the same vein, the acting of the IMF in the aftermath of the peak of the crisis has been detrimental to the recovery of core advanced industrial states. Traditional ‘core’ regions of advanced capitalism haven’t recovered at all, hence lowered the ‘World Industrial Production’:
Ongoing RecessionFigure 3 (see Drezner 2014: 132)

Furthermore, the ‘right’ policy response at the height of the crisis also could be interpreted as ad-hoc reactions of individual states and their finance ministers and central bankers, facilitated by three G20 Summits (2007 – 2009) that entrusted essential financial resources to the IMF (see Woods 2010: 51).

This kind of Keynesianism has been described as ‘bastardised’ by Alex Callinicos, since it means no longer a “comprehensive policy regime, [but] more a set of tools to be set at work, but then swiftly abandoned once the immediate occasion of their use has passed” (Callinicos 2012: 75) With other words: In order to ensure the duration and existence of their institutional arrangements, the neoliberals were forced to use tools they ideologically reject. The enormous costs of these interventions have been translated into austerity programs that hinder the advanced capitalist states as well as many development countries that suffer from their weakness (see Woods 2010: 51), to recover.

b) Global governance mechanisms and the new financial architecture:
Precursors of the economic crisis!

This part examines one crucial complementary aspect of the international architecture that primarily has been developed by Drezner’s own country (USA) and which he largely avoided to assess since it ultimately caused the crisis: The neoliberal international financial architecture. The following part attempts to go deeper in assessing why some ‘systemic’ financial institutions emerged in the first place. Responsible is the same neoliberal ideology that enabled (or rather forced) the IMF staff and central bankers to act uniformly in terms of the 2007/8 rescue and bail-out mechanisms.

In his brilliant 2012 article “Neoliberalism and the new international financial architecture”, the Political Economist Aaron Major shows how neoliberalism in the international financial arena is best understood.

He contrasts the view that neoliberalism merely appeared via financial market deregulation. Major observes a specific kind of neoliberal re-regulation, a manifestation of neoliberalism in the altered forms of financial market regulation, making it much harder to oppose. The roots are located in the aftermath of the Bretton-Woods-Breakdown. Market liberalization and elimination of controls on capital movements have been the neoliberal ‘solutions’. However, a row of crises showed that financial instability followed these unregulated relaxations which have been embedded in institutional arrangements of monetary management that allowed for the “international diffusion of reserve requirements” (Major 2012: 539). The supplementary construction of a new international monetary stability followed the rationale of removing states from the process of immediate regulation and shifting the power away from real regulatory oversight and political control towards independent technocratic modelling. Consequently, central bank independence and inflation targeting (price stability should guarantee stable exchange rates and replace the Bretton Woods mechanisms – namely capital controls and fixed exchange rates – that guaranteed similar exchange rates among nations) became the new instruments.

Unfortunately, the new rationales manifested in the ‘Basel II Accord’ provided severe incentives for asset securitization: The decision to regulate banks via their capital reserves meant that private market actors – individual banks and their shareholders – became responsible for banking regulation ensuring of sufficient money reserves. Consequently, banks restructured their balance-sheets in order to minimize the amount of real reserves to be guaranteed in relation to sold assets. The allowance to spread actual risk and label risky assets as ‘highly secured’, triggered the process of ‘asset securitization’. Without powerful and enforced national and international regulatory rules, banks could place very risky assets (providing great benefits) on bank balance-sheets on which their risk has been spread in order to let them appear as to be safe. Consequently, many investors jumped on these shadow banking deals, the economy grew as a soap bubble. The American government even fueled this process by supporting the conditions for housing asset securitizations and promoting low interest rates for citizens that have been willing to build a house (see Thompson 2012).

At this point, an excurse to Marxist analysis might enhance the insights in the process of ‘financialization’. Some Marxists (e.g. Duménil/Lévy 2011: 18 f.) argue quite similar to Major and equate financialization with the economic and political dominance of finance, hence financialization has been institutionalized through neoliberal policies. A probably richer perspective offer those Marxists who oppose this assessment. Indeed it has some pitfalls, especially when asking why elites haven’t started to question neoliberalism in the course of 2007 – 2009. Following the ‘Great Depression’, Keynesian economic arrangements have been installed; the 1970s Bretton-Woods-Breakdown resulted in the turn to Friedman’s neoliberal ‘Monetarism’. Why do we still miss a similar shift today?

Drezner would argue that the arrangements proved to be alright at all.

Some Marxists, however, would point to the problem of overaccumulation: Financialization is simply needed in order to overcome falling rates of profit. The disciplination (e.g. liberalisation of working conditions.) of labour in the 1980s didn’t solve the problem. Displacement of capital in the financial sector offered much higher profits than those offered by productive investment. Asset bubbles actually have been promoted (at least tolerated) by Alan Greenspan and his Federal Reserve (see Callinicos 2012: 70) in order to obtain more short-term economic growth. This kind of neoliberalism is in principle not able to overcome the problem of overaccumulation – rather covering it and postponing it. As soon as it comes publicly blatant that some securitized products are not that worthy and save as the spread of risks made them appear, people sell their assets immediately and start a run on the shadow banking system.

With the Marxist explanatory model in mind, it is easier to confront the question why global governance mechanisms totally failed in terms of forestalling the securitization without risk transfer in order to prevent a run on the shadow banking system in the summer of 2007. If we stick with Thiemann (2005), we can observe one further structural problem: The G20 and other international bodies actually even undermined the capacity of “national banking regulators to deal with the deviant activities of their banks” (Thiemann 2005: 1203). The structural problem a regulator faces when tackling a financial innovation that evades global rules is very simple: In general there always exists the possibility to exclude specific activities of domestic banks from international regulation through national laws – national bankers tend to take advantage of this possibility, especially when they recognize similar practices by foreign colleagues. In this context, the regulator just has a very short time gap to impose tighter rules on foreign banks, until the same game repeats. According to Thiemann, the multilevel rules of the ‘Basel II Standard’ suffered in their undefined reach and “led to the national reappearance of concerns over competitive disadvantages” (1205). Consequently, while waiting for ‘Basel III’ to be implemented (which took a very long time thanks to various different national concerns) the national states avoided to impose stricter domestic regulation and triggered competitive banking, therewith providing a vital ground for unlimited speculatory action and a widening of the shadow banking system. As we have seen, neither the international financial architecture, nor its regulation has been ‘working’ in a beneficial way.

Well, if all these elaborations are accurate…what should be the appropriate conclusion of democratic Socialists?

This blog post assessed Drezner’s claim that the global economic governance institutions worked well at the onset of the crisis. It enhanced the narrative and therewith the room for critique on his actually intended purpose – an advocacy for the “liberal international order as an organizational logic of world politics” (Drezner 2014: 157).

The neoliberal global governance arrangements are indeed working: They serve, maintain and produce severe crises, which then are going to be alleviated – under giant costs – by the same arrangements. It is not easy to judge whether the institutional arrangements have been that highly responsible for the immediate response to the crisis as Drezner suggests. They had their impacts, but probably as supplementary elements to the decisions of governments and their central bankers to act in concerted action (while not underestimating the role of the G20 Summits in this regard).

Moreover, the systemic reason of the embeddedness in the global financial market, not necessarily the institutional arrangements forced states to act in the way they acted, as Drezner himself notes: “China has acted like a responsible stakeholder” (Drezner 2014: 155). In this regard, the U.S. predominance has held on, thanks to its hegemonic currency and financial market arrangements which reach into all other important economies.

However, it will be interesting to see if this changes within the following decades. The empowered G20 contains several countries that ideologically differ from the G7 core countries (see Beeson/Bell 2009). Additionally, Major, Thiemann and Callinicos convincingly illustrated how the maintained neoliberal beliefs and arrangements have been responsible for the emergence of the crisis itself and furthermore responsible for the immediate turnaround to austerity policies that hindered countries to recover and led to the great recession. Probably due to this fact, even the IMF has experienced changes in its ideational uniformity, allowing for capital controls and showing a new, but fairly limited scope for macroeconomic conditionality in the case of structural adjustment programs (see Grabel 2011).

While there indeed seems to be a potential for a more heterodox economic approach which has been and will be supplemented by complementary modifications of global governance, it neither has abandoned the incentives for securitization, nor the contradictions of financialization in the latest phase of capitalism, yet, as Callinicos pointed out.

It calls for radical institutional transformations accompanied by a much more extensive economic reorientation!

It calls for a strong political left – for democratic, internationally unified Socialists that reorientate their political agenda to the bitter hardships of the masses!


Beeson, M. and S. Bell (2009): “The G-20 and International Economic Governance: Hegemony, Collectivism, or Both?” In: Global Governance, 15. 67 – 87.
Callinicos, A. (2012): “Contradictions of austerity”. In: Cambridge Journal of Economics, 36. 65 – 77.
Drezner, D.W. (2014): “The System Worked – Global Economic Governance during the Great Recession”. In: World Politics, 66. 123 – 164.
Duménil, G. and D. Lévy (2011): “The Crisis of Neoliberalism”. Cambridge, MA: Harvard University Press.
Grabel, I. (2011): “Not your grandfather’s IMF: global crisis, ‘productive incoherence’ and developmental policy space”. In: Cambridge Journal of Economics, 35. 805 – 830.
Major, A. (2012): “Neoliberalism and the new international financial architecture”. In: Review of International Political Economy, 19:4. 536 – 561.
Momami, B. (2005): “Recruiting and diversifying IMF technocrats”. In: Global Society, 19:2. 167 – 187.
Nelson, S. (2014): “Playing Favorites: How Shared Beliefs Shape the IMF’s Lending Decisions”. In: International Organization, 68. 297 – 328.
Saad-Filho, A. and D. Johnson (ed.) (2004): “Neoliberalism. A Critical Reader”. London: Pluto Press.
Thiemann, M. (2014): “In the Shadow of Basel: How Competitive Politics Bred the Crisis”. In: Review of International Political Economy, 21:6. 1203 – 1239.
Thompson, H. (2011): “The Limits of Blaming Neo-Liberalism: Fannie Mae and Freddie Mac, the American Stat and the Financial Crisis”. In: New Political Economy, 17:4. 399 – 419.
Woods, Ngaire (2010): “Global Governance after the Financial Crisis: A New Multilateralism or the Last Gasp of the Great Powers”. In: Global Policy, 1(1): 51-63.

About the author: Henning Schmidt (23) is a proud Graduate of Democracy (’15) and currently pursuing an MA in Political Economy at King’s College London.


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