Paradise Lost: Why Fallen Markets Will Never Be the Same
Ian Bremmer and Nouriel Roubini assert that the financial crisis has discredited free-market capitalism.
Crises breed denial. Whether a crisis concerns an individual’s health, career or marriage, a company’s reputation or market share, or a nation’s place in the global pecking order, powerful incentives exist within the stricken entity to aspire to a return to normalcy — and to proceed as if that result represents the only option. However, as we all know from human experience, some setbacks are irreversible. We believe the recent meltdown suffered by the U.S. and its partners on the liberal side of the global economy is one of them.
Still, many policymakers and economic thinkers in the U.S., Europe and Japan remain shrouded in denial. They assume that after a period of healing, high growth will return and the rules of global capitalism will restore the preeminence of the U.S. economy and the appeal of a chastened (yet only slightly less freewheeling) laissez-faire Anglo-Saxon model.
Such thinking is either dangerously naive or the result of epistemological blindness. A scenario can be charted in which the U.S. and its liberal market adherents not only return to precrisis “potential growth” but even exceed it. But the political, economic, financial and psychological hurdles standing in the way of this scenario suggest it would require divine intervention to make it so. An extended period of anemic, subpar growth is the much more likely scenario as there is a painful deleveraging by households, financial sectors and governments. One cannot even rule out the risk of a double-dip recession in the U.S. and other advanced economies.
Clearer-minded souls understand that the world of the bubbles is gone and that hard work looms ahead if the advanced economies are to emerge from this period with any hope of keeping pace with the developing world. The policymakers of the market liberal bloc — and yes, in this grave new world, that’s how we should think of the old Group of Seven — would need to be willing to take bold action (see “Seven Ways to Save the World”).
Even if there is growth after the current anemic period, the ancien régime (that is, the G-7) is on a trajectory to be overtaken by the rising powers of the emerging world as the century unfolds. Because of this, the U.S. and the rest of the free-market economies must use the political leverage they have today to lock in rational safeguards and agreements that will govern the global economy of tomorrow.
After a few more years of lackluster growth — unavoidable due to the deleveraging needs of households and the business sector — financial institutions and governments will seek a return to growth and even demand that national governments move, or move out of the way, to increase it. This will be a dangerous moment — one that war correspondents refer to as “survivor’s euphoria.” The illusion, of course, is of invulnerability, and too often lessons learned in previous brushes with mortality are cast aside.
One thing the U.S. could do for itself, and for the world, is forgo the seemingly inevitable hand-wringing and political posturing that are already ramping up over the question of the country’s declining influence. It has become increasingly clear to all but the most ideological of analysts over the past several years that U.S. strength is on the wane. Conventional wisdom has it that a U.S.-dominated unipolar global system is giving way to a multipolar order, one in which various emerging powers advance competing ideas for how the world should be run and act to further their agendas. Conventional wisdom has it wrong. The financial crisis and global market meltdown have created conditions for a “nonpolar” order — one in which America’s chief competitors remain much too busy with problems at home and along their borders to bear heavy international burdens.
This trend is most clearly visible in the transition of the past two years, hastened by political and economic upheaval, from a G-7 to a Group of 20 model of international decision making that provides the governments of increasingly influential and deep-pocketed developing countries like Brazil, China, India, Saudi Arabia and the United Arab Emirates with seats at today’s most important international bargaining table. Without these countries, multilateral efforts to solve pressing transnational problems wouldn’t have much credibility. But getting this varied group to agree on anything beyond declarations of vaguely worded principle will be profoundly difficult. And countries like China continue to seek a free ride, not realizing that sitting at the table of global economic and financial governance implies both rights and duties. As the artificial unity imposed in 2008–’09 by a shared sense of crisis continues to erode, this problem will grow.
How could it be otherwise? When the number of negotiators in the room expands from seven to 20, it’s much harder to reach consensus on much of anything. More worrisome still, the G-20 includes countries with sharply diverging views on democracy, the proper role of government in an economy, investment rules, the importance (and meaning) of transparency, and the best way to ensure that institutions like the United Nations, the International Monetary Fund and the World Bank reflect today’s true balance of power. The G-20 could never have forged a “Bretton Woods II,” an absurdly ambitious 21st-century attempt to update the multilateral agreements of 1944 that established the rules and institutions that have governed the international monetary system ever since. In fact, the G-20 will become not so much a second Bretton Woods as a supersized U.N. Security Council: a dysfunctional institution often undermined by irreconcilable differences among veto-wielding members. The recent Toronto G-20 communiqué — which is several times longer than any G-7 declaration and fudges the disagreements over growth and austerity now — is an example of this kind of impasse.
An organization that includes members with such fundamental philosophical differences can produce results only when everyone is afraid of the same thing at the same time, such as during the global economic and financial meltdown of 2008–’09. Given the obvious differences in the ways that American, Brazilian, Chinese, German, Indian, Japanese, Russian and South African officials calculate their interests, solutions to pressing transnational problems like global trade imbalances, nuclear nonproliferation and climate change are unlikely to come in coordinated fashion. Policymakers in different countries will try to tackle these problems on their own or will choose to ignore them. This lack of coordination will exacerbate global economic and financial asymmetries. Reducing global current-account imbalances that were one of the causes of the financial crisis requires overspending countries — the U.S. and other Anglo-Saxon nations, as well as the PIIGS (Portugal, Italy, Ireland, Greece and Spain) — to spend less in the private and public sectors, and oversaving countries like China, Germany and Japan to save less, consume more and let their currencies appreciate.
Governments design stimulus plans to satisfy political and economic demands at home, not to revitalize the global economy. In response to the slowdown among China’s largest trading partners — the European Union, U.S. and Japan, respectively — Chinese officials implemented a program to boost state spending on roads, bridges, ports and energy infrastructure. The main intent was to create jobs that would keep Chinese workers productive and off the streets, reducing the risk of civil unrest and large-scale domestic challenges to the Communist Party’s right to rule. The leaders of developed countries have acted in much the same way. Washington bailed out U.S. automakers to keep thousands of U.S. workers from losing their jobs, and promises made during G-20 meetings to avoid actions that would shield domestic companies from foreign competition weren’t going to stop it.
G-20 heads of state will gather in Seoul in November, and there will be plenty more such summits in years to come. Yet policy responses to transnational problems will continue to be improvised and incomplete. U.S. negotiators will resist any institutional framework that allows foreign leaders to impose binding rules on Washington. China will stoke growth to create new jobs, managing development to try to prevent crises that could provoke the kind of social unrest the state can’t contain. Russian leaders will continue to try to attract foreign investment while extending state control across strategic sectors of the domestic economy and using the country’s energy resources as geopolitical leverage. India will pursue trade liberalization at its own pace. Brazil will try to use its newly discovered offshore oil to enable state-run oil company Petróleo Brasileiro to become an ever-more useful tool of economic policy. Saudi Arabia will use its still-considerable reserves to help manage oil prices and will act as producer and lender of last resort when it finds good value for its money. Efforts to move these governments toward harmonious and effective policy responses to problems that extend beyond the financial crisis — collective security, counterterrorism, climate change and global public health emergencies — will fall short.
Individual governments or coalitions of governments will not have much success in addressing these problems on their own. In the U.S. the Obama administration will have to focus on finding creative ways to spur domestic economic growth and to create jobs in a political environment in which Republicans will demonize continued government spending and resist needed tax increases, with the risk of an eventual fiscal wreck. The U.K. will downsize its foreign policy ambitions as its coalition government works to put the country’s fiscal house in order. Fears for the future of the euro zone will dominate discussion in Brussels. Recent legislative elections hint at more upheaval to come in Japan’s politics.
Nor is there competition among the world’s leading emerging states to fill the vacuum in global leadership. The governments of China, Russia and Saudi Arabia are far too preoccupied with domestic challenges to accept the risks and sacrifices that come with playing a truly major role. Brazil and Turkey have worked to lift their international profiles — by proposing a compromise solution in the fight over Iran’s nuclear program, for example — but neither nation has the means to extend its clout much beyond the diplomatic arena.
In other words, at the risk of repeating ourselves, the U.S.-led unipolar order, Western political and economic dominance, and consensus among the world’s power players in favor of free-market democracy are all gone. And they’re not coming back.
Another major reason that international poli-tics won’t return to a pre–financial crisis status quo is the rise of state capitalism. A generation ago, as command economies imploded in Eastern Europe and the Soviet Union, faith that governments could mandate lasting prosperity seemed dead. Western power — fueled by private wealth, private investment and private enterprise — seemed to have established the final victory of liberal free-market economics. Over the past decade, however, public wealth, public investment and public enterprise have made a stunning comeback. An era of state-driven capitalism has dawned, one in which governments inject political calculation into the performance of markets.
Authoritarian governments including China and Russia, not content with simply regulating markets, are moving to dominate them. Political leaders in these countries know that only capitalism can generate the long-term growth that can sustain their political survival, but they want to ensure that the state controls as much as possible of the wealth that markets generate. They need that wealth to spur growth, create jobs and protect banks when times are tough — and to minimize the risk that profits will empower potential rivals for political power.
The rise of state capitalism is most obvious in the energy sector. National oil companies have been with us for decades, but they now control more than 75 percent of the world’s crude oil reserves. Beyond petroleum, the Chinese and Russian governments control state-owned enterprises in aviation, defense, mining, power generation, telecommunications and many other sectors, and other governments have begun to follow their lead. These governments also use politically loyal, privately owned “national champions” to advance state interests. And they have created a new class of sovereign wealth funds to maximize the state’s return on investment, finance its dominance of domestic economies and extend its geopolitical influence. In a free-market system, markets exist to serve those who participate in them. In a state capitalist system, governments dominate markets to maximize the political power of the state and its leadership’s chances of survival.
The growing power of state capitalism will have important implications for the politics of globalization — the processes by which ideas, information, people, money, goods and services cross international borders at unprecedented speed. For years many developing countries have welcomed Western companies and investment, in part to build their domestic economies by exposing local businesses to the advanced technology, managerial expertise and marketing techniques that only foreigners could provide. But as local companies mature, state capitalist governments will begin to more openly promote and protect them at the expense of outsiders. As local businesses begin to compete more effectively, some will begin to see foreign partners as commercial rivals — and will begin to use their growing clout with state and local bureaucracies to rig the game in their favor.
State-owned companies will have even greater advantages. In authoritarian state capitalist countries, laws are written and enforced to help the state maintain order and manage economic development, not to safeguard the rights of individuals and companies. Western companies facing this problem will have little choice but to turn to their governments for help, exacerbating tensions between developed and developing states. Eventually, state capitalism may hamper long-run global economic growth, as businesses trying to maximize political goals cannot be sources of innovation and productivity growth. But though state capitalist companies may thrive in the short run, there is a risk of a race to the bottom, with greater interference in markets even in market capitalist economies.
More broadly, state capitalism will produce a reversal in the trade and capital account liberalization of the past several years as protectionism breeds more protectionism. Authoritarian state capitalists clearly have no monopoly on unfair trade practices, but they have a much easier time imposing them. In Washington trade restrictions are debated in public, interest groups sound off on cable television, proposals under discussion are available to the general public, and individuals and companies can expect a fair hearing in court. State capitalist governments exert enough control over courts, journalists and interest groups to ensure that their plans move forward.
Given the tough economic climate facing U.S., European and Japanese companies and consumers — and the unpopularity of most of their incumbent political leaders — the risk will only increase the likelihood that the developed world will meet financial protectionism with more protectionism. That risk is especially high for the U.S. and China. Friction between the world’s largest economy and its fastest-rising competitor will lower the longer-term trajectory of the global economy, creating more uncertainty in international politics.
As many of the world’s emerging markets, many of them democracies, look for a safe way forward out of economic crisis into sustainable growth, in whose image will they seek to mold themselves? Will they turn to the champions of free-market capitalism?
In the U.S., President Barack Obama and congressional Democrats are preparing themselves for a likely beating from opposition Republicans in November’s midterm elections — not because the GOP is offering bold new ideas, but mainly because the economy and jobs aren’t getting better quickly enough. British voters swept the Labour Party from power, but didn’t have enough confidence in Conservatives or Liberal Democrats to give either a working majority. French President Nicolas Sarkozy’s Union for a Popular Movement and German Chancellor Angela Merkel’s Christian Democrats both suffered ringing defeats in recent local elections. The Democratic Party of Japan won a historic election victory in September 2009 and promptly lost its majority in Japan’s upper house of Parliament earlier this year. With internal party elections coming in September, the DPJ may soon be looking for its third prime minister in the past year. For leaders of developing states looking for models of political stability, the world’s largest free-market democracies have little at the moment to recommend them. Worse, in many of these economies, policymakers, driven by short-term electoral concerns, are kicking the can down the road, postponing necessary fiscal austerity and structural reforms.
Many developing powers will look to China. It’s impossible to know how well China’s leadership would poll with its people — as if any poll could provide an accurate portrait of public opinion in a country without an organized political opposition or a free press. But it’s safe to say that three decades of double-digit growth can buy a government a certain amount of popular goodwill, particularly when that government appears to have emerged first and strongest from the global economic meltdown.
More to the point, China’s performance looks appealing to outsiders who are searching for a political and economic system that appears capable of producing both rapid growth and political stability. But past performance is no guarantee of future success, and there are vitally important questions hovering around China and its growth model. Can export-dependent China continue to power the global economy given slow growth among its three largest trading partners? Can it reduce its savings rate and move toward a consumer society fast enough? Is the country’s political system flexible enough to adapt successfully to the profound changes China will face over the next generation? Can it create a formal social safety net big enough to accommodate the largest emerging middle class in the history of the planet? Can it maintain public confidence as profound environmental damage takes an ever-increasing toll on the quality of life across the country? As China relies more on technical innovation for future growth and each additional unit of GDP creates fewer jobs, can the Chinese economy continue to provide work for so many people?
There are good reasons to believe that the answers to some of these questions are no. That reality ensures that the global economy is moving into truly unknown territory. And yet that reality may not be enough to discourage many developing economies from adopting increasingly statist economic practices. In that regard, perhaps the most important headway the “Chinese model” has made is in Russia, where a very Eurasian variant of state-controlled capitalism supplanted the liberal market shoots that failed to blossom in the first years of this century. The lessons of Russia’s early post-Soviet experiments with market economics, and particularly the default and ruble collapse of 1998 (and the role international “speculators” had in forcing it), severely tainted the euphoric talk of the benefits of shock therapy to formerly closed economies.
Of course, it would be overly simplistic to see the world as moving toward a new bipolar moment, with the U.S. leading a free-market, democratic faction and China a state-dominated, authoritarian camp. Large countries of great significance — Brazil, South Africa and Turkey — appear highly unlikely to forsake the market entirely or to turn back from democracy. India’s uniquely bureaucratic system has allowed pockets of market liberalism, and its future course remains uncertain. So too in Indonesia, Mexico and other rising economies.
Again, the emergence, virtually overnight, of the formerly obscure G-20 as the world’s preeminent economic policymaking body provides a glimpse into a more chaotic future. It also suggests that the old levers of hegemonic stability and influence exercised so expertly by the British in the first golden age of globalization (roughly 1880 to 1914) and by the U.S. in the second (1989 to 2008) will have far less purchase in the new, postcrisis age. What, after all, has the G-20 accomplished? Since the initial consensus on the need to implement global stimulus reached during the 2008 G-20 summit in Washington, serious policy initiatives have largely failed. Disagreements — over regulatory issues and fiscal policy, for instance — often pit the heirs of post–World War II “Western” order against those now rising to challenge it.
The Toronto G-20 meeting in June featured shadowboxing between the U.S. and China over the undervalued renminbi, as well as more public prodding by the American delegation for China to take steps to lower its savings rate and increase domestic consumption. The inevitable Chinese answer to this lecture from its spendthrift debtor: We will, when you get your fiscal house in order. The inability of either side to make significant moves to address global imbalances does not portend well for future such meetings. A simmering dispute between the U.S. and Europe over stimulus versus austerity has further eroded chances for consensus.
The frictions between advanced and emerging economies have bedeviled other international organizations for some time. Recent flare-ups include the failure of the Copenhagen climate conference last December, complaints from emerging-markets countries over the role of the dollar as the world’s primary reserve currency, the still-G-7-heavy makeup of decision-making bodies at the IMF and the World Bank, and the increasing discord over the role or even the legitimacy of Cold War entities like the North Atlantic Treaty Organization and the Organisation for Economic Co-operation and Development. From the viewpoint of many outside the U.S., the resistance of the former hegemon explains this dysfunction. Yet the U.S. and many of its allies counter that even relatively small institutions — the U.N. Security Council, for instance — are paralyzed by rules requiring consensual or even unanimous agreement. Writ large, this fact suggests that the G-20 may already contain the seeds of its own demise, or at least the G-20’s neutering as an effective policymaking body.
Indeed, it is harrowing to project the current dysfunction of the G-20 onto some future “expanded and reformed” Security Council, which seems inevitably on course to add as permanent members at some point Brazil, India, Japan and perhaps any mixture of middleweight players (Egypt, Germany, Indonesia, Italy, South Africa). Already-difficult decisions on international security matters like Iran’s nuclear program might become hopeless.
In the real world, of course, the weightiest decisions — monetary policy, currency devaluations, war and peace — will still be made at the national level. As the hangover of the financial crisis lingers in the advanced world, the toolbox available to policymakers on both the economic and political sides will get smaller. The Greek crisis and political pressures have taken stimulus off the table in Europe, and the corruption-fueled comeuppance of Japan’s new government within a year of taking office has led it to scale back its own spending plans. In the U.S. deficit hawks bearing down on Obama ahead of the midterm elections have done much the same. In all of these places, economic growth will have to find organic fuel, and recent releases from the G-7 suggest that those sages who saw green shoots last spring may actually have been smoking them, as anemic growth is still with us.
Under such conditions, central bankers (at least in the U.S. and Europe) once again represent the last bastion against a double-dip recession. While not our main scenario, the risks of a double dip have been rising for months. The inflation- and deficit-focused European Central Bank may well be dooming the euro zone to a second round of economic decline by maintaining a too-tight monetary policy and backing German calls for fiscal austerity at all costs — again, a political reflex, born of German voters’ anger at having to bail out their imprudent Mediterranean cousins. In the U.S. the Federal Reserve Board, having (barely) survived postcrisis efforts to bring monetary policymaking under legislative purview, has started talking again about reentering the market for either mortgage securities or U.S. government bonds. With interest rates near zero, this new round of quantitative easing would signal a desperate moment — a groping of the bottom of the tool kit, with all the peril that public disclosure of such a decision would bring with it.
The reopening of the fire hoses of credit and capital that occurred during the bubble years will happen again and intensify the boom-and-bust cycles. Driven by ever-more- desperate policymakers in the U.S., Europe and Japan, these cycles will both shorten and magnify. Political, policy and regulatory uncertainty will increase, and as a result, financial crises will become more frequent and costly, while risk aversion, volatility and uncertainty will rise. The illusions of the Great Moderation — a phrase coined by Harvard University economist James Stock to describe the two-decade period that started in the late ’80s, with its quasireligious embrace of market efficiency and infinite American power — will have created the era of the Great Financial Instability. And nothing could hasten the decline of American influence more than another self-inflicted catastrophe of global market capitalism.
Ian Bremmer is the president of political risk research and consulting firm Eurasia Group and the author of The End of the Free Market: Who Wins the War Between States and Corporations? Nouriel Roubini is a professor of economics at New York University’s Leonard N. Stern School of Business, chairman of Roubini Global Economics and co-author of Crisis Economics: A Crash Course in the Future of Finance.