The Policy Corner

Navigating a changing world

When integration does not follow interdependence

·

Edoardo Marra

An overlook on the weakening of global governance

An overlook on the weakening of global governance

The international discourse on globalisation has completely changed direction over the beginning of the 21st century. Not even twenty years ago the question was how do we tame globalization, whereas in the current geo-economic (dis)order, the main concern is shifted on how to re-establish an effective global cooperation framework.

Globalization, albeit never well defined, is often linked to a positive, but oscillating, phenomenon of strengthening economic interdependence. In this sense, globalization is shaped throughout the linkages in markets, the increase of trade in goods and services, the mobility of capital. In the alternating waves of globalization, it is crucial to evaluate how integration – global governance – reshapes. Global integration is the administrative aspect of globalization,  it is the ability of states to cooperate, to adopt and recognize rules that define interdependence, and to overcome crises that stem from it. Greater integration is not in fact a linear reaction to greater interdependence. The last century has shown how global integration can positively affect interdependence, and how it can remain powerless in the face of change. This is because, as will be observed in this article, governance is not endogenous to the process of globalization, but must re-adapt to provide stability.  

At the dusk of World War II, a group of delegates from 44 nations met in Bretton Woods, New Hampshire, for the United Nations Monetary and Financial Conference. The meeting had a precise scope: redefine the international system so that it could resist systemic crises and allow for post-war reconstruction. What the Bretton Woods Conference ended up delivering on the 22nd of July 1944 was at all effects a new global regime, based on 4 cardinal points.

Firstly, a new currency exchange regime, the Gold Exchange Standard, where countries could exchange their domestic currency at a fixed exchange rate with the US Dollar, that on its side was still anchored to gold reserves at a rate of 35$ an ounce. To ensure stability of the new exchange system, and to assist countries with balance of payments deficits, a new organization, the International Monetary Fund was created. While the IMF was established to address short term monetary policy issues, the World Bank Group – and more particularly the International Bank for Reconstruction and Development (IBRD) was entrusted with the task of providing economic assistance to nations for post-war reconstruction. Finally, an institution to promote trade liberalization was envisioned, the ITO. Even if it never saw the dawn of day, one of its founding agreements, the General Agreement on Trade and Tariffs (GATT) was signed in 1947 and became the de-facto organization for trade rules and promoting liberalization.

​​Under this institutional context a new period of commercial opening takes shape.  This First Economic Order, characterized by consensus and growing integration, will last for the next 20/25 years; before paving the way for a new international crisis. This phase of the globalization process presents several characteristics that made the constitution of a “virtuous cycle” possible, where economic interdependence and global integration positively affected one another. The virtuosity of the period stems directly from factors that determined 3 separated equilibria: the security field, where the bipolar division between the US and the USSR was unequivocal; the economic hegemony of the US and the centrality of the USD; the macroeconomic equilibrium, based on the US Balance of Payments deficit.  

These three layers are the rationale for why economic interdependence and integration could grow together. But one implicit ingredient made this compounding effect possible: the centrality of one actor, the US, and the subordinate role of its allies.

The context of the Cold War made it possible for the United States to overlap the military coverage of its allies, particularly in Europe, to ward off potential economic conflicts.

As a result, a rise in consensus on the Bretton Woods institutions and political cooperation between world powers. If security justified the increase in international integration, the latter created an even more suitable environment for economic interdependence. With security concerns dominating economics, all of the major allies would have benefitted from strengthening trade relations with the hegemony. Threatened by the potential conflict, Europe and Japan (the two main economic actors after the US) understood that entering into trade liberalizing agreements would both favour global integration through the Bretton Woods System, and guarantee peace, as the cost of conflict was ultimately higher. 

Free trade was seen as a win-win situation: by interconnecting their economies, countries could gain in economic terms, ensure protection from the hegemon and cooperate in a trustworthy multilateral environment. To add to this consideration, one must consider macroeconomic equilibrium. The US could afford having a BoP deficit with the rest of the world. This is fundamental to understanding why economic interdependence and integration could happen simultaneously. The US trade deficit was balanced by its allies’ – Europe – surplus, creating a zero-sum game. Demand was high to the level that originated a virtuous circle between industrialized countries: US deficit created liquidity, boosting demand; on the other side exporting made Europe (and Japan) grow and contribute to demand, thus generating more trade and growth.

Economic interdependence was therefore justified by security, but supported by demand, US demand. As Europe and the US cut trade barriers and interlinked their economies, BW institutions gained consensus and served as global governance bodies, fueling trade liberalization once again.
This compounding effect made it possible for Europe, the EEC at the end of the 1960s, to gain both a strong position in terms of governance and economy. 

The virtuous circle ultimately came to an end in the mid 1970s and a new phase of globalization began. The virtuosity of the Bretton Woods period until the 1970s made possible for the EEC to technologically catch up with the US. Reallocation of resources to tradable sectors fueled European growth and changed its economic structure. It was by all means the third industrial revolution.

The change in regime was a direct consequence of disruption of the previous 3 equilibria.
The end of the Cold War diminished the security threat aspect that previously contributed to drive the integration process. The bipolarity of the economic power distribution between the US and the EEC changed the macroeconomic equilibrium. The end of the GES paved the way for a new resolution of the irreconcilable trilemma. The transition to a floating exchange rate system, and the privatization process – direct result of the neoliberal policies of Reagan and Thatcher – created fertile ground for an increase in capital mobility.  Neoliberal economic theory gained momentum and states lost their power. What we can delineate as Hyperglobalization (1980s-2008) is a new stable globalization wave, characterized by the end of the US economic hegemony, the rise of the until-then marginal actors (China and the Asian Tigers), and a more-than-ever expansion of global economic growth. 

Interdependence starting from the 1980s assumed a completely different shape than before.

While we discussed that trade liberalization in the previous phase was mainly the removal of trade barriers between US and Europe to the point that the latter eventually caught up with the former, as a result of privatization and private investments, trade openness was now based on global value chains. The difference in endowments between capital intensive, technologically developed countries and labour intensive, developing, countries fueled the increase of trade in intermediate goods, sustaining the growth of the Asia-Pacific. If economic growth of the Bretton Woods era was demand led, the 1980s boom was sustained by supply. Offshoring assembly and manufacturing phases into Asian factories boosted production and involved them in global trade dynamics.

Despite an impressive increase in interdependence, due to developing countries, mainly China, producing and exporting intermediate and low-tech goods, integration did not follow as before. The limitations of the previous era became obvious: the BW mechanism was a product of its time, and several failures – particularly of the IMF and its copy-and-paste neoliberal policies – eroded consensus on the whole governance system. It appeared evident that the Bretton Woods system could not continue in the tripolar economy that was rapidly emerging. 

At the same time another multilateral institution saw the day of light, the World Trade Organization, founded on the adjusted GATT 1994. Thanks to higher sensitivity towards developing countries, the WTO gained widespread support. When looking at this new framework, one could be mistaken that integration would converge again to meet interdependence; however, the outcome turned out to be the opposite. 

The WTO system was indeed effective in further liberalizing trade, but on the other side it was unsuccessful in achieving higher global integration. Two forces have contributed to this result. Firstly, the unwillingness of the US and the EU to divide the governance pie with emerging economies, China and India among the others. The Doha Development Round (2001) failed to overcome the differences between developed and developing countries. The economic weight of the latecomers was not acknowledged and demands were so stringent that the whole round ended up in failure. Secondly, by its very nature, WTO’s dispute settlement mechanism tended to limit government interference, handing dispute resolution in the hands of legal experts rather than the states themselves. Trade-concerning conflicts being approached on a case-by-case basis didn’t affect global integration, but surely facilitated trade openness. 

With capital and goods reaching peak levels of mobility freedom, without effectively being governed multilaterally, uncertainty spread through the rusty neoliberal machine, making it just a matter of when and how for the whole system to collapse. The GFC was the emblematic demonstration of an unsatisfactory risk management system; a direct consequence of an international governance not fit to manage such a high level of economic interdependence, sourced from GVCs, ICT diffusion and capital mobility improvements. 

The following Slowbalization phase, characterised by resort to protectionism and final rupture of consensus on BW institutions, demonstrates that a weak governance system unwilling, rather than unable, to recognize change, could only last until hegemonies and marginal actors were more different than equal in economic terms. 

The change of century has been shaped by the rise of China, and its subsequent structural change. When the US and Europe first engaged Beijing during the 1990s, they found fertile ground for boosting economic growth, transferring intermediate goods’ manufacturing in China, without necessarily having to cooperate politically. The result was the discussed-above increase in trade relations and the fast growth of the Chinese economy. Already in 2015, China occupied the largest share of World GDP.
The quick surge of China has challenged the bipolar economic distribution, especially as China contested more and more Western hegemony in pivotal markets. Together with economic growth, China has consistently revised its industrial policy transforming the country from labour intensive, to a leadership contender in automotive, defence, space, military sectors.

The threat has been perceived by Washington and Brussels, albeit in different timelines. Trump 1 (2016-2020) administration has marked the beginning of the trade war with Beijing, and, rather than resorting to the tools of international governance that the United States itself  created, has preferred killing them once for all. 

While distribution of economic power has polarized around three precise nuclei, integration has been ultimately boycotted. 

However, the turmoil of the Slowbalization period recalls what already happened in the mid 1970s, rather than being a completely new phenomenon. The resort to protectionism and the neglect of the trusted framework happened similarly in 1971, with the US abandoning the GES, backbone of the macroeconomic equilibrium in the BW era. There is nonetheless a crucial difference. The subsequent phase was characterized by a unilateral view on economic growth, despite the bipolar distribution of economic power. Neoliberalism was embedded in the system both by the US and Europe (UK especially), and sold to the marginal actors as the only functioning method. While we could argue that the global governance framework was in principle thought to be asymmetric – centered around the US hegemony – it continued to function, but not to improve, and to boost growth through interdependence when the economic distribution lost its single dimension. In a sense the asymmetry of power continued to occur, dividing the neoliberal West from the runners-up. 

What changed with the rise of Asia-Pacific countries, and China in particular, in forming a tripolar economy, was the cumbersome presence of a second ideology. A different path for economic growth – one of planned economies and state intervention – discredited the Global North narrative. The rising of emerging countries has uncovered the fallacies of the global governance framework which, in absence of reforms capable of resizing the political weight of the actors involved, has been gradually undermined. Proof of this is the desire of the Global South to envision alternative governance models, based on regionalization rather than globalization and on friendshoring. The insurgence of a third economic pole appeared to weaken multilateral cooperation, but it was rather what it brought along the rise. 

The coexistence of two different economic narratives, and the distrust that one vis-a-vis the other (and vice versa), has shaken the fragile balance of trust and/or dependence that had been created between the G7 nations and the rest of the world. China has threatened the leadership of the West, in the economic, defense and ideological field, presenting itself as a leader for a new global scheme. Indeed, what has Slowbalization shown is China’s desire to create a new asymmetric order, with Beijing as its central hub and a series of indebted ‘capillaries’; just as Bretton Woods did for Washington. 
This doesn’t necessarily mean that the World order will develop in Beijing’s direction. China does not have the freedom of maneuver that the US had in 1944. Far from it, the resulting scenario is of nationalistic character, fed by distrust. States prefer to strengthen economic ties with their neighbors, favoring friend-shoring over offshoring. This has led to a variety of regional cooperative blocks, rather than relying on a central global order. This push for nationalism has contributed to damaging stable multilateral coalitions, most notably the G7 bloc. As confirmed by the assertive Trump 2 administration, and the calls for resilience and rearmament by the European Commission, deglobalization is not a closed chapter, but it may have entered its darkest hour.

Bibliography