Following the financial meltdown in 2008, the international economic system did better than it’s credited for, says a Fletcher professor
In the aftermath of the financial crisis of 2008 and what is now called the Great Recession, the prevailing view in international economic circles is that the governing global economic institutions, including the International Monetary Fund (IMF) and the World Trade Organization (WTO), didn’t do such a great job managing the crisis, and should have prevented the worst aspects of the resulting economic downturn.
Daniel Drezner, a professor of international politics at the Fletcher School, takes a contrarian view in his new book, The System Worked: How the World Stopped Another Great Depression (Oxford University Press). Despite what the pundits say, the international system did work well, at least at the beginning of the meltdown, he argues, and a worse crisis was averted.
That’s not to say the system is perfect; there is plenty of room for improvement in international economic governance, Drezner says. But recognizing what worked well could help strengthen those institutions, instead of setting an agenda to fix things that aren’t broken.
Drezner, who is also a nonresident senior fellow at the Brookings Institution and writes a daily blog for the Washington Post, spoke with Tufts Now about what was done right—and wrong—following the 2008 meltdown, and the lessons that have been learned.
Tufts Now: Why did you decide to write the book, especially knowing it might come back to haunt you if the global economy went south again?
Daniel Drezner: In the fall of 2008, most of my colleagues and I were pretty doom and gloom about where the global economy was headed, and we were equally skeptical about the ability of global economic governance to do anything about it. But around about 2012, I was kind of struck, as I started researching the topic, that the system hadn’t done all that badly. This was puzzling to me, because the overarching tenor of the commentary was that the world was going to hell, that the institutions were doing really badly. But I don’t think that’s an accurate picture of what’s happened since 2008.
“The system” is two things. The first is the rules of the global economic game: to what extent actors can trade or exchange goods, services and ideas free from government interference. There’s always some degree of government interference, but if there is more in the form of high tariffs or capital controls, for instance, economic growth will be reduced. And then there are traditional treaty-based organizations like the WTO and IMF, and also informal arrangements like the G7 [finance ministers and central bank officials from the United States, Great Britain, Germany, Canada, Japan, France and Italy] or G20 [the larger group of finance ministers from 20 countries, including those in the G7], which monitor and enforce the rules.
What did institutions like the IMF and WTO do right?
When you have a systemic financial crisis, which we had in the fall of 2008, you want to make sure that trade barriers don’t suddenly go up. You don’t want trade wars or what are called beggar-thy-neighbor policies to start. The WTO and the G20 functioned reasonably well in mutually pledging that its members would not suddenly raise tariffs or raise non-tariff barriers.
That’s not to say no protectionism took place, but it was all pretty minor. Economists’ models predicted that we should have seen protectionism on the order of seven times what we actually saw.
It’s also important to have liquidity injected into the system. You want to make sure that banks and other financial institutions are going to be backstopped by someone, that if they decide to lend, they will not go under. And that’s one thing that even skeptics of global governance acknowledge happened in the wake of the 2008 financial crisis. First the G7 and then all the G20 economies agreed that we needed to cut interest rates, and, for at least the first two years, some pledged to increase fiscal expenditures.
That’s different from what happened leading up to the Great Depression?
There was some tentative effort to cooperate right after the 1929 stock market crash, but it didn’t work terribly well. What’s interesting is that in 2008, if you look at trade flows and economic output, 2008 was a bigger shock than 1929. But sustained cooperation prevented what happened post-2008 from becoming a second Great Depression.
Why is there a general impression that global economic governance didn’t work?
You could argue that in some cases, these institutions really were asleep at the switch. Part of the reason Europe is in such bad straits now is that prior to 2008, the Basel Committee on Banking Supervision approved banking standards that basically exacerbated the bubble rather than easing it. That’s one reason.
The other reason is there’s been a mismatch between the centers of economic growth and where the centers of punditry about the global economy are. The developing world has done remarkably well, to the point where poverty rates have gone down faster over the last decade than they did in the 1990s, despite the financial crisis.
On the other hand, the people who write about this stuff live in D.C., New York, London or Brussels. The advanced industrialized states have not done terribly well. The tendency is to assume we’re not doing well where we live, ergo, everyone else is not doing well.
Why has the U.S. done better than Europe?
The Eurozone economic response was truly catastrophic after the first year or two. The Germans in particular became convinced by the Greek debt crisis that there was too much debt and advocated austerity policies. That turned out to be a galactically stupid policy recommendation. The U.S. pursued an expansionary fiscal policy for a lot longer, though beginning in 2011, it did start moving in a more conservative direction, but in a milder way.
You say in the book that the financial crisis of 2008 was not really unusual.
One of the things I point out is that crisis is endemic to the system; this is not a thing that goes away. The question is, How well can the system repair and manage the crisis when it does happen? By that standard, 2008 worked out surprisingly well, contrary to a lot of people’s expectations.
Did we learn from the mistakes made during Great Depression?
I think we’ve almost learned the lessons from the Great Depression, but not quite. We learned that we need to maintain an open global economy. Countries that are more open to trade have higher rates of economic growth and higher rates of growth in productivity. Trade is a growth multiplier; it allows you to be better at what your country’s doing, and it also allows you to consume much more cheaply.
One of the fatal mistakes of the Great Depression was that governments pursued austerity in one form or another. For two years after 2008, we avoided that. There was a consensus that the private sector’s not doing well, so the government has to spend money; it’s the only way to maintain any kind of positive economic growth. But after two years, you saw austerity become the new buzzword—and that debate is still going on.
What’s been the response to the book?
In some ways, the point of the book is to say the glass is half full. And a lot of the responses have been, Yeah, but the glass is half empty, and why aren’t you talking about the half-empty glass? But I think there are plenty of people already making the glass-half-empty argument.
If the consensus is that everything worked badly, wouldn’t the likes of the WTO be viewed as not worthwhile?
Right—perceptions matter in world politics. So if everyone keeps reading the same five pundits who say everything is broken, then you start giving up hope. If nothing else, I’m trying to push back on that.
Taylor McNeil can be reached at taylor.mcneil@tufts.edu.
