Please come down off the ledge, dear readers


Note:  in my last blog post, I might have sounded juuuuust a wee bit pessimistic about the state of the global political economy.  That was my intent, but it wasn't necessarily how I actually felt.  My aim was to assemble as negative a brief as possible about the state of the global political economy.  The aim of this post is to argue that, despite all the recent bad news, the fundamentals of the global political economy are surprisingly sound.  I'm not actually as optimistic as the rest of this post suggests, either -- but I do lean more in this direction.  The fact that I'm blogging this from a zombie-proof vacation redoubt should in no way affect your evaluation of the following few paragraphs.  

So, when we last left off this debate, things were looking grim.  My concern in the last post was that the persistence of hard times would cause governments to take actions that would lead to a collapse of the open global economy, a spike in general riots and disturbances, and eerie echoes of the Great Depression.  Let's assume that the global economy persists in sputtering for a while, because that's what happens after major financial shocks.    Why won't these other bad things happen?  Why isn't it 1931? 

Let's start with the obvious -- it's not gonna be 1931 because there's some passing familiarity with how 1931 played out.  The Chairman of the Federal Reserve has devoted much of his academic career to studying the Great Depression.  I'm gonna go out on a limb therefore and assert that if the world plunges into a another severe downturn, it's not gonna be because central bank heads replay the same set of mistakes. 

The legacy of the Great Depression has also affected public attitudes and institutions that provide much stronger cement for the current system.  In terms of publuc attitudes, compare the results of this mid-2007 poll with this mid-2010 poll about which economic system is best.  I'll just reproduce the key charts below: 

2007 poll results

2010 poll results

The headline of the 2010 results is that there's eroding U.S. support for the global economy,  but a few other things stand out.  U.S. support has declined, but it's declined from a very high level.  In contrast, support for free markets has increased in other major powers, such as Germany and China.  On the whole, despite the worst global economic crisis since the Great Depression, public attitudes have not changed all that much.  While there might be populist demands to "do something," that something is not a return to autarky or anything so drastc. 

Another big difference is that multilateral economic institutions are much more robust now than they were in 1931.  On trade matters, even if the Doha round is dead, the rest of the World Trade Organization's corpus of trade-liberalizing measures are still working quite well.  Even beyond the WTO, the complaint about trade is not the deficit of free-trade agreements but the surfeit of them.  The IMF's resources have been strengthened as a result of the 2008 financial crisis.  The Basle Committee on Banking Supervision has already promulgated a plan to strengthen capital requirements for banks.  True, it's a slow, weak-assed plan, but it would be an improvement over the status quo. 

As for the G-20, I've been pretty skeptical about that group's abilities to collectively address serious macroeconomic problems.  That is setting the bar rather high, however.  One could argue that the G-20's most useful function is reassurance.  Even if there are disagreements, communication can prevent them from growing into anything worse. 

Finally, a note about the possibility of riots and other general social unrest.  The working paper cited in my previous post noted the links between austerity measures and increases in disturbances.  However, that paper contains the following important paragraph on page 19: 

[I]n countries with better institutions, the responsiveness of unrest to budget cuts is generally lower. Where constraints on the executive are minimal, the coefficient on expenditure changes is strongly negative -- more spending buys a lot of social peace. In countries with Polity-2 scores above zero, the coefficient is about half in size, and less significant. As we limit the sample to ever more democratic countries, the size of the coefficient declines. For full democracies with a complete range of civil rights, the coefficient is still negative, but no longer significant.

This is good news!!  The world has a hell of a lot more democratic governments now than it did in 1931.  What happened in London, in other words, might prove to be the exception more than the rule. 

So yes, the recent economic news might seem grim.  Unless political institutions and public attitudes buckle, however, we're unlikely to repeat the mistakes of the 1930's.  And, based on the data we've got, that's not going to happen. 

Daniel W. Drezner

Is the world cracking up?


So, just to sum up the past week or so of global political economy events: 

1)  U.S. government debt got downgraded by Standard & Poor;

2) Global equity markets are freaking out;

3) The eurozone appears to be unable to solve its sovereign debt problem

4) London Britain is burning;

5) The Chinese are pissed that they appear to be underwriting downgraded, debt-ridden train-wrecks... and this is on top of being pissed about their own train wrecks.

This all sounds very 2008, except that it's actually worse for several reasons. First, the governments that bailed out the financial sector are now themselves the object of financial panic and political resentment. Second, the tools used to try and rescue the global economy in 2008 are partially to blame for what's happening right now. Despite all the gnashing of teeth about the Fed twiddling its thumbs, it's far from clear that a QE3 would actually stimulate anything besides a rise in commodity prices.

With both Europe and the United States unable to stimulate their economies, and China seemingly paralyzed into indecision, it's worth asking if we are about to experience a Creditanstalt moment.

The start of the Great Depression is commonly assumed to be the October 1929 stock market crash in the United States. It didn't really become the Great Depression, however, unti 1931, when Austria's Creditanstalt bank desperately needed injections of capital. Essentially, neither France nor England were willing to help unless Germany honored its reparations payments, and the United States refused to help unless France and the UK repaid its World War I debts. Neither of these demands was terribly reasonable, and the result was a wave of bank failures that spread across Europe and the United States.

The particulars of the current sovereign debt crisis are somewhat different from Creditanstalt, and yet it's fascinating how smart people keep referring back to that ignoble moment. The big commonality is that while governments might recognize the virtues of a coordinated response to big crises, they are sufficiently constrained by domestic discontent to not do all that much.

So... is this 1931 all over again?

There are three aspects of the current situation that make me fret about this. The first is the sense that developed country governments have already tapped out all of their politically feasible methods of stimulating their economies. This is the time when both politicians and voters start to ask themselves, "Why not pursue the crazy idea?"

The second is whether the Chinese government will do something to satiate their nationalist constituency. Neither Joe Nye nor James Joyner thinks this is likely, and I tend to agree that any effort at economic coercion will hurt China as much as the United States. When autocrats are up against the wall, however, then they might take risks they otherwise would never consider.

The third is this working paper on what causes societal unrest in developed economies (h/t Henry Farrell). The abstract suggests more trouble on the way:

From the end of the Weimar Republic in Germany in the 1930s to anti-government demonstrations in Greece in 2010-11, austerity has tended to go hand in hand with politically motivated violence and social instability. In this paper, we assemble crosscountry evidence for the period 1919 to the present, and examine the extent to which societies become unstable after budget cuts. The results show a clear positive correlation between fiscal retrenchment and instability. We test if the relationship simply reflects economic downturns, and conclude that this is not the key factor.

So... there are, unfortunately, numerous reasons to think that we're headed down a bad road... which is the pretty much point of this post.

Readers are encouraged in the comments to offer counterarguments for why things aren't as bad as 1931. I'll be offering some thoughts about why 1931 won't happen again later in the week.