Beattie whos in charge here; how governments are failing the world economy (2012)

In April 2007 the International Monetary Fund, the sentinel of global financial stability, smiledbenignly as it surveyed the economic landscape.. Weakness in the USA’s overstretched mark

Who’s in Charge Here?

How Governments are Failing the World Economy

Alan Beattie

RIVERHEAD BOOKS

a member of Penguin Group (USA) Inc

New York2012

To John and his family

My Lord, wise men ne’er sit and wail their woes,

But presently prevent the ways to wail

William Shakespeare, Richard II, Act 3, Scene 2

1 Introduction

2 How many divisions has the Pope got?

3 Partisan paralysis and polder politics

4 Brics without straw

5 What is to be done?

A free excerpt from Alan Beattie’s False Economy

How we got hereAnd everything had been going so well In the spring of 2007 the big new things in the world economywere the rise of a social media site called Facebook, then celebrating its twenty-millionth member,and a new rival named Twitter, favored by narcissists pressed for time Clearly, globalization wasabout to enter a new and excitingly solipsistic phase

In April 2007 the International Monetary Fund, the sentinel of global financial stability, smiledbenignly as it surveyed the economic landscape “Notwithstanding the recent bout of financial

volatility, the world economy still looks well set for continued robust growth in 2007 and 2008,” theIMF said “Spillovers have been limited, growth around the world looks well sustained, and inflationrisks have moderated.”

In retrospect, that forecast rivaled for hubris the infamous prediction of Irving Fisher, the

legendary Yale economics professor, who opined two weeks before the 1929 stock market crash thatshare prices had reached “what looks like a permanently high plateau.”

By 2007 the world had seen nearly two decades of almost uninterrupted growth, first reaping thepeace dividend from the end of the Cold War and then seeing digitization and the Internet dissolvehundreds of separate markets in goods, services and money into one But subterranean subsidence hadbeen silently and invisibly eroding the foundations of global capitalism, and in the summer of 2007the ground started to give way

Over the next five years, the crisis would metastasize and spread Weakness in the USA’s

overstretched market for mortgage finance became a general international credit squeeze as financialmarkets started to dry up, then a rolling banking crisis that swept around the industrialized world, thenthe squeeze turning into a crunch as the entire global financial system threatened to grind to a halt,then a worldwide recession as years of excess were undone, and most recently a wave of

governments across Europe heading toward bankruptcy

At every stage since the crisis hit, two things have been clear One is that the governments, centralbanks and international institutions charged with safeguarding the world economy have had almost noidea about the severity of what was coming The second is that official reactions have for the mostpart been slow and inadequate within countries and disjointed and uncoordinated between them Ateach turn, the international response to the successive attacks of financial contagion has been hobbled

by complacency, misplaced ideology, a failure to coordinate and a lack of political will

Along the way, to be fair, individual policymakers and institutions have improvised some

remarkable responses to the unprecedented challenges But as things stand, dysfunctional politics andwrongheaded economics are posing the biggest threat of another worldwide depression since the onethat followed the crash of 1929

So what went wrong?

In the coming chapters we will see how the system we are supposed to have for coping with theglobal economy has largely failed, how the dysfunctional political cultures in Europe and the USAtook hold, how the emerging economic powers have been big enough to be part of the problem

without being part of the solution, and finally where we should be going from here

As the Queen of England famously asked on a visit to the London School of Economics in 2008:

“If these things were so large, how come everyone missed them?” The reply she got, from the head ofthe management school, was a pretty good one: “At every stage, someone was relying on somebodyelse, and everyone thought they were doing the right thing.” In the end, the strength of globalization—its speed, its breadth and its complexity—also proved to be its weakness The buzzword of the 2000s

was “globalization”—the worldwide integration of markets in goods, services and capital But itturned out that governments did not understand the dangers that it had created And when disasterstruck, it turned out that the crisis could travel faster than the boom—and faster than governmentscould react.

* * *

As is now generally known, the crisis started with, or at least was triggered by, problems in the U.S.housing market For years mortgage lenders, encouraged by low interest rates and weak financialregulation, had been overextending loans to risky “subprime” borrowers When the borrowers started

to miss payments and default, the problem cascaded not just through the mortgage lenders but alsoacross the financial system The streams of forthcoming payments on those mortgages had been

parceled up as separate financial assets, combined, remixed, ludicrously labeled as “safe” by creditratings agencies and sold on to a huge variety of financial institutions The poison of bankruptcy

spread through the world financial system as those assets, in the favored idiom, began to “turn toxic.”

In the summer of 2007, governments got an early sense of just how far the problem had spread, asfinancial markets across the world started to shake Banks became reluctant to lend to each other andthe reverberations started knocking down wobbly institutions In September it caused the first run on aBritish bank in more than a century with Northern Rock, a UK mortgage lender that had ridden

Britain’s housing bubble by borrowing huge amounts of short-term cash to lend to long-term

mortgages

Right from the beginning the problems in U.S subprime mortgages and British banks showed one

of the key features of the crisis—that responsibility for preventing and stopping problems was

scattered across an array of different agencies The mortgage lenders whose recklessness led to theU.S subprime crisis could shop around different regulators—the Federal Reserve (the central bank),the Office of Thrift Supervision, the Office of the Comptroller of the Currency and more—to find theone with the lightest touch All of them were in charge, and so none of them was

In the UK, while the Treasury had overall responsibility for financial stability, the Financial

Services Authority supervised individual financial institutions and the Bank of England, the centralbank, was “lender of last resort,” able to bail out troubled banks if their bankruptcy threatened thewider financial system For weeks in September 2007, as lines of anxious savers formed at NorthernRock’s doors, the bank, misjudging the extent of the problem, rebuffed pleas from the FSA and theTreasury to intervene in the financial markets to help banks lend to each other, while the crisis

worsened All of them were in charge, and so none of them was

It was a pattern that was repeated, on an international scale, when the problem entered its criticalphase a year later In this case the trigger was not a humble British mortgage lender but Lehman

Brothers, a venerable U.S investment bank dating back to the nineteenth century that found itself

unable to meet its obligations On September 15, 2008, Lehman Brothers collapsed, and the crisisspread outward through the tens of thousands of deals it had entered into with other banks and financehouses Because there was no record of who owned what, no one had any idea of how bad it was.Ignorance bred panic, and as banks around the world feared for each other’s solvency, so they

stopped lending to each other, even for a day or two at a time, and the “interbank” market seized up

In came the governments, like a cavalry charge of pantomime horses The U.S Treasury decided

it wanted $700 billion to buy up toxic assets from the banks, a figure that Hank Paulson, U.S

Treasury secretary, later admitted was pulled from thin air The request to the U.S Congress for themoney—a vague proposal put down on three pages of paper, strikingly close to an actual blank check

—was turned down Stock markets went into free fall, and though Congress voted a few days later to

grant the money, confidence in the authorities’ ability to fight crises was badly hit (We will return toU.S congressional dysfunction later.)

In Europe, where banks operated in something close to a single market, thanks to the rules of theEuropean Union, the logical thing to do would have been to organize a similar rescue fund on

international lines, or at least to coordinate actions by regulators But such a mechanism did not exist.Not for the first time, a market in Europe had grown much faster than the policy infrastructure around

it (We will return to European ineptitude later.)

Instead, countries jumped for the lifeboats—even if it meant pushing others into the water Twodays after Lehman Brothers collapsed, Ireland, whose banks were in severe trouble after fueling anunsustainable housing bubble, massively expanded a government guarantee of bank deposits anddebts Since the Depression of the 1930s, it has been routine for governments to guarantee savers’deposits up to a certain level to stop destabilizing runs on banks But the sudden expansion of theguarantee was enough to start UK savers fleeing British banks to shelter under Irish government

protection (We will return to disjointed financial regulation later.)

In one extraordinary week in October, governments first deepened the crisis and were then forced

to scramble to undo the damage On Monday, October 6, Angela Merkel, the German chancellor,blocked a French idea to create a cross-border rescue fund Instead, just hours after an emergencyEuropean summit had called for greater coordination among the continent’s big economies, she

unilaterally issued her own deposit guarantee, infuriating France and the UK

That Wednesday, in one of the more decisive actions of the crisis, half a dozen of the world’scentral banks simultaneously cut interest rates to try to thaw frozen financial markets In another,Gordon Brown, the UK prime minister, later that day announced a rapidly assembled plan to injectpublic money into British banks, which had faced a real risk of collapse within hours Initially,

France and Germany rejected similar plans Guaranteeing savers’ deposits to prevent a bank run wasone thing; plowing taxpayers’ money into banks offended German financial orthodoxy Within twodays the threat of financial collapse forced them to perform a U-turn

At the annual meetings of the International Monetary Fund the following weekend in Washington,visibly scared finance ministers put together a vague plan to do, in essence, whatever it took to bailout the financial system No bank the size of Lehman Brothers would henceforth be allowed to fail.The USA, which had previously rejected the idea of putting public money into banks, abruptly shiftedcourse after realizing that their own institutions would hemorrhage business if they did not

On Sunday, a European summit at the Elysée Palace showed an almost complete reversal of

ideology within a week EU governments pledged to guarantee savers’ deposits, guarantee banks’borrowing, pump public money into the banks themselves—anything to prevent a meltdown In sevendays, governments of the world’s leading economies went from “no need to panic” to “whatever ittakes.”

That extraordinary week in October was not a victory In soccer terms, Europe and the USA hadbarely tied the game before the final whistle Unprepared, uncoordinated, gripped by a

noninterventionist ideology, the governments of the rich countries had taken global finance to thebrink of total collapse before being forced to retreat

The world could surely not go on being governed like this Something had to be done

Enter, like a pantomime horse manned by a troupe of slapstick clowns, the G20 grouping of largeeconomies A full account of the diet and habits of this peculiar beast is left until Chapter 2, but itmade its first appearance in the saga in November 2008 when the USA convened a meeting of G20heads of government in Washington The tone of the meeting was self-consciously historic and

transformative, with the dining metaphor being much used to boast that the big emerging economieshad for the first time been invited to the “top table” of global governance.

Gordon Brown, the UK prime minister, never one to undersell an international meeting in which

he had the slightest role, predicted that the meeting would resemble a second Bretton Woods—thegathering in the eponymous New Hampshire ski resort in 1944 that created a new global monetarysystem out of the ruins of the Great Depression and the Second World War That invitations to theG20 were prized is not in doubt Spain, whose population and economy were too small to warrantinclusion, managed to wangle a spare invitation after a frantic round of calls of European and LatinAmerican countries to ask them to lobby for its admittance

The Spaniards need not have bothered They wouldn’t have missed much Attendees at the summitissued a series of grandiloquent pronouncements about the new geopolitical realities of the

interconnected world, changing paradigms of inclusive international governance, rising aspirations to

a truly innovative global consciousness, and other strings of abstract nouns But the fate of the

specific promises that the G20 made gave astute observers an early clue that this was a groupingwhose ratio of rhetoric to action was set to be stratospheric

* * *The G20’s challenge was clear: avoid a second Great Depression Although the immediate threat offinancial collapse had receded, there was a growing awareness that the global economy itself washitting a wall The world’s big central banks, having largely learned the lessons of the 1930s, weredoing what they could The U.S Federal Reserve was fortunate to have as its chairman Ben

Bernanke, a renowned scholar of the Depression It cut interest rates in effect to zero and found moreand more ways to pump money into the financial markets, a measure known prosaically as

“quantitative easing.” The European Central Bank, which set monetary policy for the economies thathad adopted the euro, acted similarly

But households and businesses, their borrowing constrained by the credit crunch and their

optimism battered by the near-meltdown of the financial system, were sharply curtailing their

spending Big emerging-market countries such as China for a while looked as though they had, in themodish jargon at the time, “decoupled” from the rich world But that hope lasted only a couple ofmonths until their stock markets, too, nose-dived, and their growth, too, faltered International trade,which had grown quickly during the globalizing 2000s, went into free fall (By February 2009 it

would be seen to have shrunk by a fifth from its pre-crisis peak.) Concern rose about a repeat of theGreat Depression of the 1930s, where a collapse in trade had been accompanied by a destructiveresort to trade protectionism, as crisis-hit countries walled off their economies behind import tariffs

Boldly, the G20 governments promised that they, like their central banks, were determined that thehistory of the 1930s would not be rerun They pledged to keep fiscal policy loose—boosting or

maintaining government spending and keeping down taxes—to make up for the shortfall in demandfrom households, businesses and export markets They promised to eschew protectionist actions and

to maintain a free and open global economy And, specifically, they set a goal for trade ministers tomeet before the end of 2008 to agree to a framework deal in the so-called “Doha round” of globaltrade talks that had been running since 2001

Such a breakthrough would indeed have been impressive, and an excellent early achievement forthe G20 The talks, under the aegis of the World Trade Organization, the global guardian of opencommerce, were the ninth such series of global negotiations since the WTO’s forerunner was created

in 1947 Launched in the eponymous capital of the Gulf state of Qatar two months after the September

11 attacks on the USA, they had been intended as a symbol of global solidarity at a time when the

world seemed divided But negotiations over reducing import taxes on agricultural and industrialgoods had stalled the process Governments’ ritual vow to complete the Doha round had become ameaningless pleasantry on a level with “Have a nice day!”

The G20’s specific immediate pledge not to take protectionist actions was a down payment, or atleast a sign of good faith and of their willingness to complete the trade talks The G20 meeting

finished on a Saturday in Washington It was on the Monday morning in Moscow that Russia, a

member of the G20, announced that it would go ahead with a rise in car tariffs to block cheap

imports The solemn and binding promise to eschew protectionism had lasted about thirty-six hours.Soon afterward India piled in with a rise in steel tariffs, followed a short while later by the EU

reintroducing controversial export subsidies to dump their dairy products on the world market, andthe pledge was in tatters

The promise to complete the Doha round proved no more effective A few weeks after the

summit, talks broke down again and the cryogenically preserved round was quietly returned to itsfreezer cabinet True, the world did not return to economic isolationism: countries continued to stick,

by and large, to the commitments they had made in previous agreements, and protectionist actionswere fewer than in other recessions But of collective determination to extend the reach of globaltrade rules there was little sign

The other specific pledge made at the G20, for governments to keep the fiscal taps open, washardly any more productive China, showing that it had learned a thing or two about pre-summit spinfrom the rich countries, announced a spending program of nearly $600 billion—equivalent to 15

percent of its national income—the week before the G20 Finally, perhaps, China was taking up some

of the burden of global consumption that the USA and other rich countries had been pressing on it foryears As it happened, the plans had been in the works for months, and were merely timed around theG20 for dramatic effect And the actual public spending programs turned out to be much smaller, therest being made up of the government leaning on state-controlled banks to increase their lending

In February 2009, once Barack Obama had taken office, the U.S did put through a stimulus

program of tax cuts and spending increases that he had promised while on the campaign trail Buteven there, the package was rather smaller than some in his administration wanted, thanks to

resistance from Congress And in the year after the November summit, no major G20 economy

announced any significant increase in discretionary spending—that is, spending excluding automaticpayments such as unemployment benefits—that it had not already planned The G20 fiscal pledge, too,turned out to be a fiction

But it was not for want of trying, at least on the part of the White House (a strong believer in thevirtues of fiscal stimulus) Just ahead of the next summit in London in April 2009 Larry Summers, thepugnacious chief economic adviser to President Obama, uncompromisingly declared of fiscal policy:

“There’s no place that should be reducing its contribution to global demand right now.” But with thecrotchety air of a dowager duchess sending a substandard amuse-bouche back to the kitchens, Jean-Claude Juncker, Luxembourg prime minister and chair of the “eurogroup” of finance ministers fromthe single currency zone, said sniffily: “Finance ministers agreed that recent American appeals

insisting Europeans make an added budgetary effort were not to our liking.”

Still, if ever there was a politician ready to do good PR for the G20 irrespective of the underlyingreality, it was the host of the London summit, Gordon Brown The British prime minister was by nowinfamous in the UK for conjuring big public spending announcements out of nothing with statisticalsmoke and mirrors—double- and triple-counting money, re-announcing or relabeling existing plans,rolling up multi-year programs into a single commitment—and now he had a global stage on which to

practice his fiscal sleight of hand.

“The Trillion-Dollar Summit” was the headline Mr Brown wanted, and by and large he got it Heclaimed to have achieved a $1.1 trillion boost to the world economy, including $500 billion for theIMF’s war chest, a $250 billion boost for trade and a $250 billion increase in the global money

supply The Guardian newspaper, a habitual cheerleader for the prime minister, ran its story under

the millenarian headline “Brown’s New World Order,” and even less slavishly loyal papers wereenthusiastic

The reality was less impressive The $500 billion for the IMF was very welcome, as the

institution had already started to eat into its reserves with a string of rescue loans for Eastern

European countries in late 2008 But some of the money was already in train—Japan had offered a

$100 billion loan the previous year—or would not be agreed until months after the summit, and anincrease in the future firepower of a crisis lender was not an immediate boost to the world economy

The $250 billion support for trade was more like $4 billion: it was a subsidy for the provision oftrade credit (a basic form of finance that had been in short supply during the credit crunch) and the

$250 billion was a highly optimistic assessment of the amount of trade that subsidy might help supportover three years The $250 billion boost to the world’s money supply was an issuance of “SpecialDrawing Rights,” a form of asset that governments could add to their foreign exchange reserves anduse if they chose to As it happened, most chose not to

The standard view of the G20 among most commentators is that it started well, in Washington andLondon, but thereafter achieved little In reality, only the second half of that is true

* * *The global economy pulled out of recession in 2009, with a lot of help from supportive monetarypolicy, leaving minds to turn to longer-term problems One was coordinating financial regulation toprevent international “regulatory arbitrage”—a race to the bottom where banks and finance housesmoved from one financial center to another to find the softest touch But governments remained atodds on a host of matters: how to regulate financial institutions across borders, how much capitalbanks should be required to hold, whether “derivatives”—complex financial assets—should be put

on organized exchanges, whether banks should be subject to a special tax

France and Germany seemed obsessed with taxing financial transactions and with their long-helddesire to constrain risk-taking investors in lightly regulated hedge funds (despite the fact that hedgefunds had not been a major contributory factor to the crisis) One astute observer likened this to apugilist with a grudge in a bar brawl, waiting till the fracas broke out and then taking a swing at theguy he had always wanted to hit, whether or not the target had had anything to do with starting thefight in the first place

Another issue was a problem in the world economy that had long predated the financial crisis:huge global imbalances in trade Throughout the decade before the crisis, the USA had run giant tradedeficits by sucking in goods from exporters such as China, which accordingly ran massive surpluses.The USA needed to borrow abroad to fund this consumption, and a good chunk of the money alsocame from China In other words, China was operating a system of vendor finance, lending the USAthe money to buy its own exports Since at some point it would need to be paid back, this was not anindefinitely sustainable situation

Washington had been complaining vociferously for most of a decade that this dysfunctional

embrace was the result of China continually intervening in the foreign exchange markets to buy

dollars and sell its own currency, the renminbi, to make its exports cheaper The USA had tried avariety of diplomatic ways over the years to put pressure on China to let its currency rise, mostly via

the IMF, but all to no avail Washington spotted in the G20 a new opportunity, and through the nextthree G20 summits—Pittsburgh in September 2009, Toronto in June 2010 and Seoul in November2010—it tried to corral the G20 into an international posse to go after the currency outlaw.

But though China grudgingly allowed the renminbi to start crawling higher against the dollar in

2010, the USA soon found itself under a counterattack when the dollar started falling almost acrossthe board The “currency wars”—accusations that each country was trying to boost its own economy

at the expense of others by weakening its exchange rate—got under way The Federal Reserve’s

super-loose monetary policy, shoveling money into financial markets, may have averted disaster inU.S financial markets, but it was unpopular abroad Some emerging-market countries such as Brazilwere seeing their currencies soar against the dollar They blamed the Fed for weakening its owncurrency by creating so much of it, encouraging speculators to borrow heavily in cheap dollars andthen use the money to buy Brazilian assets

As the currency wars raged in the run-up to the Seoul summit in November 2010, the USA tried toget the G20 to set numerical limits for current account balances, in order to put pressure on China torestrain its surpluses Determined resistance from China, and other countries sitting on the fence,meant the initiative largely ended in stalemate Throughout 2011, China slowed the rise of the

renminbi to a crawl It ended the year just 5 percent higher against the dollar than it had begun—theUSA wanted at least twice as much—and, according to authoritative estimates, remained at least 20percent undervalued against the dollar

* * *

By the middle of 2011, the USA and Europe were back to having rather more pressing things to worryabout—specifically, the bankruptcy of their own governments When governments in Ireland and

Spain had bailed out their banks with public money in the first wave of the crisis, those banks’

problems became the governments’ problems, and their debt became sovereign government debt Add

to that countries such as Greece and Italy, which had long experienced difficulty collecting enough taxand controlling spending sufficiently to balance their budgets, and the sequel to the 2008 horror movie

went on general release: Lehman Brothers II: This Time It’s Sovereign.

The Lehman crisis had shown that the EU, and particularly the eurozone, had not established ways

of intervening cooperatively to rescue its banks Similarly, the gradual slide of first Greece, thenIreland and Portugal, and then Spain and Italy, toward government bankruptcy, revealed the

weaknesses that critics had said had been present in the structure of the euro since the single currencywas launched in 1999

The eurozone had no real means to stop its member governments from overborrowing Indeed,when it tried to set ceilings for government deficits, it was France and Germany—the supposedlyresponsible parents of the EU project—that were the first two countries to break through them, whichthey did with impunity Nor did the eurozone have a substantial central taxing and spending authoritythat could transfer money to stricken countries to keep their economies going or lend to their

governments when private investors took fright Once stuck in the eurozone, if a country such as

Greece found itself uncompetitive relative to a powerhouse such as Germany, there was no way tocorrect this except by slowly grinding down wages and prices, a process normally only achieved by apainful economic recession And yet, encouraged by financial regulation that treated sovereign bonds,

or debt, as a safe investment, French and German banks had merrily loaded up on bonds from heavilyindebted governments such as that of Greece

Most countries have a central bank that acts as a lender of last resort, bailing out banks and, ifnecessary, the government in order to avoid meltdown The European Central Bank specifically ruled

out acting in this way to prevent sovereign bankruptcies Neither eurozone governments collectivelynor the European Commission—the executive body of the wider European Union—were supposed tomount bailouts for troubled countries.

Moreover, it became painfully evident as the crisis hit that the eurozone’s slow, unwieldy policyframework was horrendously unfit for the purpose Looking back, the whole problem might have beenavoided if the eurozone had moved swiftly in January or February 2010, when investors started toflee Greece and the government was having difficulty supporting its debt burden A modest €50

billion or so rescue loan to tide the country over, a measured reduction in the debt that Greece owed

to banks and other investors, and confidence might well have been restored But it was not only theeurozone at fault: the USA was also slow to wake up to the threat from Europe, an initial view insidethe U.S administration being that the Greek economy was only the size of Rhode Island’s

Instead, over the next two years, as country after country slid toward trouble, the eurozone

governments, the European Central Bank and the European Commission put on an extraordinary

display of chaotic policymaking To return to the sporting metaphor, had this been a soccer game youmight have assumed they had been bribed to throw it

European governments repeatedly dithered and bickered They disagreed in public about whetherthe EU was allowed to do bailouts at all They were divided about whether the IMF ought to be

brought into the rescue to provide cash and credibility—eventually it was, but only after valuabletime had passed and confidence had been lost They fought about whether countries such as Irelandand Greece should forcibly reduce the debt that their governments or nationalized banks owed toforeign banks to stop them being crushed by debt burdens (The answer should have been yes, but theECB said no.)

The eurozone’s governments created a bailout fund, the European Financial Stability Facility, andthen spent months arguing about what form it would take, what it was allowed to do and where itcould borrow money from They held crisis summit after crisis summit—at least a dozen in 2011—which repeatedly raised expectations of a comprehensive solution and then dashed them Some

European leaders wanted to solicit money from the emerging-market countries such as China to helpwith the rescue; others said it was unnecessary

And misplaced ideology persisted at every moment The German government and the ECB had ananalysis of the crisis often starkly at odds with the facts The view in Berlin and Frankfurt was that itwas all caused by fiscally profligate governments, rather than being largely to do with the bankingcrisis In countries such as Ireland and Spain, that was flatly untrue The misreading of the situationprevented the one institution that really could have helped, the ECB, from intervening in sufficientamounts to prevent the crisis spreading The eurozone, and the G20, tried to find expensive and

complex ways to do what the ECB could have been doing cheaply and easily—lending in large

amounts to troubled governments, via the IMF if necessary, to stem panic in the markets Only

gradually and painfully was the ECB induced to intervene

And so, as 2011 ground on and the rest of the world watched in astonishment and alarm, the

policymaking deficit was filled by an extraordinary abrogation of power The eurozone authorities—which by this point meant “Merkozy,” German chancellor Angela Merkel and French president

Nicolas Sarkozy, or increasingly just Merkel—in effect appointed technocrats to run Italy and Greeceafter their governments fell Germany embarked on creating a central fiscal authority in the eurozonethat should have been done a decade before There then followed a constitutional crisis when the UKobjected to changes to EU treaties necessary to make the new system work

It was like watching a gang of irascible, quarrelsome architects trying to redesign a house in the

middle of a raging fire.

It was a hell of a way to run a bailout

Still, while the eurozone was having a serious sovereign debt crisis, at least it hadn’t meant to.Across the Atlantic the USA was undergoing a somewhat less destructive but in many ways evenmore misguided process, flirting with voluntarily defaulting on its national public debt and in duecourse receiving the first credit downgrade in U.S history The culprit: an ideology propagated by apolitical faction that, rather than learning from the mistakes of the Depression, seemed to want tomake them all over again

The rise of the Tea Party might be an object lesson in the old adage that no good deed goes

unpunished Taking its name from the Boston Tea Party remonstrance against British colonialism in1773—originally a protest against a tax cut, but let that pass—the modern movement arose, bizarrely,from a rant by a cable TV presenter against government help for the troubled U.S housing market.Within months, a populist movement helped on its way by copious dollops of cash from traditionalpolitical funders had turned into a national organization that inserted itself firmly into the

conservative wing of the Republican Party

Blooding itself in battle by opposing Barack Obama’s plan to reform health care, the Tea PartyRepublicans proceeded to pursue an extreme version of fiscal stringency Periodically, the federaldebt ceiling—the U.S government’s ability to borrow—needs to be raised, if only because the

absolute level of borrowing will go up when the economy expands Normally this is a routine

administrative procedure In August 2011 it became an unforced fiscal crisis as some in Congresstried to use it as a lever to try to force big long-term cuts in government spending The implications ofthis went well beyond U.S shores The rest of the world economy depended on the USA continuing toexpand, and the Tea Party was trying to knock away the one reliable prop of growth

And so, the world struggled into 2012 with a dire outlook for the global economy and financialmarkets Eurozone governments faced debt default and the USA was set for indefinite gridlock overserious reform of tax and spending

The IMF, though it had failed to spot the crisis coming, managed to maneuver itself back into aserious role in combating the financial crisis—and its advice was among the saner views expressedduring the eurozone bailouts Emerging markets such as Brazil, though their policy record was farfrom spotless, used the reserves they had built up to cushion themselves from the impact of the crisiselsewhere Some countries such as Canada and Australia, which had had relatively good financialregulation (though also benefiting from high commodity prices) rode out the first few years of thecrisis without much damage

But overall, the collective response of the world’s big economies since 2007 has been slow,disorganized, usually politically weak and frequently ideologically wrongheaded The rest of thisbook will examine how things got to be as bad as they are, and where we might go from here

How many divisions has the Pope got?

Why international institutions are too small and too weakWait a second Aren’t we supposed to have organizations to deal with this sort of thing?

Yes, we are Specifically, we have the set of institutions created after the Second World War toensure the Great Depression would not happen again: the International Monetary Fund, the WorldTrade Organization and the World Bank

But the world economy has gotten a lot bigger and its house rules have become much more

complex since then True, the institutions have done their best to adapt and keep up In fact, the

performances of the three have been among the better responses to the global financial crisis, thoughadmittedly that involves hopping over the lowest of low bars But two factors have prevented themfrom doing more One, they do not have the size or the power to meet a global crisis with anythinglike overwhelming force Two, they are only as good as the countries that set them up and, ultimately,govern them

Despite the grand talk of global cooperation, and particularly the self-appointment of the G20grouping of leading economies as a steering committee for the world economy, those “shareholder”governments have proved themselves fickle, self-interested and disunited

The International Monetary Fund, above all, is the obvious institution to step forward during

global financial turmoil The Fund (as insiders, in a slightly Orwellian fashion, call it) was set up atthe international monetary conference in Bretton Woods, New Hampshire, in 1944, to oversee a

system of fixed exchange rates and controls on international movements of capital The Bretton

Woods exchange rate system was supposed to bring stability by anchoring the value of other

currencies to the dollar and the value of the dollar to the price of gold But the mechanism collapsed

in the early 1970s as the USA started creating too many dollars, not least to fund the war in Vietnam.Inflation started to take off, the dollar’s link to the price of gold was broken, and the global economyentered the era of largely floating exchange rates and free movement of money across borders

The IMF, which had previously lent mainly to Western European countries (its first loan was toFrance, in 1947) to enable them to cope with shortfalls in their balance of payments, has since

transmuted into an all-purpose government crisis lending institution that until recently mainly dealtwith poorer countries Essentially a credit union—a lending institution owned and controlled by itsmembers—it is funded by money put on deposit by its shareholder countries and bails out any of thosegovernments that are at risk of going bankrupt Being backed by governments, its lending is cheap, atlow interest rates, but generally comes loaded with tough conditions to restore solvency by cuttingpublic spending and raising taxes And from the 1980s onward IMF loans were often made

conditional on implementing controversial so-called “structural reforms” such as privatizing owned companies, reducing import taxes and getting rid of controls on food prices and exchangerates

state-By the time the credit crunch hit in 2008, the Fund, though its membership was pretty much

universal, with 187 shareholder countries, was an institution looking for a purpose It had seen a

flurry of rescue lending in the late 1990s with the Asian and Russian financial crises, followed by theongoing disaster of Argentina, which defaulted on its government debt in 2001 despite massive IMFassistance, and a couple of notable successes staving off default in Turkey and Brazil in the early2000s But half a decade of rapid global economic growth, confident investors and buoyant financial

markets had left it with little to do A cartoon in The Economist in 2006 nailed it perfectly: IMF staff

were a bunch of bored firefighters sitting around an idle fire engine

Despite subsequent events in hotel rooms in New York City, the IMF was fortunate to have

Dominique Strauss-Kahn (“DSK”) as its managing director when the global financial crisis hit

Strauss-Kahn, a former French finance minister and one-time economics professor, had the unusualcombination of political clout, negotiating guile and intellectual credibility Simon Johnson, a formerIMF chief economist, described DSK as “Metternich with a BlackBerry”—referring to the

legendarily wily nineteenth-century diplomat of the Austrian Empire The Fund swung back into

action in 2008, bailing out a succession of mainly Central and Eastern European countries to whichforeign banks had lent heavily in anticipation of their joining the euro

Since the Fund’s resources had stayed constant while the global economy and its financial

markets had grown, Strauss-Kahn—with the help of one or two other political heavyweights such asTim Geithner, U.S Treasury secretary, and Gordon Brown, then UK prime minister—seized the

moment to raise fresh contributions and triple the size of the Fund’s war chest By 2010, the IMF hadfound a bunch of fires to put out, had by and large doused the flames successfully, and had restoreditself to a dominant position in rescuing small- to medium-size countries in crisis

That, however, was about as far as it could go on its own When the Western European economiesstarted to implode in 2010, with Greece followed by Ireland and Portugal, DSK managed to get theFund involved in the rescue effort, overcoming initial resistance from the European Central Bank Butits firepower was not big enough on its own Greece alone (with an economy, let us recall, only thesize of Rhode Island) required an initial bailout of €110 billion, which would have used more than athird of the IMF’s entire lending capacity Funding the Irish and Portuguese rescues would have

cleaned out its war chest completely

The IMF joined the eurozone bailouts only as a junior partner, providing around a third of themoney for Ireland and Portugal and a slightly smaller share for Greece, with the rest coming fromeurozone governments The conditions for the loans were set by the so-called “Troika” of three

institutions—the IMF, the European Commission and the European Central Bank (Someone was

either ignorant of history or had a dark sense of humor: “troika” was also a name given to kangaroocourts of three judges in the former Soviet Union that ordered executions of innocent men on the word

of the secret police.)

When the Troika started making bad decisions in 2010, the IMF was dragged along During

negotiations over the Irish bailout and the Irish banks that had been nationalized, the idea was

(rightly) mooted of those banks forcibly reducing their debt payments to the foreign banks and

financial institutions that had foolishly lent to them Officials involved in the negotiations said that theFund appeared somewhat amenable to the idea (The image of the IMF as a kinder, gentler crisis

lender was one that a lot of people took time to accept.) But the ECB blocked the plan, not least

because many of those lenders were elsewhere in the eurozone In Ireland, the ECB was widely seen

as a debt collector for feckless French and German banks

As the Greek economy weakened and the rescue plan slid off track in 2011, the IMF watched withintense frustration the dithering and disunity of the two other members of the Troika But for the IMF

to pull the plug and refuse to authorize payments in the bailout program would have precipitated

government default and opened the Fund to the accusation that it had created chaos in the eurozone.This was a familiar dilemma for the IMF, but worsened in the eurozone by its junior financingrole When it becomes highly unlikely that a borrower country can avoid bankruptcy, the best course

of action in the long run is to stop lending and reduce or “restructure” the government’s debt ratherthan loading it up with more loans, thus worsening the default when it comes But at any given point, it

is easier to keep doubling down on bets than to admit that the game is up It was this that kept the IMF

lending to Argentina for far too long before that perennially troubled country finally slid into chaoticdefault in 2001 It was politically even harder to stop lending in the eurozone when the Fund was only

a minority partner

Not only that, but the eurozone’s influence over the IMF itself was, well, considerable The Fund

is, after all, a credit union: it is owned and controlled by its member governments, with their votingpower roughly reflecting their importance in the global economy and international trade And despitelong—and, frankly, bureaucratically tedious—struggles to shift power toward the emerging

economies, its governance structure still mainly resembles the world of the 1940s The USA is thelargest shareholder, with 17 percent of the votes on the IMF’s executive board—in fact rather smallerthan the U.S share in the global economy—but European countries collectively hold around a third ofthe votes Until a reform in 2008, Belgium had a bigger share than India

Since its inception, European countries have also had a gentleman’s agreement that they in effectget to nominate the head of the IMF, while the USA appoints the president of the World Bank Thedeal was originally supposed to ensure that the European countries that were the Fund’s first

borrowers felt it was a cooperative institution rather than an American-run debt collector Since

Europe and the USA between them have nearly half of the votes on the IMF’s board, this sordid littledeal has been relatively easy to maintain

Despite Europe’s shambolic management of the eurozone debt crisis, its governments have

insisted on this tradition continuing The gentleman’s agreement produced the IMF’s first female headwhen another former French finance minister, Christine Lagarde, was appointed managing director inJuly 2011 to replace the disgraced DSK In other words, as Paulo Nogueira Batista, the Brazilianrepresentative on the IMF’s board, put it to me: “The debtors are in charge of the bank.”

It is hardly surprising it kept lending

* * *Despite its partial return to relevance as a crisis lender since 2008, the International Monetary Fundhas struggled to extend its influence to other areas Although conspiracy theorists persist in seeing theIMF as an embryonic world economic government, its ability to direct the overall global economyhas proved minimal

But it was not through want of trying One of the IMF’s other functions, alongside bailouts, is toact as a center of expertise on economics It makes forecasts of economic growth—though generally

no more accurate than other forecasters’ predictions, which is to say not very accurate at all And,under the Fundspeak term “surveillance,” it monitors and offers advice on running its members’

economies and financial systems

The surveillance function, like everything else in the Fund, can be subject to intense politicallobbying Gordon Brown, who chaired the IMF’s ministerial steering committee while he was UKchancellor of the Exchequer, was a strong supporter of a prominent role for IMF surveillance—

except when it came to criticizing his own handling of the UK’s economy, whereupon he embarked on

an aggressive campaign of lobbying bordering on intimidation to get Fund officials to pipe down

If the institution showed bias toward the eurozone in lending, it leaned toward the USA and the

UK in its thinking, and particularly in its support for “light-touch” financial regulation Despite itsminority shareholding, the USA has generally played a dominant role in directing the organization, notleast because the U.S Treasury is four blocks from the IMF in downtown Washington, D.C

The IMF managed spectacularly to miss the global financial crisis coming, saying inaccuratelyand ungrammatically in the summer of 2008 that “the U.S has avoided a hard landing” and “the worstnews are [sic] behind us.” A report by the IMF’s watchdog Independent Evaluation Office in 2009

was sharply critical It concluded: “The IMF’s ability to correctly identify the mounting risks washindered by a high degree of groupthink, intellectual capture, a general mindset that a major financialcrisis in large advanced economies was unlikely, and incomplete analytical approaches.”

Indeed, far from spotting the dangers in the U.S financial system, the Fund spent most of the yearsrunning up to the crisis trying to do the USA’s work for it And yet, revealing another of its big

weaknesses, it failed

During the 2000s the USA recruited the IMF to its long campaign of persuading China to let therenminbi rise in order to curb its import growth and—so the U.S belief went—to rebalance the

world economy China resisted, and the dispute turned into a mighty and prolonged bureaucratic war

of attrition during which much ordnance was exchanged, but which achieved a net outcome that waspretty much nil

The USA tried to use the IMF’s artillery against China in several different campaigns First itorganized a “multilateral consultation” exercise inside the IMF involving itself and China, wheeling

in Japan, the eurozone and Saudi Arabia to maintain the facade that this was a broad consultativeprocess China politely declined to be surveilled into accepting the U.S view that its exchange ratewas an important contributor to global current account imbalances

In 2007, just before the credit squeeze began, the USA then tried an even more direct route,

successfully pressing the IMF to conduct special direct surveillance on exchange rates The drive wascontroversial even within the IMF Raghuram Rajan, another former IMF chief economist, later saidthat the decision to focus on currencies was “an unmitigated disaster” that made the Fund look biased

The USA raised the stakes by trying to get the IMF to name China as a “currency manipulator”—apolitically loaded description that would imply that Beijing was undermining the spirit of

international cooperation China objected so violently that Strauss-Kahn dared not bring any

discussion of China’s economy to the Fund’s executive board for more than three years—they aresupposed to happen annually—for fear of the diplomatic explosion that might ensue

These and other efforts to use the IMF as a global currency enforcer all failed, and yet the USAhas kept trying In 2009 it got the G20 to commission the IMF to conduct a so-called “mutual

assessment process,” and tried to set targets for individual countries’ current account deficits andsurpluses, which would have put pressure on Beijing to allow renminbi appreciation in order to

reduce its surplus China fought back strongly in the G20, and the campaign stalled Separately, theIMF started to publish its own “spillover reports,” which detailed how policies such as China’s

intervention to hold down its exchange rate affected other countries With no sanctions for ignoringthem, they dropped dead off the presses There remains no effective international constraint on

governments’ currency policy

What all these efforts show is as follows The IMF has substantial power over small- to size countries to which it is lending money, as it can force them to follow policies or cut them offfrom finance, but not over anyone else Your mother can try to stop you smoking through moral

medium-suasion, but she is much more likely to succeed if she can take away your pocket money

As a technocratic institution, the IMF is ideally placed to do analysis, though it does not

necessarily get it right But as a political institution, it is badly placed to arbitrate or even mediatedisputes such as that of China with the USA In that intractable dispute, the IMF’s management founditself caught between the global economy’s current hegemon and its possible future one; between itscurrent biggest shareholder and potentially its biggest shareholder down the line

Dominique Strauss-Kahn, speaking after the largely unproductive Seoul G20 summit in 2010,said, tongue imperviously lodged in Gallic cheek: “I am happy when I see that people are expecting

the IMF to become a kind of dictator of the global economy.” But then he added wistfully: “That isnot going to happen we have no teeth, no police, no army to send to countries.” The IMF

criticizing the major economies rather resembles the old Robin Williams stand-up routine about anunarmed British policeman trying to apprehend a fleeing suspect: “Stop! Or I’ll shout stop again!”

The IMF has regained a role as a crisis lender: it does not, however, run the global economy

* * *There is a similar story across the street—as in literally across Nineteenth Street in Washington, with

an underground passageway between the two buildings—at the World Bank Set up and directed bygovernments, much like the IMF, it was originally created to make longer-term loans to rebuild

shattered countries after the war Like the IMF, its first customer was France Gradually, like theIMF, it transmuted into an organization focused mainly on developing countries, though unlike theIMF it has not found the need to go back into Western Europe The World Bank, like the IMF, seizedthe opportunity of the global financial crisis to enlarge itself: it increased its capital base to allow it

to borrow more on the open markets and continued to increase contributions from its richer donorcountries to enable it to give grants and very low-interest loans to the poorest countries

All fine, but as the global economy has grown, and with it the ability of low- and middle-incomecountries to borrow from international private investors has risen, so the bank finds itself playing aless important role in filling financial holes Indeed, during the 2000s one of the biggest threats to itspreeminence was an emerging-market country itself China, seeking sources of raw materials and newexport markets, invested heavily around the developing world and particularly in Africa Over 2009and 2010, the Chinese agencies that give loans and grants to middle-income countries were largerthan their counterparts at the World Bank And in any case, since the global financial crisis was

concentrated in the rich countries, the demand for external finance from the developing world roseafter 2008 but it did not skyrocket

And so to the World Trade Organization Rarely can there have been an institution with a biggergap between critics’ perceptions of its overweening power and the mundane reality When it becameone of the hate objects of the anti-globalization movement in the 2000s, the WTO was regarded asboth sinister and omnipotent The charge sheet was as follows: the WTO was undemocratic and

secretive, with deals stitched up by the rich countries while the poor ones were shut out; the WTOsnatched medicines out of the hands of Africans by enforcing patents for Western pharmaceuticalcompanies; the WTO destroyed whole swaths of industry and the livelihoods of millions of farmers

by subjecting them to the vagaries of global competition; the WTO let multinational corporationssecretly run the world economy

Not all of those criticisms are complete nonsense, but most are One of the least understood

aspects of the WTO as an organization is how small it is and how little power it has Protesters

turning up to its headquarters in Geneva expecting a towering edifice of global capitalism are

generally taken aback to encounter a drab gray building about the size of a smallish comprehensiveschool

The central organization housed in the building, known prosaically but accurately as “the

Secretariat,” has very little power of its own Unlike the IMF—an organization with some executivepowers, albeit guided by its executive board of shareholder countries—the WTO is, as the stockphrase has it, “a member-driven organization.” The organization has 153 such countries, and a

cartoon popular with WTO staff shows a car having careered into a ditch, the caption explaining it is

a member-driven vehicle

In fact, the WTO was a minimalist Plan B created once the main Plan A had been rejected The

Bretton Woods conference that created the IMF and the World Bank also proposed a counterpartInternational Trade Organization, but it foundered on multilateralism fatigue in the U.S Congress andconcern that an ITO would end up interfering in members’ domestic economies.

Instead, the world wound up with a limited treaty, the snappily named General Agreement onTariffs and Trade GATT finally managed to transmute into an actual organization, the WTO, in 1994.But it remained a weak one Mainly, the WTO is there to host negotiations over rules about the globaleconomy In GATT days these were mainly about taxes (tariffs) on imported goods Increasingly, a

“round” of WTO talks has multiple strands that are supposed to be negotiated more or less

simultaneously and then come together in a single agreement The lengthening list of issues reflects theincreasing complexities of globalization: export controls and quotas, agricultural subsidies that

distort trade, intellectual property rights, trade in services, rules about being able to block imports ofgoods that have been unfairly subsidized or are being sold below cost, and so on and so forth

As we have seen, the WTO’s negotiating function ground to a halt during the 2000s during the called “Doha round” of talks that began in the Qatari capital in 2001, not least because of the round’ssheer size and complexity Though many governments have yet to admit it—and continue to wastetheir travel budgets and their civil servants’ careers, throwing good time and money after bad—Dohawill be the first failed round since the GATT crawled into existence in 1947

so-Repeated clashes between the same governments over the same issues—often the USA trying toget its agricultural exports into developing countries, and those countries trying to get the USA to cut

farm subsidies—had given the Doha talks something of the air of Waiting for Godot, or Groundhog Day A meeting of trade ministers in Geneva in July 2008 collapsed without agreement for the third

summer in a row, and the round was effectively dead

Given the way it makes decisions, it is surprising this hasn’t happened before WTO officials andtrade negotiators laugh hollowly at accusations that it is undemocratic The WTO system is in fact sodemocratic it can hardly move Deals require not just majority agreement but unanimity: every

member country must acquiesce to every agreement within every round This system was aptly oncedescribed by Pascal Lamy, the WTO’s current director-general, during his earlier days as the EU’schief trade official, as “medieval.”

Any single government, however small, can block a WTO deal Agreements were driven through

in the past—and this is where criticisms of secrecy have some validity—by the “Quad” grouping offour rich economies (the USA, EU, Canada and Japan), who stitched up a deal between themselvesand then bullied everyone else into accepting it Now that emerging economies such as India andBrazil have been added to the core negotiating group, talks are more representative but also less

productive

The failure of the Doha round does not bode well for future attempts at multilateral trade

liberalization The alternative to the WTO is not to have no trade deals It is more likely a future

where the global trade system splinters into hundreds of separate bilateral and regional pacts that cancomplicate commerce as much as liberalize it—and where, in fact, rich economies are much morelikely to be able to go back to bullying poor countries into one-sided agreements

This would be a pity Unable though it is to write new rules, the WTO has been surprisingly good

at holding countries to existing ones—surprising because its enforcement mechanism is slow andbureaucratic and has limited sanctions at its disposal

The WTO’s “court,” which rules on cases where one member country accuses another of havingbroken existing WTO law, is an institution with another snappy title—the Dispute Settlement Body.The Secretariat has very little power over the quasi-independent DSB Its judicial panels and appeal

bodies are staffed with current and former trade officials and lawyers The DSB’s only power ispermitting wronged countries to impose limited trade sanctions on the wrongdoer As this also meansdepriving themselves of cheap imports, which hurts their consumers and any companies that depend

on imported supplies, most trade economists regard this as roughly equivalent to being granted

permission to shove rusty spikes through their own feet

And yet, by and large, governments tend to comply with its decisions At the same time that theDoha round was sputtering, China agreed to eliminate a number of illegal state subsidies, and the EUreformed its rigged sugar market after DSB rulings Even the USA, not a big fan of being bound byinternational agreements, has a fairly good record at complying The WTO may, in fact, be the lastmajor multilateral institution by which the USA allows itself to be bound—having, for example,

pulled out of the International Criminal Court and rejected the Kyoto Protocol on climate change.There is not much more sacred to the U.S Congress than tax—“no taxation without representation”and all that—but it twice rewrote part of its corporate tax code after a WTO panel ruled it was

tantamount to an illicit subsidy for exports

And through the first three years of the financial crisis, though it may not have produced the

breakthrough in Doha that was promised, WTO agreements held up pretty well Like the IMF and theWorld Bank, the WTO did what it could (And like the IMF, amusingly enough, it was run during thecrisis by a French Socialist, Pascal Lamy.)

When, for example, the U.S Congress tried to restrict government spending to American

companies as part of its 2009 stimulus package—the so-called “Buy American” clause—a quietcough from the White House reminding Capitol Hill of WTO law was enough to have them modify it.Unlike the 1930s, there has been no widespread return to protectionism during the global financialcrisis Both the WTO and the World Bank set up monitoring operations to watch for signs of

widespread protectionism, but on most measures this has remained much lower than in previous

postwar recessions, let alone the Great Depression

What actions there were, such as the string of decisions that broke the G20 protectionism pledge,were regrettable but limited—and permitted under current WTO agreements In truth, the WTO’sproblem is not that its rules are ignored but that there aren’t enough of them There remain a swath ofways in which countries can interfere with trade—licenses and regulations, controls on raw materialexports to divert them to domestic companies, implicit subsidies to state-owned enterprises—thatWTO agreements cover inadequately, if at all These more insidious forms of distortion—sometimescalled “murky protectionism”—have been rising over the past few years, without laws and treaties tostop them Some skeptics go so far as to say that the WTO does not prevent protectionism at all—itjust forces governments to be more creative about it

* * *

It should have become obvious by this point that simply having institutions isn’t enough What matters

is the political will to give them powers and to implement what they say Without a shared sense ofpurpose and a degree of consensus about how the world should be run, the governments that directthese institutions are hardly likely to be keen on being bound by them

Traditionally, the three institutions described here—the IMF, World Bank and WTO—were run

by small informal cliques of rich countries The WTO, as we have seen, was driven by the Quad ofadvanced economies The steering group for the Bretton Woods institutions, most of the time, wascomposed of finance ministers from the Group of Seven, or G7 The G7, which sometimes describesitself as a club of rich democracies, started life as the G5 in 1975 (USA, UK, Japan, France and WestGermany) before later adding Italy and Canada Their heads of government also met annually, and at

heads of government level the G7 became the G8 in the 1990s, Russia being invited on the

overoptimistic assumption that it, too, would soon become a rich democracy

Throughout the 1990s and up to 2008, the IMF’s two sets of meetings a year—one in the springand the full annual meeting in the autumn—were inevitably preceded by a joint pronouncement fromthe finance ministers of the G7, and it was rare that their view did not eventually prevail The G7 maynot have been particularly representative, but it was a manageable group of usually like-minded

nations

But during the 2000s, as China and other middle-income countries emerged, the trade-off betweennimbleness and accountability began to shift in favor of expanding the charmed circle Accordingly,the middle years of the 2000s were marked by endless conversations about which countries might beinvited to widen the grouping These interminable discussions over the optimal constellation of

countries suddenly began to produce results during the global financial crisis The rich countries

recognized that it would look absurdly out of touch first to let a global problem emerge from theirfinancial systems and then to refuse to invite rapidly growing emerging economies to be part of thesolution

In the autumn of 2008, the USA decided to call a summit of heads of government But whom toinvite? They could have tried to work out a new set of important countries, ensuring geographical andeconomic balance, with all the unbelievable amount of detail (and lobbying for inclusion) that thatwould have involved, like a giant game of geopolitical Sudoku Instead, they pulled off the shelf aready-made solution—the “G20” of big economies, including the larger “emerging market” countriessuch as China, India, Brazil, Turkey and South Africa The G20 had been created during the previousburst of enthusiasm for global governance changes following the Asian financial crisis of 1997–98,but had thereafter been left to wither, with increasingly junior officials having increasingly pointlessdiscussions

But as we have seen, though it was heralded as the dawn of a new age, the G20’s achievementswere much more spin than substance Increasingly its role was to provide a peripatetic gladiatorialarena for the latest round of intractable international disagreements—over fiscal policy in 2009, overcurrencies in 2010, over the eurozone crisis in 2011

The reason for the G20’s weakness goes to the heart of what international institutions are for, andwhy some work and some do not There are essentially two functions that international governmentinstitutions perform The less controversial one is to act as a repository of specialized knowledge: theWorld Bank, for example, is a global clearinghouse of expertise about water management in

developing countries The second is to help to coordinate different governments when everyone

knows it is in their best interest to cooperate, but at each point there are strong domestic pressures not

to The classic example is fishing quotas: everyone knows it is in everyone’s long-term interest tomaintain fish stocks by limiting catches, but no one wants to be the mug government that voluntarilyrestrains its own fleet while others vacuum the oceans clean

For such a coordinating function to work, there first has to be agreement on what the actual

problem is For many of the issues the G20 addresses, there is not In theory, for example,

coordination would be possible between the USA and China on economic policy The USA wouldrein in its long-term fiscal and trade deficit, thus reducing the need to borrow from China, and Beijingwould allow the renminbi to appreciate faster, thus buying more exports from the USA to replace thefall in government demand But China simply does not agree that its manipulation of its currency hasmuch to do with the USA’s trade deficit, and many in Washington do not think that long-term fiscalconsolidation will do much to reduce trade deficits In areas such as this, the problem is not one of

coordination—it is of a fundamentally different analysis.

Even where there is agreement on the underlying aim, such as the need to prevent rising

protectionism, the international institutions only work if they are sufficiently credible to be a decisivefactor in domestic policy decisions So, when the White House wanted the Congress to drop the “BuyAmerican” provisions in the stimulus bill, it was much easier to argue that it had to be done because

of the USA’s commitments under the WTO—and because the USA itself benefited from the rules inthe WTO system to give its exporters access to other markets—than it would have been to argue thecase on its own merits

But designing institutions like this is difficult, takes time and works much better when countriesare bound into a formal system of rules than when they are simply making commitments in principle.The inability of the G7 and G8 to hold governments to promises had already been on display In 2005,Tony Blair, then UK prime minister, used the G8 meeting he chaired in Gleneagles, Scotland, to make

a grand gesture toward development in Africa by getting attendees to sign up to a set of promises toincrease overseas aid by 2010 Mr Blair had the eight leaders solemnly and personally sign the

communiqué to hold them accountable

But in truth, there was no real sanction (and no genuine threat of a domestic political backlash) ifthose promises were broken—as indeed, for the most part, they duly were In fact, of the eight heads

of government who signed the communiqué, the only one to be back in office in 2010 when the pledgebecame due was Silvio Berlusconi in Italy—and it was Italy that had most blatantly broken the aidpromises made at Gleneagles Since there was no sanction for reneging on promises and no

reciprocal benefit for keeping them, there was insufficient incentive for countries to spend money andpolitical capital doing so Perhaps to his own disappointment, Mr Blair found that his moral

indignation—along with that of the campaigning coterie of rock stars and other celebrities who

congregated around the G8—was not sufficiently compelling to stop the aid pledges being broken.The same was true of the G20, only more so, since with more countries and more diversity ofpolitics and economies, there was even less of a sense of common purpose to bind the group together.When the G20 leaders signed up to the no-protectionism pledge in November 2008—the one thatlasted less than thirty-six hours—it was quite clearly without consulting their ministers or imaginingwhat this meant or how it might work On the very day of the summit I called a trade ministry in oneG20 economy to try to find out what the specifics of the pledge meant I got a big gust of frustrationdown the line “Alan, this pledge is not aimed at people like you who know what they are talkingabout,” my interlocutor said “This is a gesture.”

Gestures are not enough The G20 promises did not intervene significantly in domestic debatesover protectionism or anything else First rule of global governance: never mind what people say,watch what they do Governments’ lack of faith in the G20 to quell the currency wars in 2010 wasevinced by a string of unilateral interventions to weaken their currencies or keep out rapid capitalinflows By late 2010 some big emerging-market countries whose cooperation was vital to make itwork—India, Turkey, Brazil—were already complaining in public that the grouping was ineffectual

I have never heard a G20 pledge cited as the reason why a serious amendment to policy was

made—no equivalent to Congress amending the “Buy American” provision because of WTO rules.The U.S Congress actually makes a reasonably good stab at implementing decisions taken by a

grown-up organization such as the WTO, anchored in U.S law and treaty obligations, but it knows thedistinct difference between a legally binding agreement and a group hug

Still, sometimes, you hear debates go on about how the grouping might be made more effective.Should it have its own secretariat? Is it too big, or are the wrong countries in it? Should it kick out

Argentina, a country that has broken most norms of international economic policymaking over the pastdecade? Should more financial centers—such as Switzerland or Singapore—be introduced?

This debate almost entirely misses the point Global governance needs more political will, nottechnocratic tweaking Those organizations that have actually achieved something during the globalfinancial crisis—even if limited in size and scope—are those that have clear aims and the financial orlegal authority to bind their member countries into decisions they may not like

When Dominique Strauss-Kahn noted in mock regret that the IMF had no army to enforce its

decisions he was, consciously or not, echoing Joseph Stalin Someone once told Stalin that the Popewould disapprove of his suppression of the Catholic Church in the Soviet bloc “The Pope?” Stalinreplied “Screw the Pope How many divisions has the Pope got?”

In the aftermath of the Great Depression and the Second World War, the architecture of the globaleconomy was entirely redesigned So far, the global financial crisis has involved allowing two ofthose inherited institutions to begin to catch up with the huge growth in the global economy, and foragreements negotiated nearly twenty years ago to be, in the main, respected But beyond that, nothingeffective or durable has been created A second Bretton Woods this certainly is not

Partisan paralysis and polder politicsWhy the USA can’t lead and Europe doesn’t work

In the eurozone we have seventeen national parliaments Here you

seem to be having enough trouble with just one

Francois Baroin, September 2011, Washington, D.C

Touché, Monsieur Baroin Touché It was Harold Macmillan, the UK prime minister in the 1950s and1960s who watched U.S power rise as the British Empire crumbled, who famously said that Britainwould play Ancient Greece to the USA’s Rome These days, the modern-day Rome seems to be

declining, too After a century in which the USA first became one half of a Cold War duopoly andthen rose to be the undisputed global hyperpower, the crisis has severely undermined its ability toprovide international leadership

This might have provided an opportunity for the Old World to strike back The European Union,which has long envied the USA’s wealth, unity of purpose and self-assurance, has been trying to

assume the economic, diplomatic and even military trappings of a great power

But the ambitions of both to run the world now look forlorn Both are constrained, in differentways, by political cultures that make them woefully incapable of dealing with the extraordinary

challenges that the last few years have thrown up The USA has become gridlocked on taxes and

spending and its domestic divisions have weakened its international economic policy Meanwhile, theeurozone has found itself unable to stem a spreading sovereign debt crisis that threatens to plunge theworld into recession

And with the USA and its housing and credit bubble having kicked off the first leg of the crisis ofcapitalism, and the EU having played a central role in the latest episode, the intellectual authority ofboth on economic policy has sunk to its lowest level since the Great Depression

Why have the decision-making processes proved so dysfunctional?

The USA has slid toward a political culture of gridlock, as long-established trends of polarizationand interest group influence have interacted with the financial crisis In the EU, a modus operandi thatevolved to cope with the slow, organic growth of the European project has proved itself to be

spectacularly unsuited to the task of running a badly designed single currency And in both cases, out

of the confusion and the stasis, misguided ideologies and wrongheaded solutions have dominated.The USA’s political problem is that, while the letter of the law has remained largely the same, thespirit needed to animate it has dissipated The U.S Constitution, written in the eighteenth century, wasbased on a suspicion of centralized power and designed to force compromise Born out of the

rejection of a centralized colonialism in the form of the British monarchy, it was created from scratch

to put severe limits on the exercise of arbitrary power

The familiar mistake that non-Americans make when looking at the USA is to assume that thepresident is a particularly powerful figure He, perhaps one day she, is not Critics of powerful

British prime ministers such as Margaret Thatcher and Tony Blair who bemoaned their ambitions torun a presidential government should have been so lucky Two fractious legislative houses akin to theU.S House of Representatives and the Senate, elected separately on a different basis to each otherand to the prime minister, together with a powerful judiciary able to strike down laws they deemedunconstitutional, would have severely circumscribed Thatcher’s and Blair’s powers

The House of Representatives is elected by something close to a popular vote, with congressionaldistricts of roughly equal size The Senate elects two senators per state, giving disproportionate

power to the smaller states It also has a web of arcane regulations and rules of procedure with which

experienced senators can ensnare and immobilize hapless pieces of legislation that happen to flywithin reach.

Apart from those very rare occasions when one party controls both houses of Congress and theWhite House, the system only works because of the ability to stitch together alliances across partylines The 1980s are remembered as the Reagan revolution in economic policy, but the House of

Representatives was controlled by Democrats throughout It was a joint effort in 1986 between theWhite House and some congressional Democrats—particularly Dan Rostenkowski, Democratic

chairman of the House Committee on Ways and Means—that produced the last serious U.S tax

reform

Bemoaning the decline of bipartisanship in Washington is as original as complaining about theweather—particularly when coupled with Proustian laments for the balmier climate of one’s

childhood—but there is clear evidence that the political atmosphere has, indeed, gotten stormier

Figures kept by the venerable Congressional Quarterly publication show that at the end of the 1960s,

congressmen voted with their own party only around 60 percent of the time, and senators even lessfrequently By 2010, those figures had increased to around 90 percent

A system designed to force compromise is increasingly being run by politicians who pride

themselves on intransigence In 2010 Mitch McConnell, Republican leader in the Senate, said that hisnumber one aim was to make Barack Obama a one-term president To the ears of Europeans or

Japanese used to parliamentary democracy, that sounds not at all strange: it is the duty of the

opposition to oppose the government In a system like the USA’s, where cooperation is essential,threatening the effective (sometimes literal) shutdown of government and deliberately crippling apresidency is an act of intense political aggression

Why could this be?

There are a number of factors at work An obvious one is the role of the American South Thenorth–south political axis has traditionally lain at a tangent to the Republican–Democratic axis in theUSA While the South has traditionally been associated with more conservative politics and the

Democrats with the center left, the Democrats were the party of the South during the Civil War, andthat loyalty took a very long time to fade A map of Dwight D Eisenhower’s reelection as Republicanpresident in 1956 is striking Adlai Stevenson, his liberal Democratic opponent, won only a band ofstates across the Deep South (and Missouri), while Eisenhower took all the states in progressiveNew England as well as those bastions of coastal liberalism, New York and California

During the high-water mark of bipartisan cooperation in the late 1960s, it was possible to stitchtogether cross-party coalitions of conservative Democrats and liberal Republicans But when JFK’ssuccessor Lyndon Baines Johnson signed the Civil Rights Act in 1964, outlawing racial segregation,

he reportedly said that he had lost the South for the Democrats for a generation Conservative whitevoters in the South switched toward the Republicans, prompting liberal Republicans to go the otherway

“A generation” proved to be an understatement Liberal northeastern Republicans and

conservative southern Democrats are now endangered species Just before the 2010 midterm

elections there was not a single Republican congressman in New England (following a big swing tothe Republicans, there are now just two) After the 2010 elections, although there are African-

American Democratic congressmen from largely black districts, there was just one white Democraticcongressman in the whole of the five states of the Deep South Ideology as well as tribalism nowenforces party loyalty in Congress

Once tribalism has taken hold, the U.S political system allows it to propagate itself through

“redistricting.” The boundaries of electoral districts are often redrawn to consolidate existing

majorities, frequently through collusion between the two parties at a local level It is a much easierlife to carve a city into one safe Democratic and one safe Republican seat than go through all the fussand bother of having genuinely contested elections This means that the actual choice of congressmanshifts to the first-stage primary election process by which parties choose their candidates Primaries,usually restricted to voters who register as supporters of one or other party, tend to be dominated byideologues who are further toward the political extremes than are the public at large

During the financial crisis, the party tribalism combined with the intensely controversial issues ofbank bailouts and fiscal stimulus to create the Tea Party—a new, divisive force in U.S politics

Largely comprising politicians with minimal or no experience of holding public office, the Tea Partydoesn’t like cutting deals In general, Tea Partiers regard compromise as weakness Its lawmakerscame to Congress to strike poses of defiance, not to negotiate Most despise what they regard as

business as usual in Washington; many spend as much time out of the capital as possible and somesleep in their offices rather than put down roots in the city of federal government The Republicanleadership in the House of Representatives and the Senate are not Tea Partiers, but they have at timesclearly been pushed into a more confrontational position by the strength of feeling among their caucus

The Tea Partiers drew precisely the wrong lesson from the 2009 stimulus and the Troubled AssetRelief Program (TARP) bailout—that they had not worked and were a waste of public money, ratherthan that they should have been bigger In reality, the stimulus succeeded in keeping the USA out of atruly crunching recession and maintaining unemployment below 10 percent By contrast, when thehard-money balanced-budget approach was tried between 1929 and 1933, the U.S unemploymentrate went from 3 percent to nearly 25 percent

During August 2011, what is normally a routine operation of raising the ceiling on the federalgovernment’s ability to borrow turned into a political spectacle that much of the rest of the worldwatched in astonishment During the weeks of standoff, the USA—one of the most creditworthy

governments in the world—came close to voluntarily defaulting on its government bonds for the firsttime in its history and ended up having its credit rating cut

In the middle of this stands a president whose typical strategy of letting Congress fight it out ratherthan trying to impose a solution has often left him a bystander Barack Obama’s instinct to seek

consensus and compromise looks increasingly like someone trying to be president of a country thatdoes not exist One of Obama’s most famous lines was that there was no liberal America and no

conservative America, no red state (Republican) America and no blue state (Democrat) America, justthe United States of America Rarely can a president have been elected so resoundingly on such anelegant premise that turned out to be so spectacularly wrong

Even the Federal Reserve, whose independence is enshrined by law, has come under

unprecedented political pressure Traditionally regarded as a conservative institution with a

predilection toward the interests of the financial markets, the Fed’s willingness to try more radicalways of pumping more money into the economy has made Ben Bernanke, its chairman, the target ofextraordinary amounts of criticism from congressional Republicans Mr Bernanke is himself a

Republican and was appointed by a Republican president, George W Bush But in contrast to hispredecessor, Alan Greenspan, whom Democratic as well as Republican candidates for presidentpromised they would reappoint, the contenders for the Republican presidential nomination for the

2012 election have been falling over each other in their willingness to say they would remove him.Rick Perry, the Texas governor and a leading favorite of the Tea Party, in April 2011 called Mr.Bernanke’s loose monetary policy “almost treasonous.” And in a striking disregard for the political