The Redesign of the Global Financial Architecture
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The Redesign of the Global Financial Architecture

Stuart P. M. Mackintosh

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The Redesign of the Global Financial Architecture

Stuart P. M. Mackintosh

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About This Book

In 2007-2008 the global financial and economic system was in turmoil. This volume focuses on how the global financial architecture was redesigned following the financial crash of 2008. Its central claim is that the reforms constituted a paradigm shift, a move from the dominance of market authority to the re-assertion of state authority over financial markets and actors.

The book underscores that the cycle of boom and bust, of crisis response, reform and eventual relapse are not only economic but also conceptual and ideological. Ideas matter in the political and economic calculus of policy making. Economies are underpinned by and linked to ideological narrative, a prevailing policy consensus that places limits on policy actions and options and constitutes a dominant worldview or paradigm. To become real, to be lasting, to impact actual policy choices and market actor decisions, a re-regulatory paradigm shift cannot just be conceptual or ideological. It must also be present in the institutional constructs and policy decisions that flow from the ideological regulatory shift. To gauge the fluctuating strength of the paradigm shift the book addresses the G20 summit process, the creation of the FSB, the policy output of the new forums, for signs of permanency, strength, and possible effectiveness.

This work presents important new material on the financial crisis and the regulatory response to it, which will be valuable for researchers, teachers and students alike.

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Publisher
Routledge
Year
2015
ISBN
9781317531746
1 Crises and paradigm shift1
In 1543, a little-known amateur astronomer published his magnum opus. On the Revolutions of Heavenly Spheres (1543) secured Nicolaus Copernicus’s place in the history of science and constituted the beginning of what Thomas Kuhn (1962) described as a paradigm shift in scientific thought. Before Copernicus, the sun and the planets were believed to revolve around the earth. But astronomers had increasingly been bothered by growing observational anomalies with the Aristotelean, geocentric view. Copernicus hypothesized that, contrary to the dominant view, the earth revolved around the sun, as did the planets, a new, radical, heliocentric model. He was right. But Copernicus’s theory did not result in a sudden or instantaneous shift in worldview. The shift took longer to become solid as the scientific consensus adjusted, and then, more slowly, it was accompanied by a more gradual process, a societal and cultural shift supporting the new model, with empirical observations, such as Galileo’s discovery of the moons of Jupiter, underpinning its validity. These types of rare disjunctive shifts occur not only in the scientific realm, but also in the economic and regulatory policy spheres, and this book addresses one: a narrative and international regulatory policy consensus shift that began in 2008 and which continues today.
Economic cycles: crises, response, and relapse
Global and national economies and markets operate in cycles of growth that, when unrestrained, can turn into booms, which are eventually punctured by busts resulting in recessions of varying severity (Galbraith, 1954; Kindleberger and Aliber, 1978; Minsky, 2008). During the boom phase, few remember economic history, believing that this time is different (Rogoff and Reinhart, 2009; Schiller, 2006), but it never is, and booms always eventually turn to bust. Global economic cycles operate on a longer frequency than national cycles, because it is rare that the credit expansions and contractions of national economies align to create a synchronous collapse of the global economy as a whole. Normally, a national recession or a banking calamity in one part of the world is balanced partially by growth and prosperity elsewhere.
The rhythm within these cycles is not only economic but also conceptual and ideological. ‘Constructionists’ are right: ideas do matter in the political and economic calculus of policymaking. Economies are underpinned by and linked to ideological narratives, a prevailing policy consensus that places limits on policy actions and options, and constitutes a dominant worldview or paradigm.
In some, but by no means all, financial crises, a paradigm shift (Kuhn, 1962) can be triggered and becomes part of the cycle and process, particularly in severe economic crises. For instance, economic failures and stagflation in the UK (a slow-motion bust) in the 1970s paved the way for the Thatcher victory in 1979 and a significant ideological and economic policy shift that impacted the UK for decades thereafter (Blyth, 2002; Gamble, 1988).
On the international level, as with economic cycles, the ideological cycle is also of a longer frequency, measured in decades, not years. But when a sufficiently severe exogenous event or economic and financial crisis occurs, it can shake the prevailing worldview. More rarely still, a shock may result in a paradigm shift in ideological and regulatory concepts held by leaders and policymakers. In such cases, a rapid evolutionary burst of action and reform, a shift in the policy consensus and worldview, can occur.
In 1971, one economic and financial paradigm, embedded liberalism and the system of globally managed exchange rates (Ruggie, 1982), ended with US president Richard Nixon’s closure of the gold window. The end of that era gradually gave birth to another, which over time came to be characterized in part by laissez-faire neoliberalism (Gamble, 2009: 71–86), or market fundamentalism (Stiglitz, 2008), and later by the Washington Consensus (Wade, 2008; Williamson, 1993, 1994). This ideological worldview involved a championing of deregulated, unfettered global markets and firms. This shift moved economies and the financial system away from a rules-based system (Elson, 2011, pp. 208–209) to competing based on flexible exchange rates and fostering the success of their national economic models within increasingly globalized economies reliant on (it was assumed) efficient markets (Wade, 2008: 2). The series of policy decisions and nondecisions that flowed from this deregulatory narrative took shape in the late 1970s, gathered strength in the 1980s and thundered forward in the 1990s and early years of the twenty-first century.
During the decades before the 2007–2008 financial crisis, governments allowed and facilitated the erosion and diffusion of state power to other actors – a weakening of state power coupled with a retreat of the state’s willingness to supervise growing global markets and firms (Strange, 1986, 1996). Markets grew. Governmental acts or refusal to act were underpinned by the ideological and economic belief in unregulated markets rather than state regulatory power (Ackerlof and Schiller, 2009; Padoa-Schioppa, 2010; Stiglitz, 2008). Firms grew and morphed from national retail banks into global behemoths with operations interconnected across the globe. The size, impact and influence of these firms rapidly increased, as did the complexity of markets and instruments (Maclean and Nocera, 2010; Tett, 2009), the leverage seen (Turner, 2009: 19), the risks taken and levels of compensation paid to their employees (FCIC, 2011: 62; Johnson and Kwak, 2010).
There were voices raised against the dominant paradigm (Rajan, 2005; White, 2008). But they did not alter the worldview. The macro-level neoliberal narrative defended questionable economic truths and orthodoxies, blocked historical memory of previous crises, allowed regulatory laxity, overlooked the ‘capture’ of the regulators by the regulated, permitted dangerous market and firm-level risks to build up, causing mounting systemic risk, and resisted action to mitigate the worst effects until the crisis was all but upon us.
As in other previous ideological and economic cycles, the existing worldview blotted out historical memory amongst leaders and technocrats. Deregulation and self-regulation (the latter now viewed as an oxymoron) was the norm. During this period, the frequency of national boom-and-bust cycles grew (Allen and Gale, 2007), and the number and severity of national banking crises rose (King, 2011), but few paid attention. The Anglo-Saxon paradigm and narrative worshipped by political leaders and regulators precluded actors from seeing the ‘black swan’, or the extreme exogenous event or crisis, coming (Taleb, 2010); instead, a great stabilization was supposedly underway (with minimisation of systemic risk).
In this manner, the worldview provided ideological justification for the boom of the 1990s and 2000s. It fostered the creation of markets, firms and instruments that would in 2007 rapidly transmit price declines in houses and condos in Nevada and Florida sold to poor, credit-challenged Americans to banks in the UK and Germany, and then around the globe. As the credit crunch and economic contagion spread, the panic grew, and leaders faced the most significant economic and financial crisis since the Great Depression in 1929.
Confronted by a crisis of historic proportions, old solutions were insufficient. A breakpoint occurs and, as a result, ‘the possibilities for major change are particularly great and scope of possibilities and outcomes is unusually wide’ (Ikenberry, 1992: 318; see also Helleiner, 2009: 16). This time the US could not fashion the solution alone or solely with its Group of Seven (G7)2 colleagues and allies, as it had in the past. The days when two men, Paul Volcker, Chairman of the US Federal Reserve from 1979 to 1987, and Robin Lea Pemberton, Governor of the Bank of England from 1983 to 1993, could do a deal on international bank regulation that was pressed upon the rest of the world were long gone (Goodhart, 2011; Kapstein, 1992).
In 2008, US hegemonic power was in decline, and rising powers, especially China, Brazil and India, demanded a voice and a role, and they had the reserves to back their demands. Emerging countries had to be included. Recognizing this reality and making the switch to a larger leadership grouping at the topmost tier of international economic and financial diplomacy would be necessary to make any possible solutions truly global in impact and to ensure the legitimacy of the decisions taken in response to the crisis. As a result, while the crisis response in 2007–2008 exhibits common elements with prior cycles, the constructs created as a result of the architectural impulse would be markedly different, indicative of the evolution of geopolitical power relations and balances since the last major shift in 1971.
The internationally coordinated collective response in 2008 and since is part of this history of cycles of booms and busts, crisis management, and reform and gradual relapse. This especially severe crisis forced a financial regulatory paradigm shift in worldview amongst government leaders, states and their technocratic central banking community. There was a rapid evolution in the collective policymaking narrative, which underpinned new and refurbished international political, regulatory and architectural constructs. This was ‘a new phase’ (Wade, 2008: 3) – one which entailed the rejection of key aspects of the laissez-faire neoliberal worldview and its assumptions.
Utilizing Kuhn and Hall to understand crisis response
Thomas Kuhn described the process of paradigm shift. A shift occurs when anomalies arise that can only be effectively described, answered and dealt with by new hitherto controversial explanations (theories) and an accompanying worldview. Only after a paradigm shift occurs does a series of different truths take their place at the centre of the new worldview constructed of new scientific facts and a new orthodoxy. Peter Hall applied the concept of paradigm shift to analyse intellectual and political forces centred on economic policymaking in Britain and a dramatic shift from established Keynesian norms to neoliberal monetarist supply-side economics in the 1980s; this was the construction of a new policy paradigm. Hall posited three orders of change.
First-order changes are forms of normal policymaking, ‘a process that adjusts policy without challenging the overall terms of a given policy paradigm’ (Hall, 1993: 279). This is ‘paradigm maintenance’ (Skogstad, 2008: 16): adjustments or small changes in focus and direction within an agreed narrative construction. Existing truths are not challenged and are not in dispute. Second-order changes are moderately more significant, where the instrument of a policy is adjusted but not the overarching policy. Both first- and second-order changes are characterized by incrementalism (Hall, 1993). Third-order changes reflect radical changes to the overarching terms of the discourse and indicate that a paradigm shift or replacement is occurring. They involve the accumulation of anomalies, experimentation, failures and a reappraisal of existing truths. The process is likely to be contested. An intensification of debate about economic issues will occur. Issues of authority (i.e. power) are central. Third-order change, the paradigm shift described by Kuhn in the scientific world and Hall in the economic context, is a major reappraisal, an event at least an order of magnitude greater than first- and second-order changes. This book identifies a shift in narrative worldview to some extent amongst political leaders, but especially amongst the elite of the world’s central banking community, who adjust their policy consensus and champion first-, second- and third-order changes that collectively constitute the beginning of a paradigm shift.
Paradigms tend to be championed by leaders, experts and transnational actors, and are characterized by periods of stability followed by abrupt episodes of substantial change (Wilson, 2000), via a process of punctuated equilibrium. This is what we saw in the crisis response particularly in 2008–2009. For a policy paradigm shift to take place, policymaking actors must be challenged by model failures and growing anomalies (Weir and Skocpol, 1983). The paradigm or era can be said to end when its basic illusions are seen as false. The financial crisis created conditions for a paradigm replacement because the dominant laissez-faire neoliberal deregulatory model of financial architecture of the last three decades was compromised (Wade, 2008). This allowed the intellectual economic beliefs behind the prevailing paradigm to be increasingly challenged (El-Erian, 2009; Stiglitz, 2009, 2010), leading some to suggest that the Anglo-American deregulatory laissez-faire, neoliberal, neoclassical economic paradigm had become exhausted (Palley, 2009). A strong challenge to the dominant worldview is then possible because the severe economic crisis creates a transformational opportunity, a paradigmatic moment (Assenza et al., 2011; Fergusson et al., 2009; Soros, 2008).
In essence, for a paradigm shift to occur, the consensus policy narrative in a community must make a jump, when confronted by increasing anomalies; there has to be the abandonment of the old and the taking up of a new theory and related policy positions in response to recognized anomalies and failures in the past worldview. This is what began in 2008 and is still underway in 2015.
Whether or not a paradigm shift is underway is a matter of dispute. Some observers, such as Helleiner (2014), see the current crisis and response as simply a maintenance of the status quo. He is joined by Blyth (2013), who views changes underway as only first and second order; in Blyth’s formulation 1+2 does not equal 3, i.e. incrementalism alone does not signal a paradigm shift. Still others try to bridge the ‘paradigm gap’ by stretching Hall’s definition and arguing that paradigms can indeed shift via progressive incremental steps alone (Moschella and Tsingou, 2013).
This book rejects the proposition that the crisis resulted in little or no change in community narratives and po...

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