Brookings: Series - Shaping the Emerging Global Order

The Euro-Area Crisis: Weighing Options for Unconventional IMF Interventions

Domenico Lombardi and Sarah Puritz Milsom — Thu, 15 Dec 2011 15:27:00 -0500

INTRODUCTION

What started in the fall of 2009 as a fiscal crisis in a smaller European economy—Greece, which accounts for just 2 percent of the total euro area’s GDP—has evolved into a systemic crisis of the eurozone. This crisis now threatens not only to cause a meltdown of the entire European economy but also to destroy the social and political fabric that several generations of European leaders have worked to create over the last few decades.

While national governments are primarily responsible for the unfolding of the current events in Europe, the incomplete architecture of the euro area has created unprecedented scope for contagion by exposing each member of the monetary union—albeit to varying degrees—to the vulnerabilities of other members.

Italy is a case in point. The sluggish growth of its economy and its high (and increasing) stock of public debt are not new phenomena, but the crisis of the peripheral economies has provided the trigger for market investors to focus on Italy’s long run ability to service an increasing debt pile.

Escalating market pressure has led to the formation of an emergency cabinet led by economist Mario Monti, charged with the task of pursuing an ambitious reformist agenda. Meanwhile, the euro1.9 trillion of Italian public debt—equivalent to 120 percent of its GDP—serves as a harsh reminder to the finance ministries in Europe and abroad of the unpredictable consequences a potential fallout of a country like Italy could have on the global economy.

Given the sheer size of Italy’s debt, existing instruments—such as financial assistance programs via the European Financial Stability Fund (the European rescue fund) and the IMF—are inadequate as a financial backstop due to the limited lending capacity of both institutions. Acknowledging this limitation, EU leaders committed to “consider…the provision of additional resources for the IMF of up to EUR200 billion (USD 270 billion)” with the idea that the international community could provide matching funds “to ensure that the IMF has adequate resources to deal with the crisis.”

Meanwhile the European Central Bank has tried to address the crisis through a number of unconventional instruments, although it has fallen short of serving as a proper lender of last resort—a role outside of its mandate. At the end of June 2011, the ECB extended the liquidity swap arrangement with the U.S. Federal Reserve to provide U.S. dollar liquidity to euro area banks unable to access the interbank dollar market. In October, the ECB announced that by year-end it would conduct two supplementary 12-month refinancing operations to keep liquidity abundant for a longer period, which were supplemented in December by the unprecedented introduction of three-year liquidity refinancing operations.

Following escalating market pressures in Italy and Spain over the summer, the Eurosystem reactivated the Securities Markets Programme in August by intervening for euro206.9 billion (as of the week ending December 2, 2011). Unofficial reports from trading desks suggest that approximately 65 percent has been spent to buy Italian government bonds, 30 percent to buy Spanish bonds, and the remaining 5 percent for Irish and Portuguese bonds. While the ECB has not disclosed for how long it intends to continue the program, it is reasonable to assume that it may plan to do so until adequate safety nets are put in place.

Following the December 9th EU Summit, the strategy that the European leaders are using to stabilize the euro crisis can be articulated at three different layers: the first one is provided by the corrective measures to be enacted by euro-area national governments in the context of sharpened EU surveillance and disciplining sanctions; the second layer, or line of defense, is offered by a potential financial firewall that a stepped-up IMF can erect around the vulnerable sovereigns of the euro area, such as Italy and Spain, through lending programs with conditionality; and the third and last line of defense would be the ECB itself which would take the burden of any residual systemic pressures that the two previous layers would be unable to stabilize.

In light of these considerations, the aim of this paper is to review policy options that the international community could implement by strengthening the second line of defense, which hinges on an enhanced role for the IMF. These options all presuppose that the euro area as a whole will develop a credible and comprehensive strategy to effectively address the systemic crisis. However, given the credibility gap of European leaders in effectively resolving the current crisis, a quasi lender of last resort and a seal of approval by the international community would still be needed to stabilize markets and contain lingering uncertainty—even after a credible plan is eventually finalized. Following that, the options presented—admittedly, some highly unconventional and require further technical and legal appraisal—could be leveraged to prevent contagion to the rest of the global economy and the international financial system.

This paper also aims to more broadly explore the role of the IMF in systemic financial crises in general by underscoring the need to better align the institution’s policy toolkit in the context of a truly global monetary and financial system. In this respect, the IMF’s current financial capacity offers an inadequate backstop against a systemic event that would prompt larger sovereigns such as Italy to request an IMF rescue package.

As of December 1, 2011, the IMF’s forward commitment capacity stood at SDR 251 billion—approximately $390 billion or euro290 billion. However, in 2012 alone, Italy’s Treasury will need to rollover approximately euro286 billion worth of debt set to expire throughout the year. It is clear that under current conditions the IMF does not have adequate financial resources to address the euro crisis head-on. Below we explore the institutional feasibility of various options that could be explored to enhance the IMF’s financial firepower while taking into consideration the accompanying risks and institutional constraints for the fund and its members.

This paper is part of a series of in-depth policy papers, Shaping the Emerging Global Order, in collaboration with ForeignPolicy.com. Visit ForeignPolicy.com's Deep Dive section for discussion on this paper.

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Domenico Lombardi
Sarah Puritz Milsom

Image Source: © Francois Lenoir / Reuters

The Renminbi: The Political Economy of a Currency

Arthur R. Kroeber — Wed, 07 Sep 2011 14:59:00 -0400

The Chinese currency, or renminbi (RMB), has been a contentious issue for the past several years. Most recently, members of Congress have suggested tying China currency legislation to the upcoming votes on the free trade agreements with South Korea, Colombia and Panama. While not going that far, the Senate Majority Leader, Harry Reid, and Senator Charles Schumer have promised a vote on the issue some time this year.

The root of the conflict for the United States—and other countries—is complaints that China keeps the value of the RMB artificially low, boosting its exports and trade surplus at the expense of trading partners. Recent government data show that the bilateral trade deficit between the U.S. and China grew nearly 12 percent in the first half of 2011—fueling efforts to boost job creation domestically by authorizing import tariffs and other restrictions on countries that manipulate their currencies.

Although the U.S. Treasury has repeatedly stopped short of labeling China a “currency manipulator” in its twice-yearly reports to Congress, it has consistently pressured China to allow the RMB to appreciate at a faster pace, and to let the currency fluctuate more freely in line with market forces. The International Monetary Fund (IMF), the World Bank and many economists have also argued for faster appreciation and a more flexible exchange rate policy as part of a broader program of “rebalancing” the Chinese economy away from its traditional reliance on exports and investment, and towards a more consumer-driven growth model. Partly in response to these pressures, but more because of domestic considerations, China has allowed the RMB to rise by about 25 percent against the U.S. dollar since mid-2005. Yet the pace of appreciation remains agonizingly slow for the United States and other countries in Europe and Latin America whose manufacturing sectors face increasing competition from low-priced Chinese goods.

The international conversation over the RMB remains perennially vexed because China and its trade partners have fundamentally divergent ideas on the function of exchange rates. The United States and other major developed economies, as well as the IMF, view an exchange rate simply as a price. Consistent intervention by China to keep its exchange rate substantially below the level the market would set is, in this view, a distortion that prevents international markets from functioning as well as they could. This price distortion also affects China’s own economy, by encouraging large-scale investment in export manufacturing, and discouraging investment in the domestic consumer market. Thus it is in the interest both of China itself and the international economy as a whole for China to allow its exchange rate to rise more rapidly.

Chinese officials take a very different view. They see the exchange rate—and prices and market mechanisms in general—as tools in a broader development strategy. The goal of this development strategy is not to create a market economy, but to make China a rich and powerful modern country. Market mechanisms are simply means, not ends in themselves. Chinese leaders observe that all countries that have raised themselves from poverty to wealth in the industrial era, without exception, have done so through export-led growth. Thus they manage the exchange rate to broadly favor exports, just as they manage other markets and prices in the domestic economy to meet development objectives such as the creation of basic industries and infrastructure. These policies do not differ materially from those pursued by Japan, South Korea and Taiwan since World War II, or by Britain, the United States and Germany in the 19th century. Since the Chinese leaders perceive that an export-led strategy is the only proven route to rich-country status, they view with profound suspicion arguments that rapid currency appreciation and markedly slower export growth are “in China’s interest.” And because China—unlike Japan in the 1970s and 1980s—is an independent geopolitical power, it is fully able to resist international pressure to change its exchange-rate policy.

A second issue raised by China’s currency and trade policies is the persistent trade surplus since 2004 which has contributed about three-quarters of the nearly US$3 trillion increase in China’s foreign exchange reserves over the past eight years. Close to two-thirds of these reserves are invested in U.S. treasury debt. Some fear that China has become the United States’ banker, and could cause a collapse in the U.S. dollar and the U.S. economy by dumping its dollar holdings. Others suggest that China’s recent moves to increase the international use of the RMB through an offshore market in Hong Kong signal China’s intent to build up the RMB as an international reserve currency to rival or eventually supplant the dollar. All of these concerns are based on serious misunderstandings of both international financial markets and China’s domestic political economy. China is not in any practical sense “America’s banker;” it is more a depositor than a lender, and its economic leverage over the United States is very modest.

And while China’s leading position in global trade makes it quite sensible to increase the use of the RMB for invoicing and settling trade, it is a huge leap from making the RMB more internationally traded to making it an attractive reserve currency. China does not now meet the basic conditions required for the issuer of a major reserve currency, and may never meet them. Most importantly, the RMB is unlikely to become more than a second-tier reserve currency so long as Chinese leaders cling to their deep reluctance to allow foreigners a significant role in China’s domestic financial markets.

China’s Currency Policies

China’s exchange-rate policy must be understood within the context of two political-economic factors: first, China’s overall development strategy which aims to build up the nation’s economic and political power with market mechanisms being tools to that end rather than ends in themselves; and second, China’s geopolitical position.

The Chinese development strategy, which emerged gradually after Deng Xiaoping began the process of “reform and opening” in 1978, is based on a careful study of how other industrial nations got rich—and in particular, the catch-up growth strategies of its east Asian neighbors Japan, South Korea and Taiwan after World War II. A key lesson of that study is that every rich nation, in the early stages of its development, used export-friendly policies to promote domestic industry and to accelerate technology acquisition. In earlier eras, when the use of the gold standard made it impossible to maintain permanently undervalued exchange rates, countries used administrative coercion and high tariffs to achieve the same effect of favoring domestic manufacturers over foreign ones. Britain’s policies of using colonies as captive markets for its manufactured exports, and prohibiting the colonies from exporting manufactures back to Britain, were important components of that nation’s rise as the world’s leading industrial power in the late 18th and 19th centuries. Resentment of those policies was one cause of the American Revolution; once independent, the United States spurred its economic development through the “American system,” which featured high tariff walls (often 40 percent or more) through the 19th and into the early 20th century. Germany used similar protective policies to foster its industries in the late 19th century. Countries did not become advocates for free trade until their firms were secure in global technological leadership and the need for protection waned for Britain, this occurred in the mid-19th century; for the United States, the mid-20th.

After World War II, undervalued exchange rates became an important tool of export promotion, partly because new global trading rules under the General Agreement on Tariffs and Trade (GATT, which morphed into the World Trade Organization in 1995) made it more difficult to maintain extremely high levels of tariff protection. The testimony of post-war economic history is quite clear. Countries that maintained undervalued exchange rates and pursued export markets enjoyed sustained high-speed economic growth and became rich. These countries include Germany, Japan, South Korea and Taiwan. Countries that used other mechanisms to block imports and encouraged their industrial firms to cater exclusively to domestic demand—so-called “import substitution industrialization,” or ISI, which usually involved an overvalued exchange rate—in some cases grew quite rapidly for 10 years or more. But this growth could not be sustained because the ISI strategy includes no mechanism for keeping pace with advances in global technology. Most ISI countries, including much of Latin America and the whole of the Communist bloc, experienced severe financial crisis and fell into long periods of stagnation.

As it tried to accelerate growth by moving from a planned to a more market-driven economy in the 1980s, China gradually depreciated the RMB by a cumulative 80 percent, from 1.8 to the dollar in 1978 to 8.7 in 1995. Since then, however, the RMB has only appreciated against the dollar, moving up to a rate of 8.3 by 1997, and holding steady at that rate until mid-2005 after which gradual appreciation resumed. Since 2006 the RMB has appreciated at an average annual rate of about 5 percent against the dollar, to its current rate of about 6.4, and it is likely that this average rate of appreciation will be sustained for the next several years. This history demonstrates that supporting export growth, while important, is not the sole determinant of China’s exchange-rate policy. During the Asian financial crisis of 1997-1998, the consensus of most economists held that the RMB was overvalued; despite this, Beijing kept the value of the RMB steady, on the grounds that devaluation would further destabilize the battered Asian regional economy. As a consequence, China endured a few years of relatively anemic growth in exports and GDP, and persistent deflation. The leadership decided that this was a price worth paying for regional economic stability.

Conversely, the appreciation since 2005 reflects Beijing’s understanding that clinging to a seriously undervalued exchange rate for too long risks sparking inflation. This occurred in many oil-rich Persian Gulf countries in 2005-2007, which held fast to unrealistically low pegged exchange rates and suffered annual inflation rates of 20 percent to 40 percent. For Chinese leaders, an inflation rate above 5 percent is considered dangerously high, and the most rapid currency appreciation in the last few years has occurred when inflationary pressure was relatively strong. A second reason for switching to a policy of gradual appreciation was the view that an ultra-cheap exchange rate disproportionately benefited manufacturers of ultra-cheap goods, whose technology content and profit margins were low. While these industries provided employment for millions, they did not contribute much to the nation’s technological upgrading. A gradual currency appreciation, economic policymakers believed, would eventually force Chinese manufacturers to move up the value chain and start producing more sophisticated and profitable goods. This strategy appears to be bearing fruit: China is rapidly gaining global market share in more advanced goods such as power generation equipment and telecoms network switches. Meanwhile, it has begun to lose market share in low-end goods like clothing and toys, to countries like Vietnam, Cambodia, Indonesia and Bangladesh.

In short, China’s exchange-rate policy is mainly driven by the aim of enhancing the nation’s export competitiveness. But other factors play a role, namely a desire to maintain domestic and regional macro-economic stability, keep inflationary pressures at bay, and force a gradual upgrading of the industrial structure. From the point of view of Chinese policy makers, all of these objectives suggest that the exchange rate should be carefully managed, rather than left to unpredictable market forces. While economists may argue that long-run economic stability is better served by a more flexible exchange rate, Chinese officials can point to the excellent track record their policies have produced: consistent GDP growth of around 10 percent a year since the late 1990s, inflation consistently at or below 5 percent, export growth of more than 20 percent a year, and a steady increase in the sophistication of Chinese exports. Until some kind of crisis convinces them that their economic policies require major adjustment, China’s economic planners are likely to stick with their current formula.

International pressure to accelerate the pace of RMB appreciation is unlikely to have much impact. The basic reason is that other countries have very little leverage that they can bring to bear. In the 1970s, the United States was able to pressure Germany and Japan to appreciate their currencies because those countries were militarily dependent on America. (Moreover, the United States was able unilaterally to engineer a devaluation of the dollar by going off the gold standard in 1971.) Japan’s position of dependency forced it to accede to the Plaza Accord of 1985, which resulted in a doubling of the value of the yen over the next two years. China, being, geopolitically independent, has no incentive to bow to pressure on the exchange rate from the United States, let alone Europe or other nations such as Brazil. The only plausible threat is that failure to appreciate the RMB could lead to a protectionist backlash that would shut the world’s doors to Chinese exports. Yet this threat has so far proved empty: even after three years of the worst global recession since the Great Depression, trade protectionism has failed to emerge in the United States or Europe.

Other considerations further strengthen the Chinese determination not to give in to foreign pressure on the exchange rate. One is the Japanese experience after the Plaza Accord. The generally accepted view in China is that the dramatic appreciation of the yen in the late 1980s was a crucial contributor to Japan’s dramatic asset-price bubble whose collapse after 1990 set the former world-beating economy on a two-decade course of economic stagnation. Chinese officials are adamant that they will not repeat the Japanese mistake. This resolve was strengthened by the global financial crisis of 2008, which in China thoroughly discredited the idea—already held in deep suspicion by Chinese leaders—that lightly regulated financial markets and free movements of capital and exchange rates are the best way to run a modern economy. China’s rapid recovery and strong growth after the crisis are deemed to vindicate the nation’s strategy of a managing the exchange rate, controlling capital flows, and keeping market forces on a tight leash.

The Internationalization of the RMB

Despite this generally self-confident view of the merit of its exchange-rate and other economic policies, Chinese leaders are troubled by one headache caused by the export-led growth strategy: the accumulation of a vast stockpile of foreign exchange reserves, most of which are parked in very low-yielding dollar assets, principally U.S. treasury bonds and bills. For a while, the accumulation of foreign reserves was viewed as a good thing. But after the 2008 financial crisis, the perils of holding enormous amounts of dollars became evident: a serious deterioration of the US economy leading to a sharp decline in the value of the dollar could severely reduce the worth of those holdings. Moreover, the pervasive use of the dollar to finance global trade proved to have hidden risks: when United States credit markets seized up in late 2008, trade finance evaporated and exporting nations such as China were particularly hard hit. The view that excessive reliance on the dollar posed economic risks led Chinese policy makers to undertake big efforts to internationalize the RMB, beginning in 2009, through the creation of an offshore RMB market in Hong Kong.

Before considering the significance of RMB internationalization, it is worth addressing some misconceptions about China’s large-scale reserve holdings and investments in U.S. treasury bonds. Because China’s central bank is the biggest single foreign holder of U.S. government debt, it is often said that China is “America’s banker,” and that, if it wanted to, it could undermine the U.S. economy by selling all of its dollar holdings, thereby causing a collapse of the U.S. dollar and perhaps the U.S. economy. These fears are misguided. First of all, it is by no means in China’s interest to cause chaos in the global economy by prompting a run on the dollar. As a major exporting nation, China would be among the biggest victims of such chaos. Second, if China sells U.S. treasury bonds, it must find some other safe foreign asset to buy, to replace the dollar assets it is selling. The reality is that no other such assets exist on the scale necessary for China to engineer a significant shift out of the dollar. China accumulates foreign reserves at an annual rate of about US$400 billion a year; there is simply no combination of markets in the world capable of absorbing such large amounts as the U.S. treasury market. It is true that China is trying to diversify its reserve holdings into other currencies, but at the end of 2010 it still held 65 percent of its reserves in dollars, well above the average for other countries (60 percent). From 2008 to 2010, when newspapers were filled with stories about China “dumping dollars,” China actually doubled its holdings of U.S. Treasury securities, to US$1.3 trillion.

The other crucial point is that China is not in any meaningful sense “America’s banker,” and its economic leverage is modest. China owns just 8% of the total outstanding stock of US Treasury debt; 69% of Treasury debt is owned by American individuals and institutions. Measured by Treasury debt holdings, America is America’s banker—not China. And China’s holdings of all US financial assets – equities, federal, municipal and corporate debt, and so on – is a trivial 1%. Chinese commercial banks lend almost nothing to American firms or consumers. The gross financing of American companies and consumers comes principally from U.S. banks, and secondarily from European ones. It is more apt to think of China as a depositor at the “Bank of the United States”: its treasury bond holdings are super-safe, liquid holdings that can be easily redeemed at short notice, just like bank deposits. Far from holding the United States hostage, China is a hostage of the United States, since it has little ability to move those deposits elsewhere -- no other bank in the world is big enough.

It is precisely this dependency that has prompted Beijing to start promoting the RMB as an international currency. By getting more companies to invoice and settle their imports and exports in RMB, China can gradually reduce its need to put its export earnings on deposit at the “Bank of the United States.” But again, headlines suggesting that internationalization of the RMB heralds the imminent demise of the current dollar-based international monetary system are premature.

The simplest reason is that the RMB’s starting point is so low that many years will be required before it becomes one of the world’s major traded currencies. In 2010, according to the Bank for International Settlements, the RMB figured in under 1 percent of the world’s foreign exchange transactions, less than the Polish zloty; the dollar figured in 85 percent and the euro in 40 percent. There is no question that use of the RMB will increase rapidly. Since Beijing started promoting the use of RMB in trade settlement (via Hong Kong) in 2009, RMB-denominated trade transactions have soared: around 10 percent of China’s imports are now invoiced in RMB. The figure for exports is lower, which makes sense. Outside China, people sending imports to China are happy to be paid in RMB, since they can reasonably expect that the currency will increase in value over time. But Chinese exporters wanting to get paid in RMB will have a difficult time finding buyers with enough RMB to pay for their shipments. Over time, however, foreign companies buying and selling goods from China will become increasingly accustomed to both receiving and making payments in RMB – just as they grew accustomed to receiving and making payments in Japanese yen in the 1970s and 1980s.

Since China is already the world’s leading exporter, and is likely to surpass the United States as the world’s leading importer within three or four years, it is quite natural that the RMB should become a significant currency for settling trade transactions. Yet the leap from that role to a major reserve currency is a very large one, and the prospect of the RMB becoming a reserve currency on the order of the euro—let alone replacing the dollar as the world’s dominant reserve currency—is remote. The reason for this is simple: to be a reserve currency, you need to have safe, liquid, low-risk assets for foreign investors to buy; these assets must trade on markets that are transparent, open to foreign investors and free from manipulation. Central banks holding dollars and euros can easily buy lots of U.S. treasury securities and euro-denominated sovereign bonds; foreign investors holding RMB basically have no choice but to put their cash into bank deposits. The domestic Chinese bond market is off-limits to foreigners, and the newly-created RMB bond market in Hong Kong (the so-called “Dim Sum” bond market) is tiny and consists mainly of junk-bond issuances by mainland property developers.

Again, we can reasonably expect rapid growth in the Hong Kong RMB bond market. But the growth of that market, and granting foreigners access to the domestic Chinese government bond market, remain severely constrained by political considerations. Just as Chinese officials do not trust markets to set the exchange rate for their currency, they do not trust markets to set the interest rate at which the government can borrow. Over the last decade Beijing has retired virtually all of its foreign borrowing; more than 95 percent of Chinese government debt is issued on the domestic market, where the principal buyers are state-owned banks that are essentially forced to accept whatever interest rate the government dictates. There is absolutely no reason to believe that the Chinese government will at any point in the near future surrender the privilege of setting the interest rate on its own borrowings to foreign bond traders over whom it has no control. As a result, it is likely to be many years before there is a large enough pool of internationally-available safe RMB assets to make the RMB a substantial international reserve currency.

In this connection the example of Japan provides an instructive example. In the 1970s and 1980s Japan occupied a position in the global economy similar to China’s today: it had surpassed Germany to become the world’s second biggest economy, and it was accumulating trade surpluses and foreign-exchange reserves at a dizzying rate. It seemed a foregone conclusion that Japan would become a central global financial power, and the yen a dominant currency. Yet this never occurred. The yen internationalized – nearly half of Japanese exports were denominated in yen, Japanese firms began to issue yen-denominated “Samurai bonds” on international markets, and the yen became an actively traded currency. Yet at its peak the yen never accounted for more than 9 percent of global reserve currency holdings, and the figure today is around 3 percent. The reason is that the Japanese government was never willing to allow foreigners meaningful access to Japanese financial markets, and in particular the Japanese government bond market. Even today, about 95 percent of Japanese government bonds are held by domestic investors, compared to 69 percent percent for US Treasury securities. China is not Japan, of course, and its trajectory could well be different. But the bias against allowing foreigners meaningful participation in domestic financial markets is at least as strong in China as in Japan, and so long as this remains the case it is unlikely that the RMB will become anything more than a regional reserve currency.

Implications for U.S. Policy

The above analysis suggests two broad conclusions of relevance to United States policymakers. First, China’s exchange-rate policy is deeply linked to long-term development goals and there is very little that the United States, or any other outside actor, can do to influence this policy. Second, the same suspicion of market forces that leads Beijing to pursue an export-led growth policy that generates large foreign reserve holdings also means that Beijing is unlikely to be willing to permit the financial market opening required to make the RMB a serious rival to the dollar as an international reserve currency. A related observation is that an average annual appreciation of the RMB against the dollar of about 5 percent now seems to be firmly embedded in Chinese policy. An appreciation of this magnitude enables China to maintain export competitiveness while achieving two other objectives: keeping domestic consumer-price inflation under control, and gradually forcing an upgrade of China’s industrial structure.

Generally speaking, these trends are quite benign from a U.S. perspective. In substantive terms, there is little to be gained from high-profile pressure on China to accelerate the pace of RMB appreciation, since the United States possesses no leverage that can be plausibly brought to bear. While the persistent undervaluation of the RMB will present increasing difficulties for American manufacturers of high-end equipment, as Chinese manufacturers gradually become more competitive in these sectors, the steady appreciation of the currency will increase the purchasing power of the average Chinese consumer and the total size of the Chinese consumer market. United States policy should therefore de-emphasize the exchange rate, where the potential for success is limited, and instead focus on keeping the pressure on China to maintain and expand market access for American firms in the domestic Chinese market, which in principle is provided for under the terms of China’s accession to the World Trade Organization.

This paper is part of a series of in-depth policy papers, Shaping the Emerging Global Order, in collaboration with ForeignPolicy.com. Visit ForeignPolicy.com's Deep Dive section for discussion on this paper.

Authors

Arthur R. Kroeber

Publication: FP.Com Deep Dive

Image Source: © Petar Kujundzic / Reuters

The Challenges to the World Trade Organization: It’s All about Legitimacy

Joshua Meltzer — Tue, 19 Apr 2011 10:26:00 -0400

Introduction: The World Trade Organization and a Changing Global Economy

According to the World Trade Organization, trade liberalization achieved since its establishment in 1995 has raised global income by as much as $510 billion. Since its creation, WTO rules, its dispute settlement mechanism and the work of its secretariat have also become central to the management and smooth functioning of global trade. During the 2008 global financial crisis when plunging economies and rising unemployment created pressures to protect domestic industries, the WTO was credited for stopping a descent into the type of tit-for-tat protectionism that countries engaged in during the Great Depression. Despite the WTO’s undeniable success, a changing international economic environment creates a series of significant challenges for the organization.

The most obvious challenge is that the Doha Development Round—the current round of multilateral trade negotiations to further liberalize trade and reform the WTO. After a decade of talks, it still remains to be concluded. The Doha Round is focused on reducing important trade barriers in sectors, such as agriculture, industrial goods and services. This would encourage businesses around the world to specialize in the production of goods and services, achieve economies of scale, and increase their efficiency and productivity, which would allow them to deliver improved and cheaper products to global consumers. As importantly, the Doha Round is particularly focused on providing increased market access to goods and services from developing countries. In the end, the WTO estimates that the Doha Round could increase global GDP by $150 billion per year.

However since the launch of the Doha Round, countries have turned to free trade agreements (FTAs) in order to gain significant trade access in new markets and to explore new trade-related issues that are currently not addressed within the WTO. As more FTAs have been concluded, the central role of the WTO in liberalizing trade has been called into question. In addition, the WTO has played a very limited role in helping address other global issues related to trade, such as food security, climate change and global trade imbalances.

This paper is part of a series of in-depth policy papers, Shaping the Emerging Global Order, in collaboration with ForeignPolicy.com. Visit ForeignPolicy.com's Deep Dive section for discussion on this paper.

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Joshua Meltzer

Image Source: Â© Denis Balibouse / Reuters

The Changing Balance of Global Influence and U.S. Strategy

Bruce Jones — Tue, 15 Mar 2011 10:59:00 -0400

Introduction:

When historians assess America’s role in the world after the terrorist attacks of 9/11, they will judge the early failures in Afghanistan, and weigh the costs of the Iraq war against its eventual outcomes (still uncertain). They will balance the deepening of the strategic relationship with India against the deterioration, and eventual reset, of relations with Russia. Climate change will loom large, for good or ill. Twenty years from now, we will know more about the consequences of U.S. counterterrorism policies from Pakistan to Yemen to Lebanon.

They will surely debate this question: did American overstretch amplify the impact of the rise of the “emerging powers?” While America’s resources were bled by two wars, new potential rivals were growing and husbanding their energies. A mere four years after Charles Krauthammer’s manifesto for “American Foreign Policy for a Unipolar World” caught the mood of American ambition, Fareed Zakaria’s The Post-American World reflected the consequences of miscalculation. All of this before the global financial crisis drained the U.S. treasury further and highlighted China, India, Brazil and the Asian financial centers’ new weight.

While the trajectory of the rising powers is uncertain, their present influence is now a fact of geopolitics. That raises questions about the relationship between U.S. power and the changing international order. Already the financial crisis, the Copenhagen climate negotiations and the Iran sanctions dust-up have illustrated the potential, the pitfalls, and above all the centrality of the relationship between American power and the influence of the rising actors. The emerging powers cannot dictate the shape of the coming era, but they can block and complicate U.S. initiative.

Nearly a decade ago, Joseph Nye identified “the paradox of American power.” While the United States has unique military strength, it is constrained by the dynamics of the global economy and the need for international institutions to manage an interdependent world. Today, after two wars and an economic crisis have tested the limits of American power, we are confronted with a new paradox. For all of its continued heft, the U.S. looks weaker than it once did, and must navigate a world of rising powers. Yet international stability and prosperity still rest heavily on America’s continuing strengths and leadership.

American leadership is far from overturned, but it is constrained. The question is thus posed: can the United States still lead the international system? Will the rising actors acquiesce to U.S. leadership and cooperate with it? Or are they contending to challenge if not the system itself—from which they profit— then U.S. leadership of it?

This paper reviews the nature of the emerging powers’ rise and the strategies they are pursuing. An overarching picture emerges: America’s dominance is dulled but its influence is sustained. From its new position, the United States confronts not a rigid bloc of emerging powers, but complex and shifting coalitions of interest. The greatest risk lies not in a single peer competitor but in the erosion of systems and institutions vital to U.S. interests and a stable order. U.S. power is indispensible for international order, but not sufficient. No longer the CEO of Free World Inc., the United States now holds a position akin to that of the largest minority shareholder in Global Order LLC. Can the United States use its changed position to shape the emerging order?

This paper is part of a series of in-depth policy papers, Shaping the Emerging Global Order, in collaboration with ForeignPolicy.com. Visit ForeignPolicy.com's Deep Dive section for discussion on this paper.

Brookings: Series - Shaping the Emerging Global Order

The Euro-Area Crisis: Weighing Options for Unconventional IMF Interventions

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The Renminbi: The Political Economy of a Currency

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The Challenges to the World Trade Organization: It’s All about Legitimacy

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The Changing Balance of Global Influence and U.S. Strategy

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