by Erik Jones

Soft Law, Hard Ideas, and Borrowed Credibility

International political economy used to be about wealth and power.  Now the sources of influence and control are more subtle.  Governments choose to follow rules that are not enforced, they sign onto policies recommended to them by foreign nationals (or even ‘citizens of nowhere’), and they invite powerful non-state actors to assume control over crucial economic sectors, finance in particular.  Three recent books explain why this is so.

 

Like Law, but Softer

Governments sign up to agreements with one-another, even when there is no mechanism to enforce those agreements, because doing so offers greater opportunity for coordinating policy actions across countries than doing nothing at all. That much we know, and it is important. It explains how governments tackle a whole host of problems in the international arena related to issues as diverse as the promotion of human rights and the protection of the environment. It also explains how governments shape international markets, facilitating both the trade in goods and services and the flow of capital that makes it all possible. Of course, sometimes governments insist on participating in arrangements where some enforcement is possible, and rule-breaking can be sanctioned. Where such strong forms of coordination are not possible, though, governments will take whatever kind of agreement they can get. These looser forms of coordination constitute international ‘soft law’.

The implications of such agreements are not immediately obvious, particularly at the softer end of the spectrum. We can understand the desire for coordination, what is harder is to anticipate the consequences. This is where Abraham Newman and Elliot Posner come into the conversation. Newman and Posner have developed a fascinating and important argument about the potential for disruption created by non-enforceable (or voluntary) agreements on financial market regulation. Specifically, they show how such agreements become politicized within the countries that try to shape them, as different actors in the domestic arena use the advantages of international coordination to strengthen their claims in support of rules or standards that are more likely to find favour abroad. Hence, for example, Newman and Posner show how such arguments played a critical role in the international alignment of preferences around capital requirements, accounting standards, and the treatment of financial conglomerates both within the European Union (EU) and across the Atlantic.

Looser forms of international coordination also offer opportunities for domestic actors to push the level of decision-making above the national political arena. In this way, those actors can look for allies in other countries who can tilt the balance of power between their preferred regulatory arrangement and the nearest competitors. This is how financial markets regulators escaped their parochial origins and it explains both the evolution of the Basle agreement through their various stages (and levels of sophistication) and the strengthening of transnational financial lobbying organizations to run in parallel with this regulatory activity. At each step in their argument, Newman and Posner are careful to show how the claims they make are consistent with the central insight about the advantages of coordination. They also take pains to show how their explanation for the pattern of regulation compares with alternative theoretical accounts.

The book ends by suggesting that this insight about the influence of international soft-law could be disruptive in other areas of transnational engagement. There, Newman and Posner open up the possibility for analysing relations beyond the economic domain. They might look closely at what Daniel Thomas calls The Helsinki Effect, or the use of international human rights norms by dissidents behind the Iron Curtain to delegitimize Soviet communism. They might also look again at Samuel Huntington’s Clash of Civilizations, which rests on the idea that domestic groups will use transnational networks to find allies in their power struggles at home. The disruptive potential that Newman and Posner identify is central in any story about the international influence on domestic politics, no matter how technical or complex that story might seem. International soft law may be ‘soft’, but it is also important.

 

From Law to Ideas

Ideas are important as well.  The challenge is to bring them to the attention of policymakers.  This is where international institutions become important.  Such institutions are not the mouthpieces of the world’s strongest economies; the Washington Consensus is overrated in that respect.  Instead, they are policy entrepreneurs.  To see how this is so, it is necessary to start by accepting that the International Monetary Fund is more flexible than you might imagine. Sure, the IMF has strong ideas about what constitutes ‘sound’ economic policymaking. Moreover, IMF economists come from the mainstream of modern economic thought. Indeed, their role is to put the ‘best’ economic ideas into practice. And what constitutes the best, in that context, is whatever lies at the mainstream consensus. The point, Ben Clift argues, is not only that this consensus can be shaped and influenced, but also that IMF economists are actively engaged in moulding what policymakers believe.

Clift’s argument is a subtle one that in many ways mirrors the notion of Voluntary Disruptions sketched by Abraham Newman and Elliot Posner (see previous review). Through extensive interviews and a careful analysis of the IMF’s flagship publications, Clift shows how IMF economists adapt their thinking to changes in economic circumstances and then try to convince both policymakers and the academic community to shift their own thinking to match the new IMF perspective. Clift is quick to emphasize that this is an incremental process that unfolds over long periods of time – which is similar in structure and pace to the ‘disruptions’ that Newman and Posner attribute to international voluntary agreements. Moreover, the IMF tends to lose credibility when it admits to having been wrong in the past, so it is important that IMF economists stress the continuities in their way of thinking. Nevertheless, it is possible to trace the evolution of the IMF perspective and to show how that evolution ripples out into the mainstream consensus. Often these ripples play out not in the headline claims, but in the qualifications attached to recommended policies.

Clift focuses his attention on the influence of IMF economists on those countries that do not borrow IMF money. In other words, like Newman and Posner, Clift focuses on voluntary relationships that develop around the routines for IMF macroeconomic surveillance. Clift also notes that any changes in IMF thinking are part of a multi-stage process. First, economists in the IMF have to spot anomalies in the models they are using and lobby for slight alterations in the assumptions that underly their analysis. Then they have to look for allies in the academic community whose research will give this slight change in perspective more heft. They have to lobby within their respective divisions – Clift focuses on the research department and the fiscal affairs department, showing that the research arm is the more innovative while fiscal affairs is more conservative. As these new voices gain ‘traction’ within the organization – which is a term that Clift hears repeated frequently – they begin to push ideas out into the larger community, using blogs and op-ed pieces to gain traction with a wider audience.

This piecemeal process can add up to a major transformation in the IMF’s thinking. The change is not paradigmatic – in the sense of Thomas Kuhn’s ‘scientific revolutions’ – but it is important nonetheless. Clift illustrates this by showing how IMF economists have shifted away from notions of growth-enhancing austerity and toward a deeper concern for the distributive consequences of fiscal consolidation. Translated into English, that means the IMF is now arguing not only for Keynesian demand stimulus but also for focusing on the fight against inequality. This new perspective will sound unrecognizable for those used to criticizing the IMF as the institutional avatar of the Washington Consensus. As Clift reveals, such stereotypes are woefully outdated – which makes his book required reading for anyone interested in understanding what the IMF really thinks.

 

Governments Borrow More than Money from Banks

If governments get ideas from organizations like the IMF, they get market credibility from foreign banks.  This is another unexpected finding in the literature.  Here again, it is necessary to start from first principles.  When governments liberalize their capital markets, they face a fundamental choice about how they are going to encourage cross-border capital flows: they can rely on domestic banks to raise funds abroad that can be lent at home; they can allow foreign banks to set up new operations in the domestic market, and so create new sources of funds in a more competitive banking environment; or they can make it possible for foreign banks to take up a strategic position by buying up large domestic financial institutions or taking over privatized banking networks. On the surface, the third option seems the most fraught with risk. Foreign banks that take a strategic position may harvest profits during the boom period but cut and run when the economy busts. Domestic banks seem safer, even if they may require a little competitive stimulus. Beneath the surface, however, Jana Grittersová finds there are distinct advantages to giving foreigners a strategic interest in domestic finance.

Grittersová’s argument is yet another take on Newman and Posner’s Voluntary Disruptions hypothesis (see above). Governments benefit from allowing foreign banks to take a strategic position in their domestic markets because those banks enhance the credibility of the macroeconomic policy regime and so lower both inflation differentials and relative borrowing costs. Moreover, this credibility enhancement is more than just ‘reputational’; it is structural. Grittersová makes it clear that beyond being just a kitemark of international approval, ‘a foreign bank also becomes a political actor with distinct economic interests vis-à-vis the local economy and can thereby have a direct effect on a government’s commitment to sound monetary and financial policies’ (p. 24). Specifically, foreign banks can push for the adoption of international accounting standards and stricter regulation. In a pinch, those cross-border banks can also use their internal capital markets to provide lender of last resort facilities.

The statistical evidence for this reputational advantage is persuasive. Grittersová looks across a wide array of emerging market countries and shows how the presence of foreign banks correlates positively with lower interest rate and inflation differentials; by implication, foreign lenders are charging lower premia to do business with countries that have a large foreign bank presence in their domestic marketplace. Moreover, Grittersová is able to differentiate between foreign banks that have a positive reputation and those whose reputation is more questionable; the advantages only accrue from the presence of more reputable banks. Finally, Grittersová uses case studies of Bulgaria and Estonia, the Czech Republic and Poland, to show how this dynamic plays out in detail within the context of different monetary policy regimes. Bulgaria and Estonia relied on currency boards; the Czech Republic and Poland used inflation targeting. These case studies show the influence of strategic foreign banking at work.

This argument raises a host of interesting research questions, not least about the impact of the recent economic and financial crisis. Grittersová has a chapter to look at that crisis within the context of the Vienna Initiative, but it would be more interesting to drill down on specific national cases. The impact of Hungary’s about-face on the virtues of having a large foreign bank presence is one story that needs to be told; the abandonment of Greece by foreign investors is another. There is also more scope to explore the political forces that foreign banks displace. The toxic intermingling of banking and politics in provincial systems like Cyprus, Iceland, and Slovenia are obvious examples; so are the networks of regional and savings banks that are protected from foreign competition in Germany and Spain.

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These books were originally reviewed separately in Survival.  This collection is based on the manuscript version of the reviews.  Readers can download the final version of the reviews here.  The book citations are: