The Transformation of the Post War Economic Order: Alternative Scenarios

Posted by on 5 February 2009

The global crisis is reshaping global economic relations. This may well create an opportunity for developing countries to assert themselves as the new rulers within the existing order, as suggested by Dani Rodrik’s lead commentary (“Let developing nations rule”). However, this is only one of several possible outcomes. It may be worth considering alternative scenarios and their likely implications for developing countries.

Competitive Bilateralism
The ‘new rulers may decide to govern outside the established multilateral institutions (see also the comment by Nancy Birdsall). This could give rise to competitive bilateralism, i.e. new rulers using bilateral agreements with multiple countries to protect their own interests – as the US has done in increasingly in trade, investment, and aid relations. In the short run less powerful countries may benefit from increased competition. (Consider the impact of China’s growing presence in Africa.) As with regulatory competition in general, however, the outcome of competitive bilateralism may be a race to the top -- or a race to the bottom.

Global Disengagement
The economic crisis may force ‘old’ and ‘new’ rulers alike to focus primarily on domestic policies and to disengage globally. Domestic needs, perhaps even turmoil (which is becoming more likely in many countries as the crisis deepens), will prevent even economically more powerful developing countries from taking advantage of the vacuum left by the increasingly inward turning developed nations. As private and public outbound investments and capital flows contract to protect the home base the least developed countries will be left to the mercy of the IMF and/or regional development banks, and the ability of these institutions to mobilize sufficient resources for an effective rescue.

A New Core
The crisis may forge a ‘new core’ but do little to change and may even aggravate the fate of the periphery. This new core comprises of countries and/or entities that have forged interdependent economic ties prior to or in response to the crisis. A well-known example is the trade-deficit-reserve symbiosis between China and the US. Of similar importance is the web of equity ties that now links some of the largest financial intermediaries from the West to Sovereign Wealth Funds (SWF) in the Far East and the Middle East. As a result of the bailouts of major banks SWFs and Western governments have joined ranks as shareholders of these banks. They now share a common interest in the survival of these banks and the financial systems in which they operate. This may help stabilize financial relations at the core – an outcome that appears preferable to global disengagement. Yet, it may come at the price of effectively freezing out the periphery, i.e. entities and markets in most developing countries and emerging markets.

Bridging the New Divide
The only players in this global financial network with the resources to bridge the new divide between the core and the periphery are SWFs, the largest of which have US$100- $780 bln in assets. They could potentially assume the role of “sovereign development funds” (Santiso, 2008) and/or invest more heavily in emerging markets and developing countries (as proposed by the president of the World Bank). This strategy could enhance the standing of SWFs as global players and might give them more leverage in reshaping global financial relations than a minority stake in ailing Western banks.

Likely Outcomes
None of these scenarios is entirely implausible and evidence could be assembled in support of each – albeit without allowing for firm conclusions at this point in time. Perhaps not surprisingly, none is particularly forthcoming vis-à-vis the weakest countries, i.e. those in greatest need of external help to cope with the crisis and its aftermath. The countries that have the largest room to maneuver are those with the biggest SWFs (or the biggest reserves to replenish them). The strategies these countries adopt today are likely to influence the shape of global economic relations in the future.

Pistor, Katharina. 2009. Sovereign Wealth Funds and Global Financial Governance. In Sovereign Wealth Funds and Foreign Direct Investment, edited by K. Sauvant. (forthcoming).
Santiso, Javier. 2008. Sovereign development funds: financial actors in the shifting wealth of nations. In New Perspectives on Sovereign Asset Management, edited by M. Reitveld. London: Central Banking Publications Ltd.

Katharina Pistor
Michael I. Sovern Professor of Law
Columbia Law School
New Yor, NY