POLITICS
11/13/2008 05:12 am ET Updated May 25, 2011

Global Economic Crisis Likely To Have Profound Consequences For US Politics, World Relations

The global economic crisis is likely to have profound, long-range consequences for American politics and for the relations of the United States with the rest of the world, severely constraining any effort to maintain or revive the Bush administration's propensity for unilateralism, and posing a broad international challenge to free market ideologies, according to a range of experts.

The scope of these changes remains uncertain, and all those who responded to October 11 and 12 inquiries from the Huffington Post warned that predictions in these circumstances are perilous. But there is a strong consensus that it would be a mistake to minimize the coming upheavals.

In the United States, economic developments have the potential to lay the groundwork for a political transformation with major alterations in both the composition of, and balance of power between, the major political parties. There are "reasons for thinking that the American election of 2008 may be the equivalent of the election of 1932 - an electoral sea change ushering in a new wave of government intervention and, if that intervention is successful, a durable electoral realignment," says Peter Hall, Krupp Foundation Professor of European Studies at Harvard, in a wide-ranging analysis he provided to the Huffington Post, available in full at the end of this article.

In Europe, Hall contends, "the political effects are likely to be more diffuse. If the ensuing recession is not too deep, the current crisis may provide Prime Minister Gordon Brown with just enough credit for the Labour party to survive the next British election and Angela Merkel with the wherewithal to remain German Chancellor. But history suggests that electorates tend to punish governments that preside over deep recessions and to look, in some cases, to the political extremes for new faces and voices. Therefore, there is reason to worry about the rise of far right parties in Europe, in particular, where they have already made inroads by running against the market-oriented policies of the European Union."

"Although enthusiasm for market competition has been waning in European capitals for some years, the current financial crisis will strike it a serious and potentially fatal blow," according to Hall.

"Most Europeans and some Americans attribute the crisis to subprime lending in the US housing market, but that was only the trigger for contemporary events," Hall argues. "The deeper roots of the crisis lie in shifts in banking practices that led many financial institutions to borrow heavily in short-term capital markets to finance the purchase of riskier securities than they once held. The 'financial innovation' behind the development of these securities was said to diffuse risk. Indeed, it did and now everyone is at risk. These developments are symbolized by the practice of many European banks of using credit default swaps to purchase 'insurance' on risky securities, thereby allowing them to count them as part of the asset base required to meet regulatory requirements on the banking sector."

The United States could well come out on the losing end. The crisis will inflict serious damage to the international status and power of the United States, according to Thomas R. Cusack, Senior Research Fellow at the social science research institution Wissenschaftszentrum Berlin. "For economic and military purposes, it has been the conscious strategic aim of most post-WW II US administrations to entwine many parts of the world into a tightly integrated network with the US as the central node. This has given it leverage that goes well beyond its immense power base," says Cusack (whose comments to the Huffington Post are also available in full below).

The US, in this view, will pay the price for the misjudgments of the Bush administration. "The last eight years have seen US political and economic leadership reach a nadir in the ratio of cognitive capabilities to destructive capabilities. There is a great unwillingness to recognize this limitation, particularly within American culture. The Bush years have all the appearance of a Greek tragedy. Greed, hubris, and short-sighted pursuit of political advantage have been placed in the pressure cooker and the heat turned on high. The result is not that it would boil over but that it would explode. The economic empire is unraveling quietly but at a faster and faster clip. This process will eventually knock out the underpinnings of American military power and bring about a major reduction in overseas entanglements. This is to say that just as the deleveraging in financial assets has turned into an uncontrollable process, so, too, may the unwinding of the US strategic-military networks."

* * *

One eminent economist widely credited with accurately anticipating the economic meltdown, New York University's Nouriel Roubini (AKA 'PermaBear' and 'Dr. Doom'), now argues that there will need to be massive government-funded public works and social welfare expenditure programs to revive the economy, actions which would have substantial political implications:

The federal government should have a plan to immediately spend on infrastructure and new green technologies; also unemployment benefits should be sharply increased, together with targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend, old-fashioned traditional Keynesian spending by the government is necessary. It is true that we already have large and growing budget deficits; but $300 billion of public works is more effective and productive than spending $700 billion to buy toxic assets.....The financial and economic conditions are extreme; thus extreme policy action is needed now to save the global economy from that very ugly prospect.

Clearly, greater government regulation is back on the table. Peter Brecke of the Sam Nunn School of International Affairs at the Georgia Institute of Technology tells the Huffington Post:

Deregulation and regulation are two phases or tendencies in governance, particularly economic governance. Many facets of the current financial crisis became possible and happened because deregulation made possible (legal) higher levels of leveraging. This enabled more investments because you did not have to put as much money down while borrowing money to make them. However, leveraging entails the borrower taking on greater debt. If the investment does not work out, the borrower-investor can be bankrupted by that debt. The concept of economic governance is to make and enforce rules that minimize economic swings while allowing economic growth to take place, just as a governor on a steam engine in the 1800s was to control the speed of a locomotive. The current crisis is forcing us to re-regulate so that we will not have a repeat of what we are going through. The key issue is what the new rules should be so that we can have economic vitality without a high risk of another calamity. At the international level the question is how do we best institutionalize coordinated efforts made necessary by globalization.

* * *

There is some disagreement among scholars concerning the future of international economic cooperation. Steve Ansolabehere, Harvard professor of Government, contends that "the coordination among the central banks from this crisis will likely rival the international monetary cooperation developed following WWII."

In the United States, Ansolabehere argues, "this global financial system has fueled economic growth" even as it "has increasingly left the American middle class behind." While voters are increasingly angry that the "real income of the median wage earner in the US has not gone up over the past 30 years....neither party has really formulated a policy that speaks to their concern." Political reaction to the distributional consequences of major government spending has the potential to establish new party loyalties, or to further alienate key sectors of the electorate.

More pessimistic about US participation in a cooperative global economy, is Jeffrey Frieden, an expert in the politics of international monetary and financial relations in Harvard's Government Department. Frieden wrote in a prescient June 2006 article:

Whatever the preferred scenario one chooses for an end to the current imbalances, the process will create strains in the American macroeconomy - and in American politics. For the mass public support for - or at least lack of open opposition to - America's current integration into the world economy is largely due to the current boom. When the expansion comes to an end, and when many of the factors that have sustained it, turn around - when the United States goes from living beyond its means to living within its means and then some - latent tensions over globalization will almost certainly come to the fore....

There is no magical formula that makes it easy for governments to combine a commitment to international economic openness with attention to the legitimate concerns of national constituents harmed by the international economy. We cannot identify in advance what policy package is ideal for any group or country; that is the job of national political systems. However, on the basis of the past century's experience, we can have some confidence that the stakes are very high, and include the prospects for prosperity of much of the world.

Political parties which stake their claim to voter support on animosity towards government will now have to integrate to their policy positions the fact that governments play an indispensable role in steering economies. Few people are entirely happy about this. The late Stewart A. Bremer of Pennsylvania State University and SUNY Binghamton wrote: "[G]overnment is not a unitary rational actor, guided by a single objective function, but rather a complex organization pursing a multiplicity of only partly compatible goals by means of routine, but not necessarily optimal, procedures. In such organizations problem-solving tends to be myopic, incremental, and sporadic."

All of this discussion takes place against a grim backdrop.

"Despite the financial losses everyone is experiencing, one of the most disturbing features of crises is the political fallout," warns Marc Chandler, Global Head of Currency Strategy at Brown Brothers Harriman. "The Great Depression brought us fascism, Stalinism, and of course WW II. This financial crisis is of sufficient proportions that we should expect some political repercussions. Let's hope there are some lessons we have all learned."

* * *

PETER HALL comments to Huffington Post, in full:

"The current economic crisis is bringing to an end the infatuation with market competition that gripped Europe and America in the wake of the economic crisis of the 1970s, when several years of poor economic performance, widely associated in Europe with 'Eurosclerosis' led to disillusionment with the state intervention and the embrace of more open market competition as an alternative to it for allocating resources. This 'move to the market' led by Margaret Thatcher and Ronald Reagan was institutionalized in the Single European Act of 1986. It created a single market across Europe, turning a European Commission that had once been dedicated to political integration into a powerful agent for market reform and reviving the image of the United States as a model for world economies.

"Although enthusiasm for market competition has been waning in European capitals for some years, the current financial crisis will strike it a serious and potentially fatal blow. Most Europeans and some Americans attribute the crisis to subprime lending in the US housing market, but that was only the trigger for contemporary events. The deeper roots of the crisis lie in shifts in banking practices that led many financial institutions to borrow heavily in short-term capital markets to finance the purchase of riskier securities than they once held. The 'financial innovation' behind the development of these securities was said to diffuse risk. Indeed, it did and now everyone is at risk. These developments are symbolized by the practice of many European banks of using credit default swaps to purchase 'insurance' on risky securities, thereby allowing them to count them as part of the asset base required to meet regulatory requirements on the banking sector.

"Although one can blame greed for these developments, 'greed' is simply another term for the rational response to market incentives. The real failure lies in regulatory systems. As we all now know, governments in the United States, Europe and much of the rest of the world failed to regulate markets in these new financial instruments and new forms of trading. Therefore, we are seeing a massive failure in the sphere of government regulation.

"The response on both sides of the Atlantic will be to regulate financial markets more intensively, closing the barn door after the horse has left but hoping to keep any remaining horses inside. However, this will not be a smooth process. There are obstacles to it on both continents. In the U.S., the principal obstacle is the lobbying power financial institutions enjoy in a political system that runs on vast sums of private campaign finance. In Europe, the obstacle is a European Union that is supposed to 'pool sovereignty' but does not yet provide formal means for a coordinated regulatory response. This is a moment of crisis for the European Union as well as for its financial systems.

"None of the developed democracies is immune from these problems because a large portion of every banking sector is globalized and interdependence in trade will translate the economic slowdown across national borders. In our work on varieties of capitalism, however, David Soskice, an economist at Oxford, and I have drawn attention to the differences between 'liberal market economies' such as the US and the UK, which depend heavily on lightly-regulated markets to allocate resources to firms, and the 'coordinated market economies' of northern Europe and east Asia, where firms depend more heavily on corporate networks to secure access to capital, skills and technology. Encouraged by the economic boom of the last decade, the savings rate has fallen steadily in liberal market economies, while it remains much higher in coordinated market economies. As a result, the negative effects of the inevitable slowdown in lending and economic recession that accompanies it will fall more heavily on the liberal market economies. That is one reason why the German government has been reluctant to engage in an international bailout. Over the past decade, its problem has been to persuade its own consumers to save less and spend more in order to fuel economic growth. Now what was once seen as a drawback will be an economic advantage. For this and other reasons, the impact of the crisis will vary across countries.

"We are already seeing more government intervention into the financial sector, even in this country, the home of the 'free market'. That is likely to be followed by more expansionary fiscal policies, as governments seek to stimulate their economies and run deficits to pay for the bailout of the banks. This will cause major problems for the members of the European monetary union who are supposed to keep their structural deficits within 3 percent of GDP and will likely strain this rule if not the basic operating practices of the Union itself. The stage has been set for a looming conflict between the European central bank, which is committed to controlling inflation, and the member governments of EMU. The U.S. will find it much easier to run larger deficits, provided they are accompanied by enough buoyancy in the economy to persuade foreign lenders to continue to hold dollars. If they do not, of course, cutbacks in government spending will be required to defend the exchange rate and will lead to an even deeper recession in this country. It used to be said that, if a bank lends you enough money, you own that bank. We can only hope that this applies internationally to those governments now holding trillions of dollars in their foreign exchange reserves.

"As you no doubt realize, this provides reasons for thinking that the American election of 2008 may be the equivalent of the election of 1932 - an electoral sea change ushering in a new wave of government intervention and, if that intervention is successful, a durable electoral realignment.

"In Europe, the political effects are likely to be more diffuse. If the ensuing recession is not too deep, the current crisis may provide Gordon Brown with just enough credit for the Labour party to survive the next British election and Angela Merkel with the wherewithal to remain German Chancellor. But history suggests that electorates tend to punish governments that preside over deep recessions and to look, in some cases, to the political extremes for new faces and voices. Therefore, there is reason to worry about the rise of far right parties in Europe, in particular, where they have already made inroads by running against the market-oriented policies of the European Union.

"The Iraq war has already dealt the image of America in Europe a serious blow. The financial crisis will erode that image even further. However, the European economies are likely to suffer enough from problems with their own financial systems and from the unwinding of housing booms in countries such as France and Spain that few will be able to blame the debacle on the Americans. They will blame it, however, on the failure of governments to regulate the financial system more effectively, and that is likely to usher in a new wave of support for more assertive government intervention that will require some renegotiation of the terms on which the EU currently operates and an inventive new set of policies to address looming economic, as well as financial, problems. Just how inventive those policies will be will depend on the depth of the recession. At a minimum, however, the current financial crisis has also become a political crisis that is reconfiguring the role of government in the economy and conventional wisdom about the appropriate relationship between the public and private sectors."

***

Thomas Cusack comments to the Huffington Post, in full:

"For economic and military purposes, it has been the conscious strategic aim of most post-WW II US administrations to entwine many parts of the world into a tightly integrated network with the US as the central node. This has given it leverage that goes well beyond its immense power base.

"Using such power and leverage wisely is not a given; improvident use of such power can prove destructive, counter-productive, and sometime calamitous.

"This vast and complex interdependent system requires not only intelligent guidance but two other aspects of good leadership, namely a degree of selflessness and a high measure of prudence. Such attributes are relatively rare and only seldom found in combination.

"Authoritarian regimes are unlikely to produce leaders with such attributes. Nevertheless, there is little in the more limited history of democracies to suggest that they are superior to authoritarian regimes in this regard. Even when one or another democratic leader possessing one or another of these traits has arisen, that leader rarely has succeeded in democratic politics and when such a leader has succeeded for a brief period, successors have proven to be epigones -- at best.

"The last eight years have seen US political and economic leadership reach a nadir in the ratio of cognitive capabilities to destructive capabilities.

"There is a great unwillingness to recognize this limitation, particularly within American culture. The Bush years have all the appearance of a Greek tragedy. Greed, hubris, and short-sighted pursuit of political advantage have been placed in the pressure cooker and the heat turned on high. The result is not that it would boil over but that it would explode. The economic empire is unraveling quietly but at a faster and faster clip.

"This process will eventually knock out the underpinnings of American military power and bring about a major reduction in overseas entanglements. This is to say that just as the deleveraging in financial assets has turned into an uncontrollable process, so, too, may the unwinding of the US strategic-military networks."

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