Responses to Financial Crises: An Evolutionary Perspective

Abstract

As the world currently faces the ever-deepening sub-prime crisis, we are reminded that the process of globalisation can cause significant disruptions in global markets and political systems. This article focuses on the evolution of financial crisis responses to gain a better understanding of the dynamics affecting current responses. By using a focused comparison of case studies it argues that the development of crisis response and the dominance of the current multilateral actors is a result of an evolutionary process. This process privileges learning and innovation within a complex political economic system. The crises of each era, born of many of the same problems, generate a variety of responding actors, a few of which are adopted. These actors help to address the immediate problems and even work well for a while. Eventually, they are overwhelmed by the tendency of financial interactions to grow. Another set of crises generates another round of actors and mechanisms. As time goes on, crisis response requires more formal institutions that can deal with more complex systems. The article concludes that response actors are becoming more public, multilateral and global in scope. Understanding this pattern of response should help to shed light on the potential for reform of the financial architecture and help to explain the dominance of multilateralism as a crisis response.

Notes

1. Barry Eichengreen, Toward a New International Financial Architecture: A Practical Post-Asia Agenda (Washington, DC: Institute for International Economics, 1999).

2. Ibid.; Peter Kenen, The International Financial Architecture: What's New? What's Missing? (Washington, DC: Institute for International Economics, 2001).

3. A note on usage of the word institution: since the responding actor or institution varies widely from time period to time period, it is necessary to choose a generic term that encapsulates a wide range of potential responders. The use of institution, therefore, is meant to denote a wide range of possibilities which includes state governments, banks, networks of banks, international financial institutions, and networks of states (such as the G8). There are cases of individuals responding to crises but they usually do so through an institution of some sort.

4. Jeffrey Frankel, “The Asian Mode, the Miracle, the Crisis and the Fund. A Speech Delivered at the US International Trade Commission”, available: <http://ksghome.harvard.edu/~jfrankel/eacritc.pub.pdf>; Ronald I. McKinnon and Huw Pill, “International Overborrowing: A Decomposition of Credit and Currency Risk”, World Development, Vol. 26, No. 7 (1998), pp. 1267–1282.

5. John Gerard Ruggie, “Multilateralism: The Anatomy of an Institution”, in John Gerard Ruggie (ed.), Multilateralism Matters: The Theory and Praxis of an Institutional Form (New York: Columbia University Press, 1993). Ruggie presents multilateralism as “an institutional form that coordinates relations among three or more states” (p. 14). Thus, the focus is on how problems in the international system are managed by a number of state actors working cooperatively or coordinating actions.

6. George Modelski, “Evolutionary Paradigm for Global Politics”, International Studies Quarterly, Vol. 40, No. 3 (1996), pp. 321–342.

7. For a more complete discussion of functionalism see David Mitrany, The Functional Theory of Politics (New York: St. Martin's Press, 1976).

8. Hyman P. Minsky, “The Financial-instability Hypothesis: Capitalist Processes and the Behavior of the Economy”, in Charles P. Kindleberger and Jean-Pierre Laffargue (eds.), Financial Crises: Theory, History and Policy (Cambridge: Cambridge University Press, 1982).

9. The way liquidity has been provided has also changed over time. This paper will focus on the actors that provide liquidity, but the manner in which it is created has also varied over time.

10. Charles P. Kindleberger, Manias, Panics and Crashes: A History of Financial Crises, 3rd edn (New York: Wiley, 1996).

11. Andrew Crockett, The Theory and Practice of Financial Stability, Essays in International Finance, No. 203 (Princeton: International Finance Section, Department of Economics, Princeton University, 1997).

12. Anna J. Schwartz, “Real and Pseudo-financial Crises”, in Forrest Capie and Geoffrey E. Wood (eds.), Financial Crises and the World Banking System (New York: St. Martin's Press, 1985); Milton Friedman and Anna J. Schwartz, A Monetary History of the United States 1867–1960 (Princeton: Princeton University Press, 1963).

13. Minsky, op. cit.; idem, John Maynard Keynes (New York: Columbia University Press, 1975).

14. Charles P. Kindleberger, Manias, Panics and Crashes: A History of Financial Crises, 4th edn (New York: Wiley, 2000).

15. Ibid., chs. 10–12.

16. Ibid.; A. Andreades, History of the Bank of England, 2nd translated edn (London: P.S. King, 1924); Walter Bagehot, Lombard Street: A Description of the Money Market (New York: Scribner, Armstrong, 1873).

17. Alexander George, “Case Studies and Theory Development: The Method of Structured, Focused Comparison”, in Paul Gorden Lauren (ed.), Diplomacy: New Approaches in History, Theory, and Policy (New York: Free Press, 1979).

18. It should be noted that both of these Acts of Parliament were created by boards of inquiry prompted by the crises of 1825 and 1839. Andreades, op. cit., pp. 253, 269–273.

19. Harold G. Moulton and Leo Pasvolsky, World War Debt Settlements (New York: Macmillan, 1926); Paul Einzig, World Finance, 1914–1935 (New York: Macmillan, 1935).

20. Stephen V.O. Clarke, Central Bank Cooperation 1924–1931 (New York: Federal Reserve Bank of New York Publications Section, 1967).

21. Henry Schloss, The Bank for International Settlements: An Experiment in Central Bank Cooperation (Amsterdam: North-Holland, 1958).

22. Ibid.; Susan Strange, International Monetary Relations, in Andrew Shonfield (ed.), International Economic Relations of the Western World 1959–1971, Vol. 2 (London: Oxford University Press, 1976).

23. It should be noted that there are many institutions working on crisis response including the BIS, G8, regional banks and the IMF, but the IMF has been the central focus for addressing crises, particularly in the global South.

24. Barry Eichengreen, Globalizing Capital: A History of the International Monetary System (Princeton: Princeton University Press, 1996).

25. John Clapham, The Bank of England: A History, Vol. II (London: Cambridge University Press, 1944).

26. Richard Timberlake, The Origins of Central Banking in the United States (Cambridge, MA: Harvard University Press, 1978); Nelson W. Aldrich, Address of Hon. Nelson W. Aldrich, Chairman of the National Monetary Commission (Washington, DC: Government Printing Office, 1911).

27. Vera Smith, The Rationale of Central Banking (London: P.S. Kind, 1936), pp. 28–41; John Clapham, The Economic Development of France and Germany 1815–1914 (London: Cambridge University Press, 1928).

28. There may be some parallels with managing political crisis. For example, there is a literature on political crisis management which deals with the issue of smaller crises ultimately weakening the ability to address larger crises. See Coral Bell, The Conventions of Crisis: A Study in Diplomatic Management (London: Oxford University Press, 1971).

29. It is actually common for financial crises to have contagion effects, but in key crises the effect is more significant and widespread. See Kindleberger, Manias, Panics and Crashes: A History of Financial Crises, 4th edn, op. cit., ch. 8.

30. Carmen Reinhart and Kenneth Rogoff, The Time is Different: A Panoramic View of Eight Centuries of Financial Crises, Working Paper No. 13882 (Cambridge, MA: National Bureau of Economic Research, 2008).

31. E.R. McCartney, Crisis of 1873 (Minneapolis: Burgess Publishing, 1935), p. 85.

32. Charles Goodhart, The Evolution of Central Banks (Cambridge, MA: MIT Press, 1988).

33. Ibid.

34. Aurel Schubert, The Credit-Anstalt Crisis of 1931 (Cambridge: Cambridge University Press, 1991), pp. 159–167.

35. Clarke, op. cit.; Joseph Davis, The World between the Wars, 1919–1939: An Economist's View (Baltimore: Johns Hopkins University Press, 1975).

36. There is some debate about whether the BIS is an independent institution or whether it is a forum where states can pursue multilateral cooperation. The important difference would be whether there was actually an institution responding or a regime. Helleiner argues that the BIS was at the centre of a regime that managed financial crises, and while its institutional structure may be less formal, the organisation does have specific rules and characteristics that indicate a formal organisation. See Eric Helleiner, States and the Re-emergence of Global Finance: From Bretton Woods to the 1990s (Ithaca, NY: Cornell University Press, 1994).

37. Strange, op. cit., p. 84.

38. Ibid., pp. 85–86.

39. Kenen, op. cit.

40. Modelski, op. cit.; George Modelski and William Thompson, “The Long and Short of Global Politics in the Twenty-first Century: An Evolutionary Approach”, International Studies Review, Vol. 1, No. 2 (1999); George Modelski, “Is World Politics Evolutionary Learning”, International Organization, Vol. 44, No. 1 (1990), pp. 1–24.

41. Modelski, “Evolutionary Paradigm for Global Politics”, op. cit., pp. 110–140.

42. Ibid.; William R. Thompson, “Evolving toward an Evolutionary Perspective”, in William R. Thompson (ed.), Evolutionary Interpretations of World Politics (New York: Routledge, 2001).

43. Karen Rasler, “Shocks, Expectancy Revision, and the De-escalation of Protracted Conflicts: The Israeli–Palestinian Case”, Journal of Peace Research, Vol. 37, No. 6 (2000), pp. 699–720.

44. Andrew Farkas, “Evolutionary Models in Foreign Policy Analysis”, International Studies Quarterly, Vol. 40, No. 3 (1996), pp. 343–361.

45. Thompson, op. cit., p. 2.

46. Modelski, “Evolutionary Paradigm for Global Politics”, op. cit., p. 331.

47. Thompson, op. cit., p. 4.

48. Modelski, “Evolutionary Paradigm for Global Politics”, op. cit., p. 336; George Modelski and Tessaneno Devezas, “Political Globalization is Global Political Evolution”, World Futures, Vol. 63, no. 5 (2007), pp. 308–323.

49. Modelski, “Evolutionary Paradigm for Global Politics”, op. cit., p. 332.

50. Ibid., p. 328; Farkas, op. cit., p. 348.

51. Robert O. Keohane, After Hegemony: Co-operation and Discord in the World Political Economy (Princeton: Princeton University Press, 1984); Oliver E. Williamson, The Economic Institutions of Capitalism: Firms, Markets, Relational Contracting (New York: Free Press, 1985); James March and Johan P. Olsen, “The New Institutionalism: Organizational Factors in Political Life”, American Political Science Review, Vol. 78, No. 3 (1984), pp. 734–749.

52. Modelski, “Evolutionary Paradigm for Global Politics”, op. cit.

53. Maurice Obstfeld and Alan M. Taylor, Global Capital Markets: Integration, Crisis, and Growth (Cambridge and New York: Cambridge University Press, 2004).

54. Einzig, op. cit., p. 44.

55. Moulton and Pasvolsky, op. cit.; Harold G. Moulton and Leo Pasvolsky, War Debts and World Prosperity (Washington, DC: Brookings Institution, 1932), p. 5.

56. James Foreman-Peck, A History of the World Economy: International Economic Relations since 1850, 2nd edn (New York: Harvester Wheatsheaf, 1995), p. 258.

57. Eric Helleiner, “When Finance was the Servant: International Capital Movements in the Bretton Woods Order”, in Philip G. Cerny (ed.), Finance and World Politics: Markets, Regimes and States in the Post-hegemonic Era (Cambridge: Edward Elgar, 1993).

58. Obstfeld and Taylor, op. cit.

59. Strange, op. cit., p. 58.

60. Moulton and Pasvolsky, World War Debt Settlements, op. cit.; idem, War Debts and World Prosperity, op. cit.

61. The present sub-prime crisis is too current to draw any conclusions about its global effects and responses.

62. International Monetary Fund, The IMF's Response to the Asian Crisis (Washington, DC: International Monetary Fund, 1999).

63. “IMF Approves US$17.8 Billion Stand-by Credit for Mexico”, International Monetary Fund Press Release (1 February 1995); Kenen, op. cit.

64. Mark Beeson, “Reshaping Regional Institutions: APEC and the IMF in East Asia”, The Pacific Review, Vol. 12, No. 1 (1999), pp. 1–24.

65. Martin Feldstein, “Refocusing the IMF”, Foreign Affairs, Vol. 77, No. 2 (1998), pp. 20–35; Jeffrey D. Sachs, “The IMF and the Asian Flu”, The American Prospect, Vol. 37 (1998), pp. 16–24.

66. Graham Bird and Ramkishen Rajan, The Evolving Asian Financial Architecture, Essays in International Economics (Princeton: Department of Economics, Princeton University, 2002).

67. David Rapkin, “The United States, Japan and the Power to Block: The APEC and AMF Cases”, The Pacific Review, Vol. 14, No. 3 (2001), pp. 373–410.

68. Beeson, op. cit.

69. Michael Wesley, “The Asian Crisis and the Adequacy of Regional Institutions”, Contemporary Southeast Asia, Vol. 21, No. 1 (1999), pp. 54–56.

70. Paul Krugman, “Saving Asia: It's Time to Get Radical”, Fortune (7 September 1998); Eichengreen, Toward a New International Financial Architecture, op. cit.; idem, “Strengthening the International Financial Architecture: Where do we Stand?”, ASEAN Economic Bulletin, Vol. 17 (2000), pp. 175–185.

71. Curzio Giannini, Enemy of None but a Common Friend of All? An International Perspective on the Lender of Last Resort Function, Essays in International Finance, No. 214 (Princeton: International Finance Section, Department of Economics, Princeton University, 1999); George Soros, “Avoiding a Breakdown: Asia's Crisis Demands a Rethink of International Regulations”, Financial Times (31 December 1997); Henry Kaufman, “Preventing the Next Global Financial Crisis”, The Washington Post (28 January 1998), p. A17; Sebastian Edwards, “Abolish the IMF”, Financial Times (13 December 1998), p. A1.

72. Jeffrey E. Garten, “In this Economic Chaos, a Global Bank Can Help”, International Herald Tribune (25 September 1998), p. 8.

73. John Ravenhill, “A Three Bloc World? The New East Asian Regionalism”, International Relations of the Asia-Pacific, Vol. 2 (2002), pp. 167–195.

74. Ruggie, op. cit., p. 21.

75. See, for example, Lisa Martin, “The Rational State Choice of Multilateralism”, in John Gerard Ruggie (ed.), Multilateralism Matters, op. cit.; Christopher Hemmer and Peter Katzenstein, “Why is there no NATO in Asia? Collective Identity, Regionalism and the Origins of Multilateralism”, International Organization, Vol. 56, No. 3 (2003), pp. 575–607; Craig N. Murphy, International Organization and Industrial Change: Global Governance since 1850 (London: Polity Press, 1994); Christian Reus-Smit, “The Constitutional Structure of International Society and the Nature of Fundamental Institutions”, International Organization, Vol. 51, No. 4 (1997), pp. 555–589; Robert A. Denemark and Matthew J. Hoffmann, “Just Scraps of Paper? The Dynamics of Multilateral Treaty-making”, Cooperation and Conflict, Vol. 43, No. 2 (2008). Clearly there is a diverse set of theories and methods used to examine multilateralism.

76. Thompson, “Evolving toward an Evolutionary Perspective”, p. 4.

77. To get a sense of the breadth of actors in responses see Mark Landler, “Healthy Countries to Receive IMF Loans”, New York Times (29 October 2008); Eric Pfanner, “Iceland, in Financial Collapse, is Likely to Need IMF Help”, New York Times (9 October 2008); Louise Story, “Wall Street Report Tries to Dissect Financial Meltdown”, New York Times (6 August 2008); Landon Thomas and Julia Werdiger, “Britain Takes a Different Road to Rescue its Banks”, New York Times (8 October 2008).

78. See Landler, op. cit.

79. The IMF has been involved in providing liquidity in the crises in Iceland, Ukraine and Hungary, among other states. See Landler, op. cit.; Pfanner, op. cit.

80. Although Kindleberger's crises end with the Asian crisis, an examination of the Argentinean (1999–2002) and Turkish (2001) crises also puts the IMF at the forefront of response.

81. It is important to address the issue of determinism in the matter of key crises leading to reform. While the historical cases suggest that boards of inquiry and governmental actions after a significant financial crisis lead to new policy initiatives, the argument is not meant to imply that this will always be the case—of course, reforms may never come about regardless of the severity of a crisis. However, all crises, and key crises in particular, do present windows of opportunity to legislate and reform the system, and thus the political will and obstacles to reform do create the type of environment that would be likely to promote a reformist agenda.