International Finance

Benjamin Cohen. Handbook of International Relations. Editor: Walter Carlsnaes, Thomas Risse, Beth A Simmons. Sage Publication. 2002.

Once relegated to the ‘low politics’ of technical economic analysis, international finance is now recognized as a core substantive element of the field of international relations (IR) and a fertile source of inspiration for the development and testing of theory. Monetary and financial issues figured prominently in many of the field’s most important debates of the final third of the twentieth century. As they continue to evolve, the institutions and practice of international finance will persist in raising new challenges to old understandings about world politics and the nature of the global system and are sure to remain a major influence on research agendas in the twenty-first century as well.

The aim of this chapter is to provide both a retrospective and prospective overview of critical thinking about international finance in the IR field, with particular emphasis on interactions between theory and practice and between economics and politics. Coverage is necessarily selective. Contributions that are strictly institutional in nature or policy discussions that are not systematically informed by theory will not be directly considered. The focus, rather, will be on analyses that build on or contribute directly to the intellectual development of the IR field.

To set the context, discussion will begin with a brief historical narrative tracing the evolution of the international monetary system since the Second World War. The research literature has continually adjusted to the changing structure of financial relations. Key has been the gradual resurrection of global currency and capital markets, an accelerating trend which over time has greatly widened the range of actors with power to influence outcomes. Earlier in the post-war period, international finance was mainly a matter of interactions between states–the traditional dramatis personae of world politics. Today, by contrast, the cast of characters has expanded to include a multitude of non-state actors as well–the newer agents of what has come to be called the increasing ‘globalization’ of economic affairs.

These changes are reflected in the related literature, which has developed greatly since the rebirth of international political economy as a systematic area of study in the 1960s.1 Broadly speaking, two overlapping generations of scholarship may be distinguished. The first was state-centric and focused mainly on issues of policy and statecraft in monetary affairs. Most influential were pioneering works by American economists such as Richard Cooper (1968) and Charles Kindleberger (1970, 1973), together with Benjamin Cohen (1971, 1977) and, especially, the late Susan Strange (1971, 1976), a British subject trained in IR. The second generation, by contrast, has put more stress on the growing role of markets and non-state actors, cast as a direct challenge to the authority and capacity of governments. Here too Strange helped lead the way, with books like Casino Capitalism (1986) and States and Markets, first published in 1988 (second edition, 1994). Other early contributions came from Cohen (1981, 1986) and Robert Gilpin (1987). The two generations have proceeded in almost dialectical fashion, the first asserting (or assuming) the primacy of the state, the second posing states and markets as distinct and opposing principles. Following the historical narrative in the next section of this chapter, each of the two approaches will be examined in turn.

The key questions for future research involve prospects for the relationship between states and markets in the new century. How serious is the challenge to state authority, and what can governments do about it? More fundamentally, who now governs in the world of international finance? Are states and markets necessarily in opposition to one another? Or, after the thesis of state-centrism and the antithesis of market forces, is a new research synthesis needed or even possible? Our understanding of the political economy of international finance is still far from complete.

For the purposes of this chapter, international finance is understood to encompass all the main features of monetary relations between states–the processes and institutions of financial intermediation (mobilization of savings and allocation of credit) as well as the creation and management of money itself. As Strange wrote in States and Markets ‘The financial structure really has two inseparable aspects. It comprises not just the structures of the political economy through which credit is created but also the monetary system or systems which determine the relative values of the different moneys in which credit is denominated’ (1994: 90). Both aspects of international finance have attracted intense scrutiny.

The Evolution of International Finance

The key feature that distinguishes international finance from purely domestic monetary analysis is the existence of separate national currencies. Legally, the concept of state sovereignty has long been understood to include an exclusive right to create and manage money. Within national frontiers no currency but the local currency is expected, normally, to serve the traditional functions of money: medium of exchange, unit of account, and store of value. Formally, there is no money for the world as a whole (though selected national currencies have informally played important international roles). Hence when we speak of the international monetary system (or, synonymously, the global financial structure), we are talking of a universe of diverse national monetary spaces, not one homogenous entity–a Westphalian world, in short, where the nation-state, still the world’s basic unit of formal governance, remains the core (though far from exclusive) actor.

The existence of separate national currencies has both economic and political implications. Economically, monetary sovereignty means that currencies that are legal tender in one place are unlikely, with few exceptions, to be fully usable elsewhere. From that tradition stems the need for mechanism, and arrangements, such as foreign exchange and other financial markets, to facilitate transactions and interchanges between national moneys and credit systems. Politically, monetary sovereignty means that governments, in principle, each enjoy sole authority within their own borders. From that stems the need for mechanisms and arrangements, concerning such matters as currency values and access to finance, to minimize frictions and, if possible, to facilitate cooperation in financial management. It is in the interaction of these twin economic and political imperatives–the ever-shifting relations among states and between states and markets–that the modern history of international finance is written, from the Bretton Woods system of the first decades after the Second World War to what many call the ‘non-system’ of today.

From Bretton Woods to ‘Non-System’

The Bretton Woods system is commonly understood to refer to the monetary regime that prevailed from the end of the Second World War until the early 1970s. Taking its name from the site of the 1944 conference that created the International Monetary Fund and World Bank, the Bretton Woods system was history’s first example of a fully negotiated financial order intended to govern monetary relations among sovereign states. Based on a formally articulated set of principles and rules, the regime was designed to combine binding legal obligations with multilateral decision-making conducted through an international organization, the IMF, endowed with limited supranational authority.

Central to the Bretton Woods system was an exchange rate regime of ‘adjustable pegs.’ Countries were obligated to declare a par value (a ‘peg’) for their national money and to intervene in currency markets to limit exchange rate fluctuations within certain limits (a ‘band’); though they also retained the right, in accordance with agreed procedures, to alter their par value when needed to correct a ‘fundamental disequilibrium’ in their external payments. The IMF was created to assure governments of an adequate supply of financing, if and when needed, as well as to provide a permanent institutionalized forum for inter-state cooperation on monetary matters. International liquidity was to consist of national reserves of gold or currencies convertible, directly or indirectly, into gold–the so-called ‘gold exchange standard’–later supplemented by Special Drawing Rights (SDRs), a negotiated form of ‘paper gold.’ The main component of liquidity was the US dollar, the only currency at the time that was directly convertible into gold for central-bank holders.

The history of the Bretton Woods system is generally divided into two periods: the era of dollar ‘shortage,’ lasting roughly until the late 1950s, when world liquidity needs were fed primarily by deficits in the US balance of payments; and a subsequent period of dollar ‘glut,’ culminating in termination of the greenback’s gold convertibility in 1971 and collapse of the par value system in 1973. With the closing of Washington’s gold window, the gold exchange standard passed into history, to be succeeded by a polyglot collection of national currencies, gold and SDRs in the reserves of central banks. Likewise, with the end of par values, the exchange rate regime was transformed into a mixed bag of choices, some governments continuing to peg to a single currency like the dollar or to some form of ‘basket’ of anchor currencies while others opted for more flexible arrangements, up to and including free floating.

Some elements of the old system survived, of course–not least, the IMF itself, which has continued to perform vital roles as a source of finance and a forum for inter-state cooperation. Moreover, new albeit less formal mechanisms of monetary management gradually emerged to cope with subsequent threats to stability such as the oil shocks of the 1970s, the debt crisis of the 1980s and the financial market eruptions of the 1990s. Exchange rate policies remain subject to ‘multilateral surveillance’ by the Fund. Access to liquidity can still be secured, though without the degree of assurance promised at Bretton Woods. And new procedures for consultation and policy coordination have been developed and regularized, not only through the IMF but also in such now well established bodies as the Group of Seven (G-7) and the Bank for International Settlements (BIS). Still there is no question that, on balance, the system has become more decentralized and diffuse. As compared with the elaborate rule-based design laboriously negotiated at Bretton Woods, what has evolved since the early 1970s seems both less restrictive and more rudderless. In the eyes of some, it is little more than a ‘non-system’ bordering on anarchy if not chaos.

From Hegemony to ‘Privatization’

Dominating the evolution of international finance over the past half century have been two major trends in the distribution of influence over monetary outcomes. The first is a redistribution of power among states, principally involving a relative decline in the overwhelming pre-eminence once enjoyed by the United States. The second is a redistribution of power from states to markets, involving a relative increase in the role of non-state actors in deciding such fundamental matters as currency values or access to credit. Simultaneously, the system has become less hegemonic and more market-determined–less centralized and more ‘privatized,’ to recall an earlier phrase (Cohen, 1981, 1983). Together, these two trends have largely defined the research agenda for finance specialists in the IR field.

That US dominance of finance has declined, especially in relation to Europe and Japan, is widely accepted. Washington can no longer exercise quite the same degree of autonomy as during the era of dollar shortage, when the United States was effectively freed from all external constraint to spend as liberally as deemed necessary to promote national objectives. Other countries have also gained an influential voice on monetary matters. The only question is empirical: How much has US dominance declined? At one extreme is the view, particularly common in the 1970s and 1980s, that the day of American hegemony is irretrievably over. We are faced with the challenge of living in a world ‘after hegemony,’ wrote Robert Keohane in 1984 (Keohane, 1984). The United States, echoed Gilpin, ‘had forfeited its role of monetary leadership’ (1987: 142). At the other extreme are scholars like Strange, who even in her last books continued to maintain that the supposed loss of American hegemony was little more than a ‘myth’ ([1988] 1994, 1996, 1998). Most observers today would acknowledge that reality, as is so often the case, undoubtedly lies somewhere between these two polar views.

Likewise, that the role of non-state actors in finance has increased is also widely accepted. In fact, the transformation has been dramatic. A half century ago, after the ravages of the Great Depression and the Second World War, currency and credit markets everywhere (with the notable exception of the United States) were generally weak, insular and strictly controlled, reduced from their previously central role in the world economy to offer little more than a negligible amount of trade financing. Starting in the late 1950s, however, private lending and investment once again began to gather momentum, generating a phenomenal growth of cross-border capital flows and an increasingly close integration of national markets. While it is yet premature to speak of a single world financial market, it is by no means an exaggeration to speak of ‘financial globalization’–a genuine resurrection of global finance (Cohen, 1996). By the end of the century, the process had proceeded to the point where the authority of governments seemed directly threatened. Again the main question is how much? At a minimum states have been thrown on the defensive, no longer able to enforce their will without constraint. At a maximum states appear on the verge of total emasculation, with monetary sovereignty soon to be transferred in its entirety from national governments to ‘stateless’ markets. Here too we shall see that reality more likely lies somewhere in between.

Explaining State Behavior

Consider, first, the politics of financial relations between states. As in IR theory generally, it seems natural to start with governments, still the core unit in a Westphalian world. So long as national sovereignty remains the basic principle of world politics, as it has since the seventeenth-century Peace of Westphalia, the state will remain central to analysis, treated as an endogenous and purposive actor. Two broad sets of questions have traditionally been addressed by IR theorists. One has to do with actor behavior. What motivates government behavior in international affairs, and how is that behavior best explained and analyzed? The other has to do with system governance. What determines the standards for behavior in international affairs, and how do states manage (or fail to manage) their policy conflicts? Both sets of questions have been addressed in the finance literature as well, though with far more serious attention paid to the latter than to the former. Whereas discussions of monetary governance have made real contributions to the broader IR field, analysis of state motivations has tended to rely most heavily–and often simplisti-cally–on paradigms borrowed from others.

I begin in this section with the issue of actor behavior and take up system governance in the following section.

Levels of Analysis

In trying to understand state behavior, IR theory has long distinguished among three broad levels of analysis, each a general theoretical orientation in the rationalist tradition corresponding to one of Kenneth Waltz’s well-known images of international relations (Waltz, 1959). Most enduring is the familiar systemic level (or structural level) of analysis, analogous to Waltz’s ‘third’ image, which focuses on the constraints and incentives for policy associated with alternative global structures. Explanations, in Waltz’s terms (1979), are ‘outside-in,’ accounting for the behavior of individual states on the basis of attributes of the system as a whole. Next is the domestic level (or unit level), analogous to Waltz’s ‘second’ image, which addresses attention to the internal characteristics of states rather than to their external environment. Explanations are ‘inside-out,’ concentrating on the political and institutional basis at home for policy preferences abroad. And finally there is the cognitive level, analogous to Waltz’s ‘first’ image, which focuses on the base of ideas and consensual knowledge that legitimate governmental policy-making.

In earlier years, the most vigorous debates in IR theory were between various systemic and domestic approaches–in particular, between realism and its variants (neorealism, etc.) on the one hand, stressing the primacy of structural variables, and liberalism and its variants (neoliberal institutionalism, etc.) on the other, with their greater emphasis on unit-level considerations. More recently, as noted elsewhere in this volume, discourse has shifted to a newer debate between rationalist theories of all kinds (including both realism and liberalism)–labeled ‘neo-utilitarianism’ by John Ruggie (1999)–and constructivism, highlighting the role of first-image cognitive variables in shaping conceptions of identity and interest. Constructivism, as Ruggie (1999) points out, goes beyond neo-utilitarianism by asking not only what role ideational factors play in the policy-making process but also where ‘intersubjective beliefs’ come from and how they become transformed into ‘social facts.’ The IR field’s rich diversity of analytical approaches is well reflected in the finance literature, though more as consumer than producer. Alternative orientations have been borrowed wholesale from more general discussions of world politics, with few insights added to help resolve overarching meta-theoretical debates.

For many scholars writing on international finance, the temptation to simplify by ‘black-boxing’ the state, as in the traditional systemic-level approach of IR, has been overwhelming. This tendency is especially evident in studies of monetary diplomacy and negotiation, most of which derive their inspiration directly from the parsimonious logic of game theory and microeconomic analysis. For economists, nothing seems more natural than to treat the state as the equivalent of an atomistic firm, taking policy preferences as given in order to concentrate on the pivotal role of a small number of structural variables. Typical are the formal game models of Koichi Hamada (1985), which elegantly explore diverse aspects of policy strategy in a context of monetary interdependence. The same path has also been followed by many political scientists, albeit with more attention to institutional and historical detail. One example is Kenneth Oye’s (1986) study of monetary statecraft in the interwar period, which attributes much of the blame for the breakdown of great power cooperation in the 1930s to changes in the global financial structure. Another example is Vinod Aggarwal’s monumental survey of two centuries of international debt reschedulings, aptly titled Debt Games (1996), which focuses explicitly on structural characteristics of different ‘epochs’ to explain bargaining outcomes.

Only in the 1980s did a small number of scholars begin to open up the black box to explore in more systematic fashion where policy preferences might come from. Notable early contributions include studies of US international monetary policy by John Odell (1982) and Joanne Gowa (1983), both of which inter alia highlighted the role of domestic politics–inside-out explanations–to account for governmental behavior. Their lead has since been followed most prominently by Jeffry Frieden in a series of influential papers (e.g., 1991, 1994) exploring in more generalized terms the links between international finance and domestic interests. Varying degrees of capital mobility or different exchange rate regimes, Frieden argues, have a direct impact on the material interests of specific segments of society; in turn, distributional implications systematically shape group preferences and political coalitions affecting policy. The effect of interest groups or institutions on external monetary policy is now widely affirmed and figures prominently in a number of later studies, including Randall Henning (1994), Helen Milner (1997) and Beth Simmons (1994). All can be cited as evidence of the emerging synthesis of IR and the related fields of American politics and comparative politics that was suggested recently by Milner (1999).

Cognitive variables, on the other hand, have until recently played little formal part in the finance literature, perhaps because they are so difficult to operationalize for analytical purposes. As one recent source comments, ‘the role of ideas in monetary affairs … has not been sufficiently addressed to this point’ (Kirshner, 2000: 422). Odell, in his early study (1982), did stress shared ideologies and subjective perceptions as influences on America’s post-war monetary behavior. Likewise, more recently, John Ikenberry (1993) has highlighted the importance of ‘new thinking’ in helping to account for US and British agreement on the terms of the post-war monetary regime negotiated at Bretton Woods. Most suggestions, however, tend to be impressionistic at best, rarely backed by systematic testing or argument, and rest squarely in the neo-utilitarian tradition. Even less has constructivism, as a formal analytical approach, yet begun to enter the mainstream of research on financial issues. The most serious effort to date is by Kathleen McNamara (1998), who carefully explores the ‘currency of ideas’ as a driving force in the process of monetary integration in Europe.

Thus we are still very far from anything that might be described as a commonly agreed or standard theory of state behavior in international finance (just as we are still far from a standard theory of state behavior in general). Various influences at all three levels, as in the broader IR literature, are now typically acknowledged. But their relative utility and the relationships among them remain, to say the least, unclear. Most recent discussions, understandably wary of monocausal interpretations of motivation, rightly emphasize multiple factors but seem tempted to fudge, either by analyzing explanatory variables in sequence, highlighting one and then adding others to account for residual differences; or else by simply listing them more or less indiscriminately. What is needed is more effort to integrate the separate levels of analysis, with particular focus on underlying linkages and how and why they may change over time–perhaps along the lines of Robert Putnam’s ‘two-level game’ (1988) or the more elaborate frameworks proposed by Frieden and Rogowski (1996) and Garrett and Lange (1996) to analyze connections between economic internationalization and domestic politics. Formal unification of the three levels of analysis is a central epistemological challenge for all of IR theory, not just for monetary studies in particular.

Money and Power

Whatever motivates state behavior, policy is bound to be conditioned heavily by considerations of power. This is as true in finance as in any other aspect of international relations. The meaning of power, however, is no better understood in monetary scholarship than it is in the broader IR literature.

At its most general, power in international relations may be defined as the ability to control, or at least influence, the outcome of events. Two dimensions are important: internal and external. The internal dimension corresponds to the dictionary definition of power as a capacity for action. A state is powerful to the extent that it is insulated from outside influence or coercion in the formulation and implementation of policy. A common synonym for the internal dimension of power is ‘autonomy.’ The external dimension corresponds to the dictionary definition of power as a capacity to control the behavior of others; to enforce compliance. A state is also powerful to the extent that it can influence or coerce outsiders. Such influence need not be actively exercised; it need only be acknowledged by others, implicitly or explicitly, to be effective. It also need not be exercised with conscious intent; the behavior of others can be influenced simply as a by-product of ‘powerful’ acts (or potential acts). A useful synonym for the external dimension of power is ‘authority.’

Of most interest to students of international finance is the external dimension: the authority that one state can exert over others. Yet remarkably few scholars have even tried to explore monetary power in formal theoretical terms. As Jonathan Kirshner has noted, the topic is in fact ‘a neglected area of study’ (1995: 3). Kindleberger offered a few pioneering observations in his early essay on Power and Money(1970), followed a few years later by Cohen in Organizing the World’s Money (1977). Most influential to date have been Strange’s contributions in her first book, Sterling and British Policy (1971), and especially in States and Markets (1994).

For Strange, the key to authority in economic affairs lay not in tangible resources–territory, population and the like–but rather in structures and relationships. Who depends on whom, and for what? Power could be understood to operate at two levels, structural and relational. Relational power, echoing more conventional treatments in the IR literature, was the familiar ‘power of A to get B to do something they would not otherwise do’ ([1988] 1994: 24). Structural power was ‘the power to shape and determine the structures of the global political economy … the power to decide how things will be done, the power to shape frameworks within which states relate to each other’ ([1988] 1994: 24–5). Four key structures were identified: security, production, finance and knowledge. Of most relevance here of course is the financial structure: ‘the sum of all the arrangements governing the availability of credit plus all factors determining the terms on which currencies are exchanged for each other’ ([1988] 1994: 90).

Strange’s distinction between relational and structural power was critical, even inspired. In the crudest terms, one refers to the ability to gain advantage under the prevailing rules of the game, the other to the ability to create advantage by defining (or redefining) the rules of the game. Regrettably, though, there is little here that could be described as genuine theory, in the sense of a formal, systematic analysis of either the sources or the use of power at either level of operation. Strange’s approach was essentially taxonomic in nature. So too is Kirshner’s in his more recent Currency and Coercion (1995), which uses a wealth of historical material to catalog the diverse ways that money can be used in inter-state relations as an instrument of coercion. Theory calls for more than just a set of categories. The familiar challenge of theory is to provide reasonably parsimonious and well-specified set of propositions about behavior–statements that are both logically true and, at least in principle, empirically falsifiable. Neither Strange nor Kirshner meet that test. In this sense no true theory of monetary power may be said, as yet, to exist. Progress in meeting that challenge could make a contribution to power analysis well beyond the specific issue-area of finance.

System Governance

Reduced to its essence, governance is about rules–how rules are made for the allocation of values in society and how they are implemented and enforced. Rules may be formally articulated in statutes or treaties outlining specific prescriptions or proscriptions for action. Or they may be expressed more informally, as implicit norms defining behavioral standards in terms of understood rights and obligations. Either way, what matters is that they exercise some degree of authority: some degree of influence over the behavior and decisions of actors. The rules of the game rule.

And who makes the rules? In analytical discussions of monetary relations, two principles of governance have received the most attention. One is hegemony, a structure organized around a single dominant country with acknowledged leadership responsibilities (as well as privileges). The other is cooperation, a structure of shared responsibilities and decision-making. Here, unlike in discussions of actor behavior, the finance literature has been as much producer as consumer, providing insights of significance not only for students of monetary affairs but also for the study of world politics in general.

Hegemony

Of all the diverse theories that have captured attention in the IR field over the years, few have achieved the prominence, not to say notoriety, of the so-called theory of hegemonic stability–the familiar argument, as first summarized by Keohane, that ‘hegemonic structures of power, dominated by a single country, are most conducive to the development of strong international regimes whose rules are relatively precise and well obeyed’ (1980: 132). Specialists in finance can take a sort of pride in the fact that hegemonic stability theory found its first inspiration in the history of the monetary system. Writing after the breakdown of Bretton Woods, observant scholars like Kindleberger (1973) and Gilpin (1975) remarked on what seemed a striking correlation between great power dominance and financial stability both in the late nineteenth century, the era of the classical gold standard, and during the Bretton Woods period. The first period was led by Britain (a financial Pax Britannica), the second by the United States (a Pax Americana). Both Kindleberger and Gilpin found it reasonable to attribute causation to the relationship. Furthermore, given the apparent decline of US hegemony, it also seemed reasonable to fear a growing instability of monetary relations, possibly even a crash on the model of what happened in the interwar period. The basic argument has since been extended to address most other aspects of inter-state relations as well, political as well as economic, and has given rise to whole new areas of inquiry in IR, such as regime theory and theories of international cooperation and institutions. Yet for all its ubiquity, the proposition remains highly controversial–even in the issue-area of finance, where it was born.

The central issue is whether monetary leadership really matters all that much. The historical correlation noted by Kindleberger and Gilpin is a broad one that does not stand up well to detailed analysis, as Barry Eichengreen (1989) has ably demonstrated. Eichengreen considers separately the role of hegemony at three distinct stages in the evolution of an international monetary system–genesis, operation and disintegration–and compares three different experiences: the classical gold standard, the interwar period and Bretton Woods. What he finds is that ‘the relationship between the market power of the leading economy and the stability of the international monetary system is considerably more complex than suggested by simple variants of hegemonic stability theory’ (1989: 258). Hegemony appears to be neither necessary nor sufficient to explain the rise or fall of past financial orders.

But that is not the same thing as saying that hegemony thus matters not at all. Leadership is hardly inconsequential, as Eichengreen goes on to insist. Though the theory fails to explain all stages of each of the three experiences he examines, it is ‘helpful for understanding’ many of them (1989: 287). Moreover, other scholars continue to find a significant role for hegemony in diverse monetary arrangements, particularly at the regional level. Garrett (2001), for instance, makes a strong case for the leadership part that Germany played in bringing about agreement on the terms of Economic and Monetary Union (EMU) in Europe, embodied in the Maastricht Treaty of 1991. But for German initiative and concessions, it seems, the euro might never have been created. Along similar lines, Cohen argues, on the basis of a comparative historical study of monetary unions past and present, that local hegemony is a key determinant of whether an experiment like EMU, once established, is apt to prove sustainable over time (Cohen, 2001).

Such observations have led David Lake (1993) to offer a useful distinction between two different strands of hegemonic-stability theory: leadership theory, which builds upon the theory of public goods and focuses on the production of international stability, redefined as the ‘international economic infrastructure’; and hegemony theory, which seeks to explain patterns of international economic openness by focusing on national trade preferences. Only the former is directly relevant to the study of international finance where, following Kindleberger (1973), Lake summarizes the key components of the infrastructure that must be provided. These include first and foremost a stable medium of exchange and store of value as well as sufficient liquidity to support both short-term stabilization and longer-term growth. Recasting analysis in terms of public-goods theory is critical because it helps explain the diverse empirical findings of Eichengreen and others–why hegemony seems critical at some moments and yet neither necessary nor sufficient at other times.

The reason, by now well understood, is that there is nothing in public-goods theory that limits leadership to a single state. Infrastructure can also be provided collectively by so-called ‘privileged groups’ in Mancur Olson’s terminology (or ‘k’ groups, in Thomas Schelling’s terminology)–a point confirmed empirically by Eichengreen, who found that

even when individual countries occupied positions of exceptional prominence in the … international monetary system, that system was still fundamentally predicated on international collaboration. … The international monetary system has always been ‘after hegemony’ in the sense that more than a dominant economic power was required to ensure the provision and maintenance of international monetary stability. (1989: 287)

A narrow preoccupation with hegemony thus is really beside the point. The more basic question, as Lake suggests, has to do with the conditions that either facilitate or inhibit production of needed public goods, whether by one country or several. Future research, therefore, should concentrate on such issues as the cost of producing the different components of financial infrastructure and the efficacy of state power in negotiating and maintaining agreements. That is where the real challenge to system governance lies.

Cooperation

That brings us to the problem of cooperation, which has also attracted a great deal of attention from specialists in international finance. Here too money has been a particularly strong inspiration for broader theorizing about world politics; and here too much controversy remains to occupy future scholars.

In international finance as in the IR field generally cooperation among states is identified, following Keohane (1984), with a mutual adjustment of policy behavior achieved through an implicit or explicit process of negotiation. Practically speaking, cooperation may vary greatly in intensity, ranging from simple consultation or occasional crisis management to partial or even full collaboration in the formulation and implementation of policy. Cooperation may also take many forms, ranging from informal ‘networks of bargains’ of the sort envisioned by Strange ([1988] 1994) to the more formally structured procedures of bodies like the G-7 or IMF. Whatever its intensity or form, the key to cooperation is shared responsibility and decisionmaking. Related terms such as ‘coordination’ or ‘collaboration’ may be treated as essentially synonymous.

The theoretical case for monetary cooperation is clear. In financial relations, any one government’s actions can generate significant ‘spillover’ effects–foreign repercussions and feedbacks–that may influence its own ability, as well as that of others, to achieve preferred objectives. That will be true whether the policies at issue involve interest rates or exchange rates, international lending or external debt. The result of these ‘externalities’ is ‘market failure’–a situation where policies that are chosen unilaterally, even if seemingly optimal from the individual country’s point of view, will almost certainly turn out to be sub-optimal globally. Decision-making becomes inextricably enmeshed in a context of strategic interdependence. The basic rationale for cooperation is that it can correct the market failure by internalizing the externalities. If each government can claim a degree of control over the behavior of others, it is possible to move policy collectively closer to what might be considered a Pareto optimum. In other words, everyone potentially can gain from an outward movement toward the Pareto frontier. Nowhere has the case for monetary cooperation been developed so forcefully as in the formal models of Hamada (1985) cited earlier. Using a methodology borrowed directly from game theory, Hamada makes a persuasive case for the mutual benefits of overt policy coordination.

The practical impediments to monetary cooperation, however, are equally clear. Much attention has been devoted, by economists and political scientists alike, to explaining why incentives for collaboration may be diluted in the real world, even among rational policy-optimizing governments. On the economics side, several factors have been cited.7 First, in practical terms, potential gains might be too small, or the costs of coordination too large, to make the effort seem worthwhile. Second is the so-called time-inconsistency problem: the chance that agreements, once negotiated, will later be violated by governments tempted by changing circumstances to renege on their commitments. Among sovereign states, compliance mechanisms are by definition imperfect at best. And third is the possibility, quite serious in the opinion of many, that cooperation might actually prove to be counterproductive, shifting countries away from rather than toward the Pareto frontier. One possibility is that governments may choose policies that are more politically expedient than economically sound. In an early and influential article Kenneth Rogoff (1985) pointed out that formal coordination of monetary policies could, perversely, lead to higher inflation if authorities all agreed to expand their money supplies together in order to escape the external payments constraint that would discipline any country trying to inflate on its own. Another possibility is that officials may simply not understand how their policies operate and interact. In a more recent study, Keisuke Iida (1999) found much evidence to suggest that the principal cause of counterproductive cooperation is ‘model-uncertainty’–the difficulty of making firm cause–effect inferences about highly contingent events.

Political scientists, on their side, focus on the time-inconsistency and expediency issues and ask why governments might cheat on commitments or might seemingly jeopardize their own best interests. At the systemic level, the main question is whether governments are more interested in absolute or relative gains–the familiar debate kicked off by Joseph Grieco’s notorious neorealist attack on neoliberal institutionalism (Grieco, 1988). Are states primarily concerned with market failure or with distributional conflicts? In reality, it is most likely that they worry about both. As Stephen Krasner (1991) has noted, the challenge of cooperation is twofold: not just to reach the Pareto frontier but also to choose some mutually satisfactory point along that frontier, an issue that cannot be easily resolved in a world of many jealous ‘defensive positionalists.’

At the domestic level, the main question is how interest groups and institutional structures interact to determine policy preferences and strategies. Politics at home will influence not only the willingness of governments to enter into commitments abroad but also their ability to abide by such agreements over time. Putnam and Henning (1989) make a critical distinction between voluntary and involuntary defection. In practice, even if policy-makers rationally calculate that it is not in their interest to abandon Pareto-optimizing cooperation (voluntary defection), they may none the less be forced to do so because of resistance by key domestic actors (involuntary defection). Conversely, following Rogoff’s logic, it is also possible that dominant interest groups might exploit the process to promote particularist or even personal ambitions at the expense of broader collective goals.

How, then, can productive monetary cooperation be promoted? For many, the solution lies in the creation of international organizations with the capacity to constrain and shape behavior by facilitating agreements and enforcing rules. That was what governments had in mind at Bretton Woods when they created the IMF; and it is of course what others have in mind today when they call for something more or less approximating a world central bank. In practice, however, it has never been clear to what extent any international organization may realistically be regarded as an autonomous actor rather than simply a forum for the playing out of inter-state politics. The Fund is a case in point. The IMF plainly does exercise supranational authority over at least some of its members, by determining access to credit and by the policy conditions attached to its loans. But the question remains: Where does that authority come from, and on whose behalf is it exercised? One view, long espoused by radical analysts such as Cheryl Payer (1974), holds that the Fund is little more than a crude instrument for advancing the interests of its most powerful members. Formal evidence to support that view has recently come from Strom Thacker (1999), who finds that a key determinant of access to IMF credit appears to be a country’s political relationship with the United States, the Fund’s largest power. A more subtle view, best represented by the work of Louis Pauly (1997, 1999), sees the IMF as a promoter of behavioral norms reflecting a consensus of views among its stronger participating governments. The risk, according to Pauly, is that if this norm structure is then imposed upon the weak, even though they have little role in its design, the political legitimacy of the Fund will eventually be eroded, impeding rather than promoting cooperation. But as insightful as these contributions may be, we still do not have a satisfactory answer to the question. Miles Kahler gets it right when he writes that as an agent of rule enforcement, ‘the role of the IMF … remains unclear’ (1995: 49). Much room yet remains for research on the Fund’s role, or that of related bodies, in governance of the monetary system.

A more practical solution to the cooperation issue, as Martin and Simmons (1999) emphasize in an important discussion, lies in finding some way to agree on rules that can become effectively self-enforcing. A key is provided by Arthur Stein’s (1990) critical distinction between what he calls ‘dilemmas of common aversions’ and ‘dilemmas of common interests.’ Dilemmas of common aversions, otherwise known as coordination games, exist when all actors share a concern to avoid a particular outcome. The only question is how to establish a common ‘norm,’ or focal point, around which behavior may coalesce. Beyond agreeing to play by some standard set of rules (for example, driving on the right-hand side of the road), no compromise of underlying preferences is called for. This is in contrast to dilemmas of common interests, so-called collaboration problems, where reciprocal concessions are indeed required to avoid sub-optimal outcomes. Cooperation in such situations will obviously be more difficult to achieve or sustain.

Happily, in many dimensions of international finance, states do find themselves confronted more with common aversions than with fundamentally divergent interests. This is especially true in such matters as supervision and regulation of financial markets, where effective cooperation has indeed proved feasible (Kapstein, 1994; Porter, 1993; Underhill, 1995). Moreover, even in more conflictual situations, the temptation to behave selfishly in the short term will be tempered by the fact that governments must factor in potential consequences over the longer term–the long ‘shadow of the future,’ which puts a premium on considerations of reputation and credibility. As Martin and Simmons remind us, ‘repetition transforms collaboration problems into coordination problems’ (1999: 105). Separately, Simmons (2000) has demonstrated empirically the degree to which reputational concerns appear to encourage governments to comply with their legal commitments under the IMF’s Articles of Agreement.

The real challenge, therefore, would seem to be to find ways to construct focal points on which all states can agree, even where preferences might otherwise be expected to conflict–standard rules that would serve the role of the international infrastructure spoken of by Lake. How to construct relevant focal points, in practical political terms, was the implicit agenda of the old theories of international regimes that flourished in the 1980s. It is also the intent of the newer theories of international institutions that emerged in the 1990s, which explicitly address the issue of how to make agreements not only mutually acceptable but also sustainable. Martin and Simmons (1999) list a number of ways in which institutions can be structured to ‘lock in’ patterns of cooperation. The IMF provides only one possible model among many. The task for students of international finance, relatively neglected until now, is to look seriously at how the Fund or other multilateral organizations might be reformed with these specific principles in mind, in order to produce the public goods needed for effective governance of money and credit.

States and Markets

Complicating analysis, of course, is the fact that in finance, as in every area of political economy, states are not the only actors involved. Governments must contend not only with each other but also with markets–more specifically, with the myriad of non-state actors that make up the increasingly integrated markets for currency and credit across the globe. Recent decades, as indicated, have witnessed a remarkable revival of global finance, which in turn has directly challenged the authority and capacity of state actors to manage monetary affairs. Capital mobility has soared, and national financial markets have become integrated to a degree not seen since the end of the nineteenth century–all part of the wider trend toward globalization of international affairs that has become a cliché of the IR literature. Theory, however, has yet to catch up with the implications of these developments for world politics and the nature of the international system.

As in the more general IR literature, three core questions are suggested. The first has to do with causes: How did financial globalization happen? The remaining two have to do with consequences–first, for individual countries; and second, for the structure and operation of the state system as a whole. All three questions have been hotly debated in the second generation of international finance scholarship, with answers that hold promise of contributing to broader discussions of the globalization phenomenon.

Causes of Financial Globalization

What has caused the dramatic revival of global finance since the Second World War? Clearly at the center of the process is government policy: a gradually accelerating trend toward deregulation and liberalization of markets, in advanced industrial countries and developing economies alike. But what accounts for this conduct? A wide variety of explanations have been offered in the literature, with little consensus overall. Hypotheses generally break down along the lines of the three traditional levels of analysis of actor behavior in IR theory.

At the systemic level, two classes of causal interpretation can be identified, stressing the contrasting roles of market forces and state rivalries. The first class, with roots in standard neoclassical economics, points to the powerful effects of competition and innovation in the financial marketplace–particularly advances in communications and information technologies–that have literally swept away institutional barriers to market integration and the free flow of capital. This approach, not surprisingly, is the personal favorite of most economists. Typical is Ralph Bryant, a well known international monetary specialist, who confidently asserts that ‘technological nonpolicy factors were so powerful … that they would have caused a progressive internationalization of financial activity even without changes in government separation fences’ (1987: 69). On the political-science side the case has been put most firmly by David Andrews (1994), who emphasizes both the degree to which increases in capital mobility appear to have taken place independently of changes in state regulatory frameworks and also the degree to which liberalization at the national level has seemingly occurred in response to market pressures at the systemic level.

The second class of systemic explanations, more consistent with rationalist traditions in IR theory, stresses the determining role of policy rivalry among national governments, each calculating how best to use its influence and capabilities to promote state interests in an insecure world. A prime example is provided by Eric Helleiner (1994) in an admirably detailed historical study. Rejecting interpretations that highlight ‘unstoppable technological and market forces rather than state behavior and political choices,’ Helleiner contends that ‘the contemporary open global financial order could never have emerged without the support and blessing of states’ (1994: vii, 1). Most pivotal, in his view, was a process of ‘competitive deregulation’ by governments maneuvering unilaterally to attract the business of mobile financial traders and investors. From the 1960s onward, inter-state rivalry was reinforced by policy initiatives from the two leading monetary powers of the day, the United States and Britain, both with a strong interest in promoting a more open financial system.

At the domestic level, emphasis is placed on constituency politics–inside-out explanations of government behavior rather than outside-in. Representative is Andrew Sobel who, focusing on industrial countries, highlights ‘competition between organized interests within domestic political economies’ (1994: 16) as the driving force behind financial globalization. ‘The primary motivation for regulatory change rests within the domestic political economy,’ he asserts. ‘The international outcome is solidly rooted in domestic policy dilemmas and distributional debates’ (1994: 16, 19). A parallel argument is offered by Haggard and Maxfield (1996) to explain liberalization in developing countries, stressing the effects of increased economic openness on the preferences and capabilities of policy-relevant economic interests. Expanding foreign trade and investment ties, they argue, ‘increase interest group pressures for financial internationalization … while decreasing the effectiveness of government controls’ (1996: 214). Both sources place particular emphasis on the pivotal role of large financial intermediaries, corporate borrowers and institutional investors.

Finally, at the cognitive level, attention is directed to the part played by belief systems and consensual knowledge as catalysts for policy change. Helleiner (1994) himself, even while stressing structural factors and inter-state rivalries, acknowledges as well the possible importance of the dramatic ideological shift that has occurred in so many countries, from Keynesian activism to a more permissive neoliberal framework. Central has been a gradual loss of faith in the efficacy of capital controls as a conventional instrument of public policy, despite much evidence and argument to the contrary (Bhagwati, 1998). Andrews, similarly, speaks of the critical role of ‘widely shared ideological commitments’ and ‘mindsets’ (1994: 200–1)–a constellation of views labeled by Philip Cerny (1993) the new ‘embedded financial orthodoxy.’

Out of this variety of interpretations, however, no common view has emerged to account for the globalization trend–confirming once again how far we remain from anything that might be described as a standard theory of state behavior in international finance. To what extent might the three levels of analysis be linked? The possibility of interactions between explanatory variables is occasionally acknowledged but only rarely explored systematically. One exception is Cerny, who directly ties the widespread embrace of ‘embedded financial orthodoxy’ to competitive pressures at the systemic level which, in his words, have ‘undermined the structures of the Keynesian state’ (1993: 80). Another is Stephen Gill (1995), who stresses what he sees as the conjoined role of neoliberal ideology and the influence of dominant class interests in driving national policies. But to date these remain relatively isolated contributions. In this context as in other dimensions of world politics, there is still a need for more systematic effort to link and integrate the separate levels of analysis.

Consequences for States

Even less consensus exists concerning the consequences of financial globalization, whether for individual countries or for the state system as a whole. That governments are challenged by the rising tide of capital mobility is undoubted. But questions remain about how serious the challenge is or what, if anything, policy-makers may be able to do about it. At issue is the task of governance: the respective roles of states and markets in the management of monetary affairs. Research is only beginning to sort out the nature of the evolving state–market relationship in international finance.

From the perspective of individual countries, the core issue is best summarized by what has elsewhere been labeled the ‘Unholy Trinity’ (Cohen, 1993)–the fundamental incompatibility of the three desiderata of exchange rate stability, free movement of capital and autonomy of national monetary policy. The logic of the Unholy Trinity is based on the so-called Mundell–Fleming model, long familiar to economists, which Paul Krugman has called the ‘standard, workhorse model’ of open-economy macroeconomics (1993: 2). Reduced to its essence, the model asserts that states are faced with a stark trade-off. In an environment of pegged exchange rates and integrated financial markets, a government loses all control over domestic money supply and interest rates. To regain monetary autonomy, policy-makers must either sacrifice currency stability (that is, float) or limit capital mobility (via capital controls of some kind). Governments unwilling or unable to do either must learn to live without an independent monetary policy, raising serious questions of political legitimacy (Cohen, 1998; Pauly, 1995; Underhill, 1995).

Given the stringent logic of the Unholy Trinity, it is not surprising that as capital mobility has increased, so too has concern about its implications for governmental authority. Strange set the tone of debate with her vivid denunciations of Casino Capitalism (1986) and Mad Money (1998). For her, as for many others inspired by her (Cerny, 1993, 1994b; Gill and Law, 1989), global finance has become something akin to a structural feature of world politics: an exogenous international attribute that, very much in the spirit of realist or neorealist IR theory, systematically constrains state behavior, rewarding some actions and punishing others. The ever-present threat of capital flight creates irresistible pressures for a convergence of national policies. Andrews calls this the Capital Mobility Hypothesis (CMH): ‘The central claim associated with the capital mobility hypothesis is that financial integration has increased the costs of pursuing divergent monetary objectives, resulting in structural incentives for monetary adjustment’ (1994: 203).

The CMH underlies the conclusion of Goodman and Pauly, in a notable discussion of financial liberalization, that ‘systemic forces are now dominant in the financial area and have dramatically reduced the ability of governments to set autonomous economic policies’ (1993: 81). It also underlies the work of Michael Webb (1995), who examines monetary coordination in the Group of Seven. The nature of cooperation by G-7 governments, Webb observes, changed greatly after the end of the Bretton Woods period. Whereas, previously, collaboration consisted mainly of ‘external’ measures designed to manage payments imbalances generated by incompatible national policies, more recently the focus has turned ‘internal’ to address national policies themselves–a significant increase in the depth of the coordination process. The reason for the shift, Webb argues, is nothing other than the great increase of international capital mobility. Financial globalization has intensified cooperation by making it more difficult for individual governments to pursue substantially divergent monetary or fiscal policies.

Is the CMH correct? There is nothing wrong with its reasoning, of course, just as there is nothing wrong with the fundamental logic of systemic theories more generally. Global finance clearly has become a significant structural constraint on the ability of states to control activities within and across their borders–what Krasner (1999) calls their ‘interdependence sovereignty.’ Capital mobility effectively limits the range of choice available to governments by altering the relative costs and benefits of alternative policy options. At one level, the constraint operates through the effect of globalization on the allocation of credit. Privatization of international finance means, in the words of Randall Germain, that ‘private monetary agents, organized through markets, [now] dominate the decisions of who is granted access to credit and on what terms’ (1997: 163). Both Maxfield (1997) and Sobel (1999) document the extent to which governments today feel compelled to tailor their policies to the preferences of international lenders. At a second level, the constraint operates through effects on the balance of payments. Openness of the capital account affords investors the option of exit whenever governments’ behavior fails to live up to their expectations. In effect, financial markets operate as a sort of perpetual opinion poll–a kind of ‘automatic, nonpolitical system for grading [policy] performance,’ as one source puts it (Meigs, 1993: 717). There is in fact no lack of anecdotal evidence to buttress the CMH’s view of global finance as a structural feature of world politics, albeit one that tends often to be both late and exaggerated in its evaluations of policy behavior.

None the less it is clear that the proposition, like broader systemic theory, is really something of a simplification. Upon reflection, in fact, the CMH has come to be seen as little more than a caricature, an initial over-reaction to the revival of global finance that seriously misrepresents the true degree of the challenge to governments today. It is one matter to suggest that states can no longer (if they ever could) ignore the signals of the marketplace, but quite another to suggest that, as a result, public officials have been wholly deprived of their capacity to make and implement policy. As thinking about the CMH has been refined, it has become clear that the discipline imposed on governments by mobile capital is rather less than first imagined, for at least three reasons. All three factors provide grist for the mill of future research.

First is the fact that national financial markets remain very far from fully integrated internationally, despite the unmistakable increase of capital mobility in recent decades (Simmons, 1999). This is certainly true of markets for equities, which have always tended to be sharply segmented. It is also still true, albeit to a lesser extent, of most long- and even short-term debt instruments, which even today remain imperfect substitutes due to differing currency denominations and country risk factors. The Mundell–Fleming model, strictly speaking, holds only for a world of perfect capital mobility. Insofar as borders and currencies continue to be impediments to trade in financial claims, governments will retain some room for maneuver to pursue independent monetary targets.

Researchers have only begun to develop useful measures of financial openness in today’s increasingly globalized marketplace. Some rely on indirect behavioral indicators–such as interest-parity relationships, estimations of capital costs, or savings-investment correlations–while others focus more directly on existing restrictions on capital movements (Haggard and Maxfield, 1996; Quinn, 1997). All the evidence to date confirms the persistence of significant limitations on international investment flows, albeit with much variation across countries and across different categories of capital. In the future, more work will be needed to extend these diverse measures of integration to differentiate among various types of flows that may be more or less sensitive to government policy choices. As Sylvia Maxfield (1998) points out, investor motivations tend to vary considerably, suggesting that different classes of market actors will constrain states in different ways. Monetary policy may yet be effective depending on the composition of cross-border movements of capital.

Second, it is important to recall that, even within the tight limits of the Unholy Trinity, governments still have choices. In principle, trade-offs remain possible between monetary autonomy, on the one hand, and currency stability or financial openness on the other. Even if capital flight does develop, policy-makers need not abandon their domestic targets–not so long as they are willing, in practice, to consider instead the alternative options of either floating or some variety of capital controls. The question, presumably, involves calculations of relevant gains and losses, political as well as economic. Here too research has only begun to provide useful insights.

One strand of the literature concentrates on the choice between fixed and flexible exchange rates. Earlier discussions, dominated mainly by economists, naturally focused on implications for economic welfare of alternative currency regimes, using the familiar theory of optimum currency areas as a guide (Cohen, 1998: 62–3). More recent studies stress straightforward political considerations grounded in domestic politics and institutions. For some analysts, working the vein pioneered by Frieden (1994), what matters most are interest-group preferences and pressures on policy-makers. Producers of internationally traded goods and international investors, for instance, might be expected to prefer stable exchange rates, while producers of non-tradables and labor unions are more likely to favor flexible rates because of the leeway provided for an autonomous monetary policy. A prime example of this approach is provided by Thomas Oatley (1997), who explains currency cooperation in the European Union during the 1970s and 1980s mainly in terms of partisan conflict and capital–labor struggles over the distribution of income. Though the CMH correctly highlights general systemic pressures for convergence, Oatley contends, it is unable to account for the specific choices that individual governments made in attempting to stabilize exchange rates.

For other analysts, it is more a question of the structural characteristics of politics at work. Research along these lines has concentrated in particular on developing economies. Sebastian Edwards (1996, 1999a), for instance, considers a government’s traditional ability to finance its own expenditures via the printing press, otherwise known as seigniorage. The seigniorage privilege, Edwards notes, tends to be most attractive to states plagued by unstable or divided polities, where tax collection is difficult. Yet a government’s ability to support spending via money creation clearly depends on maintenance of an autonomous monetary policy, which is easiest when the exchange rate is allowed to float. Consistent with these observations, he finds empirically that resistance to pegging tends to be greatest in states with a high degree of political instability. Similarly, David Leblang (1999) demonstrates a close relationship in developing countries between exchange rate choices and domestic political institutions. Floating rates are more likely in democratic than authoritarian polities; and in democratic polities, are more likely in systems of proportional representation than in majoritarian electoral systems.

The importance of domestic structural variables is also affirmed for industrial countries in a study by Bernhard and Leblang (1999) stressing the persistent tension governments face between promoting credibility of policy and preserving flexibility for policy-makers (the rules vs. discretion issue). In this context domestic political institutions, particularly electoral and legislative arrangements, can be expected to play a critical role in shaping policy incentives. Statistical analysis suggests that in systems where the cost of electoral defeat is high and electoral timing is exogenous, politicians tend to be less willing to forgo discretion over monetary policy by choosing a fixed exchange rate. In an alternative approach, stressing the interchangeability of fixed exchange rates and an independent central bank as ‘monetary commitment mechanisms,’ Lawrence Broz (2000) finds, like Leblang (1999), that floating rates (with an independent central bank) are more likely in democratic polities and fixed rates more likely in autocracies.

Another strand of the literature, meanwhile, addresses the option of capital controls as a means to improve monetary independence. Why should governments tie one hand behind their back, it is asked, when by restoring some kind of limits on financial flows they might gain more leverage over domestic monetary conditions? For many analysts, the notion of capital mobility as a structural constraint is a red herring that unavoidably obscures the still powerful role of states in setting the parameters of market activity. What states have created, via deregulation and liberalization, they might also reverse if they so choose. The view has been promoted most vigorously by Helleiner (1996, 1999), who argues that since ‘financial globalization [was] heavily dependent on state support and encouragement. … a reversal of the liberalization trend is more likely than is often assumed’ (1996: 193–4). Others, however, attack the implication, insisting instead on a kind of hysteresis in financial markets, owing in particular to the inexorable advance of technology which, in Cerny’s words, ‘allows the markets to stay ahead of the regulators’ (1994a: 326). Says Cerny, bluntly: ‘Financial globalization has become irreversible’ (1994b: 226). Reality, once again, most likely lies somewhere between, depending on how governments reckon the costs, economic or political, associated with any attempt to reduce capital mobility–what Frieden and Rogowski call the ‘opportunity cost of economic closure’ (1996: 33). This issue too is rightly attracting increasing attention from specialists.

Finally, we must not forget fiscal policy–the state’s own budget–which is also available to governments to carry out their objectives. The trade-offs imposed by the Unholy Trinity involve only monetary policy; and as the original Mundell–Fleming model made clear, the implications of alternative combinations of currency regime and capital mobility for the effectiveness of each of the two types of policy are really very different. The same conditions that erode the effectiveness of monetary policy–fixed exchange rates and integrated financial markets–actually strengthen the impact of fiscal policy on macroeconomic performance. What governments cannot achieve via the money supply and interest rates, they can, in principle, attain via changes of public spending and/or taxation. Conversely, with floating exchange rates and capital mobility, it is monetary policy that gains leverage while fiscal policy is weakened.

Early formulations of the CMH tended to blur the distinction between monetary and fiscal policy, speaking simply (and simplistically) of ‘the declining authority of states’ (Strange, 1996: 4). Only recently have studies begun to differentiate more clearly between the two in order to highlight how much capacity still remains for public officials to exercise practical influence, depending on circumstances. Both William Clark and colleagues (Clark and Hallerberg, 2000; Clark and Reichert, 1998) and Oatley (1999) find evidence that while governments remain as motivated as ever to intervene in the economy for partisan or electoral purposes, the choice of policy instrument appears very much a function of the exchange rate regime. Fiscal policy is actively used when the exchange rate is fixed, and monetary policy when currencies are floating, just as the Mundell–Fleming model would predict. Parallel empirical studies (Garrett, 1998, 1999; Mosley, 2000; Rodrik, 1997) reinforce the impression that even with a high degree of capital mobility, fiscal policy remains a potent tool for the implementation of purposive political programs, at the microeconomic as well as the macroeconomic level. Further research should clarify other conditions conducive to an effective fiscal policy.

For all three reasons, therefore, the CMH as originally formulated must be treated with caution. Much like broad systemic theory, it is a useful starting point for thinking but hardly the last word. The world is actually a good deal more complex than the proposition suggests–more nuanced, more ambiguous and certainly more contingent. As Garrett concludes: ‘There are good reasons to believe that the policy constraints generated by [market integration] are weaker and less pervasive than is often presumed’ (1999: 165). Specialists in international finance have made considerable progress in analyzing the true nature of globalization’s challenge for governments, with lessons that should prove useful to students of IR more generally. None the less, much work remains to be done before we can claim to fully understand the consequences of financial globalization at the state level.

Systemic Consequences

The same is also true at the systemic level, where the implications of globalization seem even less well understood. Students of IR sense that something significant may be happening as markets and societies become increasingly integrated, transcending the frontiers of the traditional territorial state–something fundamental to the structure and operation of world politics. But what, precisely? Central, once again, is the issue of governance: a growing disjuncture between a political system based on sovereign territory and a world economy that is increasingly global in scope. Who (or what) makes the rules? Are governments still in charge, or markets, or perhaps no one at all? Here too opinions divide sharply, no less among specialists in international finance than in other areas of IR.

Perhaps most extreme is the view expressed by Strange in her penultimate book, The Retreat of the State (1996), where she argued that the erosion of state authority had already gone so far that it had, in effect, left no one in charge. In her words: ‘At the heart of the international political economy, there is a vacuum. … What some have lost, others have not gained. The diffusion of authority away from national governments has left a yawning hole of non-authority, ungovernance it might be called’ (1996: 14, emphasis added). But such a bold claim, while not uncommon, is based on a serious misconception of the meaning of authority in social relations. Though authority is inseparable from power, in the sense of influence over outcomes, it is in fact quite separable from the state, which is by no means the only agent capable of making and enforcing rules. Governance can also originate in a variety of other social institutions, some of which may be far less visible to the naked eye than the formal offices of the sovereign state–‘governance without govern ments,’ to use an increasingly popular phrase (Rosenau and Czempiel, 1992). Thus the ‘retreat of the state,’ such as it is, does not necessarily mean that a ‘vacuum’ of ‘ungovernance’ has been created. Allegations about Mad Money notwithstanding, the fact is that much order remains in the monetary system, as in other dimensions of world politics–too much order to suggest that we are condemned to nothing more than a ‘yawning hole of non-authority.’

What more is there? Three distinct perspectives can be distinguished in the finance literature, each with its own champions. Some analysts (e.g., Porter, 1996), concurring with Helleiner (1996, 1999), point to the still powerful role of the state, all appearances to the contrary notwithstanding. The ‘retreat of the state,’ it is contended, is more illusion than reality. Global finance operates at the tolerance of governments and is no more a threat to state authority than governments, collectively, permit it to be. As Pauly puts it: ‘Capital mobility constrains states, but not in an absolute sense. … States can still defy markets’ if they wish (1995: 373). The argument takes us back to the problem of intergovernmental cooperation and the challenge of constructing the public goods needed for effective management of money and credit. States can still make the rules if they are able to agree among themselves on the needed infrastructure.

For others, by contrast, more persuaded of the basic validity of the Capital Mobility Hypothesis, appearances are indeed reality. The state really has retreated, and in its place markets now rule. The only question, in this perspective, is how that dominion is effectuated. Some studies speak abstractly, if obscurely, of market structures reified as a distinct principle in opposition to traditional state authority. Cerny, for instance, describes a ‘new hegemony of financial markets’ (1994a: 320)–a ‘transnational financial structure’ (1994b: 225) that reduces governments to little more than rivals for market favor. This is Cerny’s notion of the competition state, struggling to make itself as attractive as possible to international investors. Likewise, Germain talks of an increasingly decentralized ‘international organization of credit [that] has robbed the international monetary system of a single dominant locus of power’ (1997: 26).

Insightful though these arguments may be, however, they remain too vague about who or what actually exercises authority–about agency, in contrast to structure–to provide much guidance for practical analytical purposes. More useful are discussions that emphasize specific groups of market actors capable of exercising effective authority in their respective spheres of activity. An early example is provided by Timothy Sinclair (1994a, 1994b), who highlights the role of credit-rating agencies in the management of offshore lending markets. Another comes from Virginia Haufler (1997), who describes how insurance firms have historically been able to create private regulatory regimes for international risks insurance and reinsurance. Systematic study of the role of private authority in international affairs is just beginning (Cutler et al., 1999).

Finally, there is a third perspective, which stresses neither states nor markets alone but rather both, acting together to make the rules and set standards for behavior. Why treat the public and private sectors as necessarily in opposition to one another? one may ask. Instead, why not seek to understand how authority might be exercised by the two sides jointly in various hybrid combinations? That is the underlying logic of the newly fashionable concept of Global Governance, which over the past decade has attracted increasing attention from IR scholars, particularly in Europe. As a recent survey puts it, Global Governance ‘offers one way beyond [a] dualistic and restrictive perspective on globalization … [It] highlights a shifting of the location of authority in the context of both integration and fragmentation’ (Hewson and Sinclair, 1999: 4–5). It is also the logic of scholars like Wolfgang Reinecke, who call for a new Global Public Policy, in the sense of new forms of governance that ‘decouple the operational aspects of internal sovereignty (governance) from its territorial foundation (the nation-state) and its institutional environment (the government) … Traditional lines of demarcation between the public and the private spheres are not only being redefined but becoming increasingly blurred’ (Reinecke, 1998: 8–9).

Applications of this third perspective are just starting to enter the literature of international finance. Among the first was Geoffrey Underhill (1997, 2000), who contended that states and markets are best seen ‘as part of the same, integrated ensemble of governance, not as contrasting principles of social organization’ (2000: 4). Another example is Cohen’s The Geography of Money (1998), where he argues that the accelerating growth of cross-border competition among currencies–a phenomenon described as the ‘deterritorialization’ of money–has created a new structure of monetary governance comprised of private and public sector actors alike, ‘interacting together … in the social spaces created by money’s transactional networks’ (1998: 5). More work along these lines would surely be useful. As we look to the future of political-economy research on financial issues, there is much to be said for an analytical approach that moves beyond the ‘either/or’ of traditional treatments of the state–market relationship.

Conclusion

Scholarship in international finance has obviously come a long way over the past third of a century. The first generation of research taught us much about the motivations of state behavior and the opportunities and limitations of intergovernmental cooperation; the second, in turn, has greatly illuminated implications of the revival of global finance for state capacity and the management of monetary affairs. Yet it is equally clear that much remains to be done to gain a full comprehension of developments in this critical issue-area of world politics. After the thesis of state-centrism and the antithesis of market forces, a new synthesis seems needed–a new generation of research exploring in detail just how it is that states and markets interact in practice and how their relationship reacts and evolves over time. Finance has by no means exhausted its challenges for students of IR theory.