Slouching Towards Liberalization

The Economic Government of the World, Martin Daunton, 2023 (Pt.II).

All the Tired Horses in the Sun, T.C Cannon, 1972

This week’s review isn’t written by me, but by my friend the very sharp Samuel Thorpe. A couple of weeks ago Sam and I realised that, by sheer coincidence, we both happened to be reading and thinking about Daunton at the same time. So I asked him whether he would be willing to write the ‘second half’ of this review, and Sam generously obliged.

Sam has also kindly written the supplemental post to the review, which is free to read this week. Not only does it cover some interesting recent research, it also gives a glimpse into Sam’s fascinating work with Rex Hsieh, Bill Gale, and Laura Kawano on heterogeneity in the effects of corporate taxes—so absolutely worth a read. Sam has recently launched his own substack, which you can check out below—I highly recommended you subscribe. While I don’t know what, when, or how often he will be writing, I promise it will be worth your time.

- Angus

Kicking things off

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The second half of Martin Daunton’s The Economic Government of the World opens in 1949. This was a year marked by several themes: the growing success of the Marshall Plan, the failure of the ITO, and the solidification of both Cold War battle lines and the Bretton Woods system. The two decades which followed are perhaps the only era in which one can speak of national governments and international organizations governing the global economy in the fullest sense of the word.

Yet by the early 1970s, this system of governance had begun to collapse. In 1973, Jeremy Morse, director of the Bank of England and chair of the C20—one of the many international organizations attempting to bring a negotiated settlement on international monetary affairs to the post-Bretton Woods world—is quoted by Daunton describing his meetings as “the end of the post-war idea that everything could and should be managed.” Not only had Bretton Woods failed, but the myriad attempts to build a successor had each failed in turn.

What caused this transformation? In addition to the conventional story—that the growth of structural imbalances, along with international business and currency markets (especially the Eurodollar market), made it increasingly challenging to manage currencies or capital flows in a coherent way¹— Daunton suggests at least three further causes. First, the balance of political and economic power shifted from 1944, when the United States and United Kingdom held almost complete authority to dictate the terms of agreements on international economic policy, to the early 1970s, when no power or group of powers was equipped to dictate terms. Second, the American decision in the 1940s to prevent Bretton Woods from including a forced adjustment for creditor nations—at the time favoring the United States—backfired by the 1970s, when it was Germany and Japan that had accumulated persistent surpluses and refused any plan for international monetary cooperation that would have obliged governments to reduce them. Third, the United States simply lost interest in international monetary leadership over this period, particularly under Richard Nixon, preferring to prioritize the domestic economy and Cold War geopolitics abroad.

Shifts in the Global Balance of Power

In 1944, as governments met in Bretton Woods and World War II hurtled to a close, American (and to a lesser extent British) power was beyond dispute. The central points of Bretton Woods had already been agreed in advance by the British and Americans, with the latter holding an effective veto: lead negotiators Harry Dexter White and John Maynard Keynes concurred that they would “have an agreed text [before the conference], though on the surface a good many matters may be presented in alternative versions”. On the remaining contentious issues, from IMF loan conditionalities to the degree of exchange rate flexibility, the final text was closest to the American point of view.

Yet things changed rapidly in the ensuing decades. By the early 1960s, the rapid recovery of European economies, the rising independence and authority of France, Germany, and other middle powers, and the transition from ‘dollar gap’ to ‘dollar glut’ had each played a role in diminishing American power. In 1972, amidst the collapse of Bretton Woods, Daunton quotes George Shultz, then Treasury Secretary, on the new balance of power: “I don’t see how we have the muscle to so dominate the situation to make a real fixed rate system of the kind we had in the post-war period”. Equally important was the challenge of creating a new monetary regime when exchange markets were already mostly open, rather than under the strict regulation and capital immobility of the 1940s. As Paul Volcker described in 1971, speaking of Bretton Woods, “such a detailed agreement, completely reorganizing the world monetary system, [could not have been] accomplished at any time except when there wasn’t any system operating at all”.

An extensive list of international fora attempted to resolve matters between 1970 and 1973. Some remain familiar (the IMF, OECD, G10), while others have been largely forgotten (the WP-3, the C20). But regardless of their members, rules, and power to implement binding agreements, each of them failed in turn. The short-lived Smithsonian Agreement, reached in late 1971 through negotiations between the G10, devalued the dollar and revalued other currencies (especially the Yen and Deutsche Mark) by varying amounts. But ultimately, these changes proved insufficient: in Volcker’s words, they merely revealed that the world “didn’t come apart” in response to monetary disturbances. In 1973, as the dollar continued to slide, Japan and most of Europe allowed their currencies to float and attempts to create a new system were abandoned.

Today, there is no promise of the sort of hegemonic power that would be required to create a system like Bretton Woods anew. The US and China remain the most important economies globally, with Europe (if taken as a single unit) close behind. But none of these countries or blocs have the overwhelming authority of the Americans after World War II, and this is all but certain to limit their ability to negotiate or enforce a new international monetary agreement.

Lack of Adjustment Mechanism for Surplus Countries

A significant part of the debate between Keynes and White at Bretton Woods focused on whether a mechanism should be introduced to force countries running current account surpluses to adjust, rather than placing the burden entirely on deficit countries. Keynes proposed a ‘Clearing Union’ providing balance-of-payments financing, the rules of which would have obliged the United States (or other persistent surplus countries in the future) to finance the drawing rights of deficit countries themselves, creating a mechanism to encourage surplus countries to reduce their external balance.

The Americans, of course, refused to accept any scheme for “unlimited liability for potential creditors”.² Ultimately, they emerged victorious: the British had to content themselves with a ‘scarce currency’ clause in Article VII of the agreements, which seemed to deal with similar issues, but was never used. However, the decision to prevent an effective enforcement mechanism for surplus countries would ultimately reveal itself a pyrrhic victory for the United States. By the 1960s, surplus countries—particularly West Germany and Japan—experienced a combination of rapid productivity growth and low inflation that rendered their currencies significantly undervalued at the fixed rates set decades earlier. Both countries had no obligation to revalue, and were reluctant to take actions that would reduce their export competitiveness.

The resulting imbalances placed mounting pressure on the dollar, as surplus-country central banks accumulated vast dollar reserves and market participants grew increasingly skeptical that the US could defend convertibility at $35 an ounce. Daunton illustrates the scene with a quote from Peter G. Peterson, then Nixon’s Assistant for International Economic Affairs: “The ghost of 17^th century mercantilism rose again… in the policies of the [surplus] countries”. Attempts to negotiate, cajole, and even threaten European countries with the withdrawal of defense funds helped preserve the system in the short term, but ultimately imbalances became too great: by 1969, “pressures on exchange rates and the failure to reach consensus on reform meant that [Bretton Woods] was heading for a terminal crisis”. With an adjustment mechanism for surplus countries, it is unlikely that the system would have continued in perpetuity, but it might have stumbled along for significantly longer.

Today, the lack of sanctions on surplus countries continues to shape the management of international economic relationships, particularly between China and the rest of the world. In the absence of some adjustment mechanism, the only meaningful levers available to countries facing waves of imports from a country with an undervalued currency are similar to what they were in the 1960s: negotiate, cajole, or threaten. That these levers were ineffective against Germany and Japan, which lacked China’s size, geopolitical influence, and military power, suggests that they are even less likely to work today.

Did America Simply Not Care?

Despite these challenges, the United States could have used its overwhelming military and diplomatic leverage to force a new agreement if it viewed doing so as essential. Why didn’t it? In Daunton’s telling, an important part of the story is that top American leadership didn’t care deeply about international monetary issues. Daunton digs up an almost comical number of quotes from Richard Nixon and his top officials about their disregard for these problems, including (but not limited to):

“I do not want to be bothered with international monetary matters… I will not need to see the reports on international monetary matters in the future”.

“Political considerations must completely override economic considerations in monetary and trade talks”.

“I don’t give a shit about the lira”.

Treasury Secretary John Connally, who oversaw the Nixon Shock of 1971 and the collapse of Bretton Woods, was not much better. His basic approach is summed up by Daunton in his own words: “The foreigners are out to screw us. Our job is to screw them first”.

It thus fell to figures lower down in the administration to debate the finer points of international economic arrangements. Most notably, Volcker, Arthur Burns, and Peter G. Peterson backed reform and continuity under a system of fixed rates, while Shultz, Herbert Stein, and Milton Friedman and the monetarist camp from outside government all pushed for an eventual move to a floating world. However, none of these figures had the authority to secure an international agreement on their own. Nixon and his senior officials were so consumed by domestic priorities and Cold War geopolitics that they proved unwilling to expend their political and diplomatic capital on monetary reform. In the absence of their intervention, floating rates gradually emerged as the path of least resistance.

Further thoughts

Daunton’s account of these shifts is very much an insider’s history. He is interested, above all else, in the individual personalities and the negotiations at play in economic governance (as Angus put it in his part of the review, the book often reads like “one negotiation after another”). This style works exceptionally well in describing negotiations between finance ministers and economic bureaucrats. But it falters in places where the action is happening at a different level, often brushing over crucial details like the rise and fall of unions’ wage-setting power or the influence of international business on the decline of capital controls in the 1960s and 1970s.

This approach also makes it challenging for Daunton to maintain the richness of detail in later periods where the main players are still alive and important archives remain closed. His account of the transition from the confusion of the 1970s to neoliberalism emphasizes the imperfect and nationally specific character of these transitions—how they were shaped by “existing national welfare systems and electoral bargains”—but does not provide a nuanced discussion of any particular such transition, outside of a strong account of changes in IMF and World Bank governance from 1980-2000 (Chapter 21). And while his attempt to give near-equal time to the developing world throughout his history is admirable, his treatment of these issues is often so compartmentalized—with development given its own chapters and referenced only obliquely in the remainder of his writing—that there is at times little connection between these ideas and those of the rest of the book.

Despite these challenges, The Economic Government of the World remains essential reading for anyone interested in how economic policy is made (or not made) by individuals, with all their complicated personalities, ideologies, and motives. Daunton’s account of why Bretton Woods failed in the 1960s and 1970s, and why no new system emerged to replace it, is a useful guide to why it is so unlikely that a new system of global economic governance will emerge in the foreseeable future. The historical conditions that made the managed age of Bretton Woods possible—global depression and war, with a single hegemonic power emerging from the wreckage—were exceptional in ways that no amount of diplomatic ingenuity has yet been able to replicate. This doesn’t imply that building such a system is impossible today. But those who hope to design a ‘new Bretton Woods’ would do well to reckon more deeply with what undid the first.

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1. Two classic sources on this ‘conventional view,’ cited frequently by Daunton, are Barry Eichengreen’s Globalizing Capital (especially Chapters 4 and 5) and Eric Helleiner’s States and the Reemergence of Global Finance. Both accept at least a modified version of this thesis, but place a substantial share of the responsibility for these changes at the feet of British and American policymakers, who they argue could have exerted significantly more control over emerging offshore currency markets in the 1960s.

2. Eichengreen, Globalizing Capital, p. 89; cited in Daunton, ch. 8