How Europe Wrote the Rules of Global Finance
Following decades of liberalization, controls on cross-border capital movements are again being discussed by financial institutions, governments, and policymakers around the globe. Professor Rawi Abdelal discusses implications and the historical roles of Europe and the United States in promoting the flow of capital across national borders. Key concepts include:
- European policymakers, particularly the French, created regulations and enforcement that govern the majority of the world's capital flows.
- The U.S. has followed an ad hoc approach to capital liberalization, with no evidence it supported a liberal international financial regime.
- The trend toward liberalization and a lessening of capital controls on worldwide finance appears to be on the wane.
The United States has been both credited and criticized for its powerful role in promoting global financial liberalization—the flow of capital across country borders. But research by Harvard Business School Professor Rawi Abdelal has shown something quite different. It was European policymakers, particularly the French, who authored the most important rules promoting the free movement of capital. The United States has been at the center of global finance, but in a very ad hoc way, Abdelal says.
In this interview about his research and his book, Capital Rules: The Construction of Global Finance, forthcoming from Harvard University Press, Abdelal discusses the rise and diminishment of capital controls in the 1900s, the coming influence of China and India on global financial markets, and a conspiracy theory that U.S. institutions rewrote the rules to force capital liberalization on developing countries. His article, "Writing the Rules of Global Finance: France, Europe, and Capital Liberalization," appeared in the Review of International Political Economy in February 2006.
Ann Cullen: How did you become interested in conducting research on this topic?
Rawi Abdelal: This research project began in the classroom during my first year as a professor at HBS. In the winter of 2000, my students and I were discussing the financial crises that erupted in Asia during 1997 and 1998. Unlike its neighbors, the government of Malaysia restricted the outflow of capital in September 1998 as part of its management of an apparently ongoing crisis.
The reaction of the international financial community—and some of my students—was severe. The capital controls were labeled "unorthodox" and "heretical," although no formal rule forbade Malaysia from regulating capital flows. The hyperbole was striking: The language of religion—orthodoxy, heresy, dogma—seems for some reason to pervade policy discussions of international monetary and financial issues. And the prevailing orthodoxy had been determined in significant part by norms of appropriate policy practices and the collective expectations of market participants.
We are already in a very different moment in history compared to the middle of the 1990s.
What most fascinated me was how much the content of financial orthodoxy had shifted during the previous century, and really more than once. During the 1940s and 1950s capital controls were perfectly orthodox tools of macroeconomic management. And forty years before that, prior to the outbreak of World War I in 1914, capital controls had then been heretical. The big, unanswered question was: Why were capital controls heretical at the beginning of the twentieth century, orthodox in the middle, and heretical again at the end?
The more I thought about the question, the more I realized that its answer must be fundamental to our understanding of the history of international capitalism. I decided to write a book on the subject, a sort of intellectual, legal, and political history of financial globalization. This article is part of the larger project. My book, Capital Rules: The Construction of Global Finance, is going to be published by Harvard University Press later this year.
Q: How did French and European policymakers play such an important role in the liberalization of capital flows?
A: Many of us, and I include myself as I was beginning this project, have tended to understand the process of financial globalization as a straightforward trend toward liberalization and a general embrace of the idea that capital ought to flow across country borders with minimal restriction and regulation. In fact, two very different visions for financial globalization have been in conflict.
The U.S. approach to globalization has been ad hoc, relying on the bilateral influence of the U.S. Treasury and private financial firms, such as Moody's and Standard & Poor's. European policymakers, in contrast, have sought to create new rules for the international system and empower international organizations, such as the EU, OECD, and IMF, to enforce them. French policymakers invented the doctrine of "managed globalization" as an alternative to U.S.-centric ad hoc globalization. A handful of French policymakers—all of them socialists, paradoxically—first liberalized France and then, upon taking leadership roles in international organizations, sought to organize and manage the process of globalization with new jurisdictions and rules.
Q: You end this article stating that in terms of norms and rules of global finance, "the height of our current era of globalization might have already been reached." What do you mean?
A: Well, if we think about globalization as a process that creates large, internationalized financial markets, then clearly that process was slowed by the crises of the last decade. But it is a process that is continuing and may well for some time to come. If, however, we recognize that globalization is also built upon institutional foundations, on a collection of ideas, norms, and rules, then I think that we are already in a very different moment in history compared to the middle of the 1990s.
The international financial community no longer embraces capital mobility with just a few qualifications; rather, the qualifications these days are many, and the consensus favors capacious domestic institutions and prudential regulations, careful sequencing, and caution. The proposal to amend the IMF's Articles of Agreement to give the organization jurisdiction over the capital account policies of members and endow it with the purpose of liberalizing capital flows failed primarily as a result of the financial crises of 1997 and 1998. Today, the IMF is very cautious about encouraging countries to liberalize, and indeed generally IMF officials offer developing countries warnings about the serious risks involved. The OECD has retreated from its once enthusiastic and unambiguous support for rapid capital liberalization. Moody's and Standard & Poor's write very often these days about the risks of liberalization, and the credit-rating agencies have praised China and India for liberalizing slowly.
I can assure you that there was no conspiracy of Wall Street and the U.S. Treasury to rewrite the rules of the international financial architecture.
The autumn of 1998 was a close as the world has ever come to a consensus—written and unwritten—that capital's right to freedom applied always and everywhere. That consensus has since been shattered, and I cannot see how it could be reconstructed in the near future.
Q: The article devotes a lot of discussion to the OECD and the liberalization of developed markets. Is it possible that a large, rapidly developing country such as India or China could have an influence in the future on this debate as they increasingly are in the role of money lender rather than money recipient?
A: The vast majority of capital flows not from rich to poor countries, but rather among the rich countries of the EU and OECD. With a few exceptions, China, India, and Brazil among them, most developing countries have little access to financial globalization. So, policymakers from developed countries have tended to dominate these debates. That may be changing in several interesting ways.
Many policymakers in the developing world, as well as officials in the IMF and analysts at the rating agencies, believe that China was insulated from the financial crises of its neighbors because of its capital controls regime. Now, that is a controversial view, but it is a perspective that has nonetheless been very influential. The formulation of that particular "lesson" is that China shows that gradualism and caution are warranted when it comes to capital liberalization.
The other way that China, India, and other developing countries may influence this debate is through the resolution of what people these days call "global imbalances"—namely, the U.S. current account deficit and the reserve accumulation of developing-country central banks, which are helping to finance that deficit. If those global imbalances are unraveled chaotically, the stirrings of a crisis of legitimacy for the free movement of capital would be strengthened. Hopefully these imbalances will not be resolved in a crisis, but if they are, then the prevailing consensus of caution could easily become a consensus of autarky and insulation.
Q: The article discusses at length the success of the EU in terms of monetary policy, but how do you feel about complaints by some EU nation politicians that adopting the euro has not been good for their economies and they would like to revert back to their own separate currencies?
A: The EU really has been a phenomenal success in integrating European economies. Despite the current mood of skepticism in Europe, the achievements of the process truly are profound. The process relies, however, on the bureaucratization of difficult issues, and so the collection of rules that compose Europe—the acquis communautaire—is treated as untouchable. Once an issue, such as capital freedom, is resolved, then it is supposed to be off of the negotiating table for good. The problem is that the original political purposes of the integration project, such as peace, political harmony, and the Europeanization of Germany, are increasingly detached from the liberal, economic means, such as financial and goods market integration. So, many Europeans are still enthusiastic about "Europe," but just not "the Brussels Europe" or "neoliberal Europe." The Italian skepticism about the euro is just one part of that broader questioning of how to reconcile the social and political purposes of integration with the economic ties that made the project a success.
Q: What role have Wall Street and the U.S. Treasury played in the story you recount of changes in capital controls since the 1980s?
A: Scholars and policymakers from both the "left" and the "right" have tended to narrate the process of financial globalization as a kind of conspiracy of Wall Street and the U.S. Treasury. So, there is much talk of a "Wall Street-Treasury Complex" or a "Wall Street-Treasury-IMF Complex" that has vigorously promoted a liberal international financial regime because such a regime benefits U.S. public and private interests.
Undoubtedly, the United States played an important role in the creation of a world of mobile capital, and the Treasury and private financial firms were influential. Unilateral liberalization, bilateral pressure, crisis management, and massive flows of capital in both directions have put the United States at the center of global finance. But neither the U.S. Treasury nor the private financial community has preferred or promoted multilateral, liberal rules for global finance. The most important liberal rules of the international financial system—those of the EU and OECD—were conceived and authored by Europeans, not by U.S. policy makers. And in the debate about a universal rule in favor of full capital mobility to be codified in the IMF's Articles, the U.S. Treasury was ambivalent, and private financial firms were publicly and vigorously opposed. The private financial community in the United States has in fact been generally suspicious of codified rules that empower international organizations. That community has, moreover, always been cautious about the dangers of capital liberalization for countries that are not prepared in terms of their macroeconomic policy making or the domestic institutional foundations for sound financial systems, in part because of the risk of contagious financial crises.
After spending so much time in the archives of these international organizations and interviewing policymakers and members of the private financial community, I can assure you that there was no conspiracy of Wall Street and the U.S. Treasury to rewrite the rules of the international financial architecture and thereby force capital liberalization on developing countries. Indeed, in retrospect it is surprising that so many observers thought that the U.S. Treasury or Wall Street would push to codify the norm of capital mobility in a way that would empower international organizations. The U.S. Treasury already effectively governs global finance. U.S. banks and financial firms are interested not in worldwide capital mobility, but in access to a handful of emerging markets, access they can, in general, acquire without the help of international organizations. The American approach to ad hoc globalization suits the interests of the Treasury and of the private financial community perfectly well, and it also fits broader patterns of American foreign policymaking over the past century.