Beattie whos in charge here; how governments are failing the world economy (2012)

Who’s in Charge Here?
How Governments are Failing the World Economy
Alan Beattie
RIVERHEAD BOOKS
a member of Penguin Group (USA) Inc.
New York
2012


To John and his family


My Lord, wise men ne’er sit and wail their woes,
But presently prevent the ways to wail.
William Shakespeare, Richard II, Act 3, Scene 2


Contents
1. Introduction
2. How many divisions has the Pope got?
3. Partisan paralysis and polder politics
4. Brics without straw
5. What is to be done?
A free excerpt from Alan Beattie’s False Economy


Introduction
How we got here
And everything had been going so well. In the spring of 2007 the big new things in the world economy
were the rise of a social media site called Facebook, then celebrating its twenty-millionth member,

and a new rival named Twitter, favored by narcissists pressed for time. Clearly, globalization was
about to enter a new and excitingly solipsistic phase.
In April 2007 the International Monetary Fund, the sentinel of global financial stability, smiled
benignly as it surveyed the economic landscape. “Notwithstanding the recent bout of financial
volatility, the world economy still looks well set for continued robust growth in 2007 and 2008,” the
IMF said. “Spillovers have been limited, growth around the world looks well sustained, and inflation
risks have moderated.”
In retrospect, that forecast rivaled for hubris the infamous prediction of Irving Fisher, the
legendary Yale economics professor, who opined two weeks before the 1929 stock market crash that
share prices had reached “what looks like a permanently high plateau.”
By 2007 the world had seen nearly two decades of almost uninterrupted growth, first reaping the
peace dividend from the end of the Cold War and then seeing digitization and the Internet dissolve
hundreds of separate markets in goods, services and money into one. But subterranean subsidence had
been silently and invisibly eroding the foundations of global capitalism, and in the summer of 2007
the ground started to give way.
Over the next five years, the crisis would metastasize and spread. Weakness in the USA’s
overstretched market for mortgage finance became a general international credit squeeze as financial
markets started to dry up, then a rolling banking crisis that swept around the industrialized world, then
the squeeze turning into a crunch as the entire global financial system threatened to grind to a halt,
then a worldwide recession as years of excess were undone, and most recently a wave of
governments across Europe heading toward bankruptcy.
At every stage since the crisis hit, two things have been clear. One is that the governments, central
banks and international institutions charged with safeguarding the world economy have had almost no
idea about the severity of what was coming. The second is that official reactions have for the most
part been slow and inadequate within countries and disjointed and uncoordinated between them. At
each turn, the international response to the successive attacks of financial contagion has been hobbled
by complacency, misplaced ideology, a failure to coordinate and a lack of political will.
Along the way, to be fair, individual policymakers and institutions have improvised some
remarkable responses to the unprecedented challenges. But as things stand, dysfunctional politics and
wrongheaded economics are posing the biggest threat of another worldwide depression since the one

that followed the crash of 1929.
So what went wrong?
In the coming chapters we will see how the system we are supposed to have for coping with the
global economy has largely failed, how the dysfunctional political cultures in Europe and the USA
took hold, how the emerging economic powers have been big enough to be part of the problem
without being part of the solution, and finally where we should be going from here.
As the Queen of England famously asked on a visit to the London School of Economics in 2008:
“If these things were so large, how come everyone missed them?” The reply she got, from the head of
the management school, was a pretty good one: “At every stage, someone was relying on somebody
else, and everyone thought they were doing the right thing.” In the end, the strength of globalization—
its speed, its breadth and its complexity—also proved to be its weakness. The buzzword of the 2000s


was “globalization”—the worldwide integration of markets in goods, services and capital. But it
turned out that governments did not understand the dangers that it had created. And when disaster
struck, it turned out that the crisis could travel faster than the boom—and faster than governments
could react.
* * *
As is now generally known, the crisis started with, or at least was triggered by, problems in the U.S.
housing market. For years mortgage lenders, encouraged by low interest rates and weak financial
regulation, had been overextending loans to risky “subprime” borrowers. When the borrowers started
to miss payments and default, the problem cascaded not just through the mortgage lenders but also
across the financial system. The streams of forthcoming payments on those mortgages had been
parceled up as separate financial assets, combined, remixed, ludicrously labeled as “safe” by credit
ratings agencies and sold on to a huge variety of financial institutions. The poison of bankruptcy
spread through the world financial system as those assets, in the favored idiom, began to “turn toxic.”
In the summer of 2007, governments got an early sense of just how far the problem had spread, as
financial markets across the world started to shake. Banks became reluctant to lend to each other and
the reverberations started knocking down wobbly institutions. In September it caused the first run on a
British bank in more than a century with Northern Rock, a UK mortgage lender that had ridden

Britain’s housing bubble by borrowing huge amounts of short-term cash to lend to long-term
mortgages.
Right from the beginning the problems in U.S. subprime mortgages and British banks showed one
of the key features of the crisis—that responsibility for preventing and stopping problems was
scattered across an array of different agencies. The mortgage lenders whose recklessness led to the
U.S. subprime crisis could shop around different regulators—the Federal Reserve (the central bank),
the Office of Thrift Supervision, the Office of the Comptroller of the Currency and more—to find the
one with the lightest touch. All of them were in charge, and so none of them was.
In the UK, while the Treasury had overall responsibility for financial stability, the Financial
Services Authority supervised individual financial institutions and the Bank of England, the central
bank, was “lender of last resort,” able to bail out troubled banks if their bankruptcy threatened the
wider financial system. For weeks in September 2007, as lines of anxious savers formed at Northern
Rock’s doors, the bank, misjudging the extent of the problem, rebuffed pleas from the FSA and the
Treasury to intervene in the financial markets to help banks lend to each other, while the crisis
worsened. All of them were in charge, and so none of them was.
It was a pattern that was repeated, on an international scale, when the problem entered its critical
phase a year later. In this case the trigger was not a humble British mortgage lender but Lehman
Brothers, a venerable U.S. investment bank dating back to the nineteenth century that found itself
unable to meet its obligations. On September 15, 2008, Lehman Brothers collapsed, and the crisis
spread outward through the tens of thousands of deals it had entered into with other banks and finance
houses. Because there was no record of who owned what, no one had any idea of how bad it was.
Ignorance bred panic, and as banks around the world feared for each other’s solvency, so they
stopped lending to each other, even for a day or two at a time, and the “interbank” market seized up.
In came the governments, like a cavalry charge of pantomime horses. The U.S. Treasury decided
it wanted $700 billion to buy up toxic assets from the banks, a figure that Hank Paulson, U.S.
Treasury secretary, later admitted was pulled from thin air. The request to the U.S. Congress for the
money—a vague proposal put down on three pages of paper, strikingly close to an actual blank check
—was turned down. Stock markets went into free fall, and though Congress voted a few days later to

grant the money, confidence in the authorities’ ability to fight crises was badly hit. (We will return to
U.S. congressional dysfunction later.)
In Europe, where banks operated in something close to a single market, thanks to the rules of the
European Union, the logical thing to do would have been to organize a similar rescue fund on
international lines, or at least to coordinate actions by regulators. But such a mechanism did not exist.
Not for the first time, a market in Europe had grown much faster than the policy infrastructure around
it. (We will return to European ineptitude later.)
Instead, countries jumped for the lifeboats—even if it meant pushing others into the water. Two
days after Lehman Brothers collapsed, Ireland, whose banks were in severe trouble after fueling an
unsustainable housing bubble, massively expanded a government guarantee of bank deposits and
debts. Since the Depression of the 1930s, it has been routine for governments to guarantee savers’
deposits up to a certain level to stop destabilizing runs on banks. But the sudden expansion of the
guarantee was enough to start UK savers fleeing British banks to shelter under Irish government
protection. (We will return to disjointed financial regulation later.)
In one extraordinary week in October, governments first deepened the crisis and were then forced
to scramble to undo the damage. On Monday, October 6, Angela Merkel, the German chancellor,
blocked a French idea to create a cross-border rescue fund. Instead, just hours after an emergency
European summit had called for greater coordination among the continent’s big economies, she
unilaterally issued her own deposit guarantee, infuriating France and the UK.
That Wednesday, in one of the more decisive actions of the crisis, half a dozen of the world’s
central banks simultaneously cut interest rates to try to thaw frozen financial markets. In another,
Gordon Brown, the UK prime minister, later that day announced a rapidly assembled plan to inject
public money into British banks, which had faced a real risk of collapse within hours. Initially,
France and Germany rejected similar plans. Guaranteeing savers’ deposits to prevent a bank run was
one thing; plowing taxpayers’ money into banks offended German financial orthodoxy. Within two
days the threat of financial collapse forced them to perform a U-turn.
At the annual meetings of the International Monetary Fund the following weekend in Washington,
visibly scared finance ministers put together a vague plan to do, in essence, whatever it took to bail
out the financial system. No bank the size of Lehman Brothers would henceforth be allowed to fail.
The USA, which had previously rejected the idea of putting public money into banks, abruptly shifted

course after realizing that their own institutions would hemorrhage business if they did not.
On Sunday, a European summit at the Elysée Palace showed an almost complete reversal of
ideology within a week. EU governments pledged to guarantee savers’ deposits, guarantee banks’
borrowing, pump public money into the banks themselves—anything to prevent a meltdown. In seven
days, governments of the world’s leading economies went from “no need to panic” to “whatever it
takes.”
That extraordinary week in October was not a victory. In soccer terms, Europe and the USA had
barely tied the game before the final whistle. Unprepared, uncoordinated, gripped by a
noninterventionist ideology, the governments of the rich countries had taken global finance to the
brink of total collapse before being forced to retreat.
The world could surely not go on being governed like this. Something had to be done.
Enter, like a pantomime horse manned by a troupe of slapstick clowns, the G20 grouping of large
economies. A full account of the diet and habits of this peculiar beast is left until Chapter 2, but it
made its first appearance in the saga in November 2008 when the USA convened a meeting of G20
heads of government in Washington. The tone of the meeting was self-consciously historic and


transformative, with the dining metaphor being much used to boast that the big emerging economies
had for the first time been invited to the “top table” of global governance.
Gordon Brown, the UK prime minister, never one to undersell an international meeting in which
he had the slightest role, predicted that the meeting would resemble a second Bretton Woods—the
gathering in the eponymous New Hampshire ski resort in 1944 that created a new global monetary
system out of the ruins of the Great Depression and the Second World War. That invitations to the
G20 were prized is not in doubt. Spain, whose population and economy were too small to warrant
inclusion, managed to wangle a spare invitation after a frantic round of calls of European and Latin
American countries to ask them to lobby for its admittance.
The Spaniards need not have bothered. They wouldn’t have missed much. Attendees at the summit
issued a series of grandiloquent pronouncements about the new geopolitical realities of the
interconnected world, changing paradigms of inclusive international governance, rising aspirations to
a truly innovative global consciousness, and other strings of abstract nouns. But the fate of the

specific promises that the G20 made gave astute observers an early clue that this was a grouping
whose ratio of rhetoric to action was set to be stratospheric.
* * *
The G20’s challenge was clear: avoid a second Great Depression. Although the immediate threat of
financial collapse had receded, there was a growing awareness that the global economy itself was
hitting a wall. The world’s big central banks, having largely learned the lessons of the 1930s, were
doing what they could. The U.S. Federal Reserve was fortunate to have as its chairman Ben
Bernanke, a renowned scholar of the Depression. It cut interest rates in effect to zero and found more
and more ways to pump money into the financial markets, a measure known prosaically as
“quantitative easing.” The European Central Bank, which set monetary policy for the economies that
had adopted the euro, acted similarly.
But households and businesses, their borrowing constrained by the credit crunch and their
optimism battered by the near-meltdown of the financial system, were sharply curtailing their
spending. Big emerging-market countries such as China for a while looked as though they had, in the
modish jargon at the time, “decoupled” from the rich world. But that hope lasted only a couple of
months until their stock markets, too, nose-dived, and their growth, too, faltered. International trade,
which had grown quickly during the globalizing 2000s, went into free fall. (By February 2009 it
would be seen to have shrunk by a fifth from its pre-crisis peak.) Concern rose about a repeat of the
Great Depression of the 1930s, where a collapse in trade had been accompanied by a destructive
resort to trade protectionism, as crisis-hit countries walled off their economies behind import tariffs.
Boldly, the G20 governments promised that they, like their central banks, were determined that the
history of the 1930s would not be rerun. They pledged to keep fiscal policy loose—boosting or
maintaining government spending and keeping down taxes—to make up for the shortfall in demand
from households, businesses and export markets. They promised to eschew protectionist actions and
to maintain a free and open global economy. And, specifically, they set a goal for trade ministers to
meet before the end of 2008 to agree to a framework deal in the so-called “Doha round” of global
trade talks that had been running since 2001.
Such a breakthrough would indeed have been impressive, and an excellent early achievement for
the G20. The talks, under the aegis of the World Trade Organization, the global guardian of open
commerce, were the ninth such series of global negotiations since the WTO’s forerunner was created

in 1947. Launched in the eponymous capital of the Gulf state of Qatar two months after the September
11 attacks on the USA, they had been intended as a symbol of global solidarity at a time when the


world seemed divided. But negotiations over reducing import taxes on agricultural and industrial
goods had stalled the process. Governments’ ritual vow to complete the Doha round had become a
meaningless pleasantry on a level with “Have a nice day!”
The G20’s specific immediate pledge not to take protectionist actions was a down payment, or at
least a sign of good faith and of their willingness to complete the trade talks. The G20 meeting
finished on a Saturday in Washington. It was on the Monday morning in Moscow that Russia, a
member of the G20, announced that it would go ahead with a rise in car tariffs to block cheap
imports. The solemn and binding promise to eschew protectionism had lasted about thirty-six hours.
Soon afterward India piled in with a rise in steel tariffs, followed a short while later by the EU
reintroducing controversial export subsidies to dump their dairy products on the world market, and
the pledge was in tatters.
The promise to complete the Doha round proved no more effective. A few weeks after the
summit, talks broke down again and the cryogenically preserved round was quietly returned to its
freezer cabinet. True, the world did not return to economic isolationism: countries continued to stick,
by and large, to the commitments they had made in previous agreements, and protectionist actions
were fewer than in other recessions. But of collective determination to extend the reach of global
trade rules there was little sign.
The other specific pledge made at the G20, for governments to keep the fiscal taps open, was
hardly any more productive. China, showing that it had learned a thing or two about pre-summit spin
from the rich countries, announced a spending program of nearly $600 billion—equivalent to 15
percent of its national income—the week before the G20. Finally, perhaps, China was taking up some
of the burden of global consumption that the USA and other rich countries had been pressing on it for
years. As it happened, the plans had been in the works for months, and were merely timed around the
G20 for dramatic effect. And the actual public spending programs turned out to be much smaller, the
rest being made up of the government leaning on state-controlled banks to increase their lending.
In February 2009, once Barack Obama had taken office, the U.S. did put through a stimulus

program of tax cuts and spending increases that he had promised while on the campaign trail. But
even there, the package was rather smaller than some in his administration wanted, thanks to
resistance from Congress. And in the year after the November summit, no major G20 economy
announced any significant increase in discretionary spending—that is, spending excluding automatic
payments such as unemployment benefits—that it had not already planned. The G20 fiscal pledge, too,
turned out to be a fiction.
But it was not for want of trying, at least on the part of the White House (a strong believer in the
virtues of fiscal stimulus). Just ahead of the next summit in London in April 2009 Larry Summers, the
pugnacious chief economic adviser to President Obama, uncompromisingly declared of fiscal policy:
“There’s no place that should be reducing its contribution to global demand right now.” But with the
crotchety air of a dowager duchess sending a substandard amuse-bouche back to the kitchens, JeanClaude Juncker, Luxembourg prime minister and chair of the “eurogroup” of finance ministers from
the single currency zone, said sniffily: “Finance ministers agreed that recent American appeals
insisting Europeans make an added budgetary effort were not to our liking.”
Still, if ever there was a politician ready to do good PR for the G20 irrespective of the underlying
reality, it was the host of the London summit, Gordon Brown. The British prime minister was by now
infamous in the UK for conjuring big public spending announcements out of nothing with statistical
smoke and mirrors—double- and triple-counting money, re-announcing or relabeling existing plans,
rolling up multi-year programs into a single commitment—and now he had a global stage on which to


practice his fiscal sleight of hand.
“The Trillion-Dollar Summit” was the headline Mr. Brown wanted, and by and large he got it. He
claimed to have achieved a $1.1 trillion boost to the world economy, including $500 billion for the
IMF’s war chest, a $250 billion boost for trade and a $250 billion increase in the global money
supply. The Guardian newspaper, a habitual cheerleader for the prime minister, ran its story under
the millenarian headline “Brown’s New World Order,” and even less slavishly loyal papers were
enthusiastic.
The reality was less impressive. The $500 billion for the IMF was very welcome, as the
institution had already started to eat into its reserves with a string of rescue loans for Eastern
European countries in late 2008. But some of the money was already in train—Japan had offered a

$100 billion loan the previous year—or would not be agreed until months after the summit, and an
increase in the future firepower of a crisis lender was not an immediate boost to the world economy.
The $250 billion support for trade was more like $4 billion: it was a subsidy for the provision of
trade credit (a basic form of finance that had been in short supply during the credit crunch) and the
$250 billion was a highly optimistic assessment of the amount of trade that subsidy might help support
over three years. The $250 billion boost to the world’s money supply was an issuance of “Special
Drawing Rights,” a form of asset that governments could add to their foreign exchange reserves and
use if they chose to. As it happened, most chose not to.
The standard view of the G20 among most commentators is that it started well, in Washington and
London, but thereafter achieved little. In reality, only the second half of that is true.
* * *
The global economy pulled out of recession in 2009, with a lot of help from supportive monetary
policy, leaving minds to turn to longer-term problems. One was coordinating financial regulation to
prevent international “regulatory arbitrage”—a race to the bottom where banks and finance houses
moved from one financial center to another to find the softest touch. But governments remained at
odds on a host of matters: how to regulate financial institutions across borders, how much capital
banks should be required to hold, whether “derivatives”—complex financial assets—should be put
on organized exchanges, whether banks should be subject to a special tax.
France and Germany seemed obsessed with taxing financial transactions and with their long-held
desire to constrain risk-taking investors in lightly regulated hedge funds (despite the fact that hedge
funds had not been a major contributory factor to the crisis). One astute observer likened this to a
pugilist with a grudge in a bar brawl, waiting till the fracas broke out and then taking a swing at the
guy he had always wanted to hit, whether or not the target had had anything to do with starting the
fight in the first place.
Another issue was a problem in the world economy that had long predated the financial crisis:
huge global imbalances in trade. Throughout the decade before the crisis, the USA had run giant trade
deficits by sucking in goods from exporters such as China, which accordingly ran massive surpluses.
The USA needed to borrow abroad to fund this consumption, and a good chunk of the money also
came from China. In other words, China was operating a system of vendor finance, lending the USA
the money to buy its own exports. Since at some point it would need to be paid back, this was not an

indefinitely sustainable situation.
Washington had been complaining vociferously for most of a decade that this dysfunctional
embrace was the result of China continually intervening in the foreign exchange markets to buy
dollars and sell its own currency, the renminbi, to make its exports cheaper. The USA had tried a
variety of diplomatic ways over the years to put pressure on China to let its currency rise, mostly via


the IMF, but all to no avail. Washington spotted in the G20 a new opportunity, and through the next
three G20 summits—Pittsburgh in September 2009, Toronto in June 2010 and Seoul in November
2010—it tried to corral the G20 into an international posse to go after the currency outlaw.
But though China grudgingly allowed the renminbi to start crawling higher against the dollar in
2010, the USA soon found itself under a counterattack when the dollar started falling almost across
the board. The “currency wars”—accusations that each country was trying to boost its own economy
at the expense of others by weakening its exchange rate—got under way. The Federal Reserve’s
super-loose monetary policy, shoveling money into financial markets, may have averted disaster in
U.S. financial markets, but it was unpopular abroad. Some emerging-market countries such as Brazil
were seeing their currencies soar against the dollar. They blamed the Fed for weakening its own
currency by creating so much of it, encouraging speculators to borrow heavily in cheap dollars and
then use the money to buy Brazilian assets.
As the currency wars raged in the run-up to the Seoul summit in November 2010, the USA tried to
get the G20 to set numerical limits for current account balances, in order to put pressure on China to
restrain its surpluses. Determined resistance from China, and other countries sitting on the fence,
meant the initiative largely ended in stalemate. Throughout 2011, China slowed the rise of the
renminbi to a crawl. It ended the year just 5 percent higher against the dollar than it had begun—the
USA wanted at least twice as much—and, according to authoritative estimates, remained at least 20
percent undervalued against the dollar.
* * *
By the middle of 2011, the USA and Europe were back to having rather more pressing things to worry
about—specifically, the bankruptcy of their own governments. When governments in Ireland and
Spain had bailed out their banks with public money in the first wave of the crisis, those banks’

problems became the governments’ problems, and their debt became sovereign government debt. Add
to that countries such as Greece and Italy, which had long experienced difficulty collecting enough tax
and controlling spending sufficiently to balance their budgets, and the sequel to the 2008 horror movie
went on general release: Lehman Brothers II: This Time It’s Sovereign.
The Lehman crisis had shown that the EU, and particularly the eurozone, had not established ways
of intervening cooperatively to rescue its banks. Similarly, the gradual slide of first Greece, then
Ireland and Portugal, and then Spain and Italy, toward government bankruptcy, revealed the
weaknesses that critics had said had been present in the structure of the euro since the single currency
was launched in 1999.
The eurozone had no real means to stop its member governments from overborrowing. Indeed,
when it tried to set ceilings for government deficits, it was France and Germany—the supposedly
responsible parents of the EU project—that were the first two countries to break through them, which
they did with impunity. Nor did the eurozone have a substantial central taxing and spending authority
that could transfer money to stricken countries to keep their economies going or lend to their
governments when private investors took fright. Once stuck in the eurozone, if a country such as
Greece found itself uncompetitive relative to a powerhouse such as Germany, there was no way to
correct this except by slowly grinding down wages and prices, a process normally only achieved by a
painful economic recession. And yet, encouraged by financial regulation that treated sovereign bonds,
or debt, as a safe investment, French and German banks had merrily loaded up on bonds from heavily
indebted governments such as that of Greece.
Most countries have a central bank that acts as a lender of last resort, bailing out banks and, if
necessary, the government in order to avoid meltdown. The European Central Bank specifically ruled


out acting in this way to prevent sovereign bankruptcies. Neither eurozone governments collectively
nor the European Commission—the executive body of the wider European Union—were supposed to
mount bailouts for troubled countries.
Moreover, it became painfully evident as the crisis hit that the eurozone’s slow, unwieldy policy
framework was horrendously unfit for the purpose. Looking back, the whole problem might have been
avoided if the eurozone had moved swiftly in January or February 2010, when investors started to

flee Greece and the government was having difficulty supporting its debt burden. A modest €50
billion or so rescue loan to tide the country over, a measured reduction in the debt that Greece owed
to banks and other investors, and confidence might well have been restored. But it was not only the
eurozone at fault: the USA was also slow to wake up to the threat from Europe, an initial view inside
the U.S. administration being that the Greek economy was only the size of Rhode Island’s.
Instead, over the next two years, as country after country slid toward trouble, the eurozone
governments, the European Central Bank and the European Commission put on an extraordinary
display of chaotic policymaking. To return to the sporting metaphor, had this been a soccer game you
might have assumed they had been bribed to throw it.
European governments repeatedly dithered and bickered. They disagreed in public about whether
the EU was allowed to do bailouts at all. They were divided about whether the IMF ought to be
brought into the rescue to provide cash and credibility—eventually it was, but only after valuable
time had passed and confidence had been lost. They fought about whether countries such as Ireland
and Greece should forcibly reduce the debt that their governments or nationalized banks owed to
foreign banks to stop them being crushed by debt burdens. (The answer should have been yes, but the
ECB said no.)
The eurozone’s governments created a bailout fund, the European Financial Stability Facility, and
then spent months arguing about what form it would take, what it was allowed to do and where it
could borrow money from. They held crisis summit after crisis summit—at least a dozen in 2011—
which repeatedly raised expectations of a comprehensive solution and then dashed them. Some
European leaders wanted to solicit money from the emerging-market countries such as China to help
with the rescue; others said it was unnecessary.
And misplaced ideology persisted at every moment. The German government and the ECB had an
analysis of the crisis often starkly at odds with the facts. The view in Berlin and Frankfurt was that it
was all caused by fiscally profligate governments, rather than being largely to do with the banking
crisis. In countries such as Ireland and Spain, that was flatly untrue. The misreading of the situation
prevented the one institution that really could have helped, the ECB, from intervening in sufficient
amounts to prevent the crisis spreading. The eurozone, and the G20, tried to find expensive and
complex ways to do what the ECB could have been doing cheaply and easily—lending in large
amounts to troubled governments, via the IMF if necessary, to stem panic in the markets. Only

gradually and painfully was the ECB induced to intervene.
And so, as 2011 ground on and the rest of the world watched in astonishment and alarm, the
policymaking deficit was filled by an extraordinary abrogation of power. The eurozone authorities—
which by this point meant “Merkozy,” German chancellor Angela Merkel and French president
Nicolas Sarkozy, or increasingly just Merkel—in effect appointed technocrats to run Italy and Greece
after their governments fell. Germany embarked on creating a central fiscal authority in the eurozone
that should have been done a decade before. There then followed a constitutional crisis when the UK
objected to changes to EU treaties necessary to make the new system work.
It was like watching a gang of irascible, quarrelsome architects trying to redesign a house in the


middle of a raging fire.
It was a hell of a way to run a bailout.
Still, while the eurozone was having a serious sovereign debt crisis, at least it hadn’t meant to.
Across the Atlantic the USA was undergoing a somewhat less destructive but in many ways even
more misguided process, flirting with voluntarily defaulting on its national public debt and in due
course receiving the first credit downgrade in U.S. history. The culprit: an ideology propagated by a
political faction that, rather than learning from the mistakes of the Depression, seemed to want to
make them all over again.
The rise of the Tea Party might be an object lesson in the old adage that no good deed goes
unpunished. Taking its name from the Boston Tea Party remonstrance against British colonialism in
1773—originally a protest against a tax cut, but let that pass—the modern movement arose, bizarrely,
from a rant by a cable TV presenter against government help for the troubled U.S. housing market.
Within months, a populist movement helped on its way by copious dollops of cash from traditional
political funders had turned into a national organization that inserted itself firmly into the
conservative wing of the Republican Party.
Blooding itself in battle by opposing Barack Obama’s plan to reform health care, the Tea Party
Republicans proceeded to pursue an extreme version of fiscal stringency. Periodically, the federal
debt ceiling—the U.S. government’s ability to borrow—needs to be raised, if only because the
absolute level of borrowing will go up when the economy expands. Normally this is a routine

administrative procedure. In August 2011 it became an unforced fiscal crisis as some in Congress
tried to use it as a lever to try to force big long-term cuts in government spending. The implications of
this went well beyond U.S. shores. The rest of the world economy depended on the USA continuing to
expand, and the Tea Party was trying to knock away the one reliable prop of growth.
And so, the world struggled into 2012 with a dire outlook for the global economy and financial
markets. Eurozone governments faced debt default and the USA was set for indefinite gridlock over
serious reform of tax and spending.
* * *
To be fair, not every single piece of policymaking during the financial crisis was a total shambles.
Some policymakers, at certain times, acquitted themselves well. The Federal Reserve and other
central banks—including the Bank of England once it had grasped the gravity of the situation—were
prepared to try all sorts of unorthodox measures to stop the economy seizing up. Gordon Brown,
whatever his manifold other faults, was right to plow public money into banks in the dark days of
October 2008 and to convince other governments to follow suit, though it did not prevent his being
forced out of office in Britain in May 2010.
The IMF, though it had failed to spot the crisis coming, managed to maneuver itself back into a
serious role in combating the financial crisis—and its advice was among the saner views expressed
during the eurozone bailouts. Emerging markets such as Brazil, though their policy record was far
from spotless, used the reserves they had built up to cushion themselves from the impact of the crisis
elsewhere. Some countries such as Canada and Australia, which had had relatively good financial
regulation (though also benefiting from high commodity prices) rode out the first few years of the
crisis without much damage.
But overall, the collective response of the world’s big economies since 2007 has been slow,
disorganized, usually politically weak and frequently ideologically wrongheaded. The rest of this
book will examine how things got to be as bad as they are, and where we might go from here.


2
How many divisions has the Pope got?
Why international institutions are too small and too weak

Wait a second. Aren’t we supposed to have organizations to deal with this sort of thing?
Yes, we are. Specifically, we have the set of institutions created after the Second World War to
ensure the Great Depression would not happen again: the International Monetary Fund, the World
Trade Organization and the World Bank.
But the world economy has gotten a lot bigger and its house rules have become much more
complex since then. True, the institutions have done their best to adapt and keep up. In fact, the
performances of the three have been among the better responses to the global financial crisis, though
admittedly that involves hopping over the lowest of low bars. But two factors have prevented them
from doing more. One, they do not have the size or the power to meet a global crisis with anything
like overwhelming force. Two, they are only as good as the countries that set them up and, ultimately,
govern them.
Despite the grand talk of global cooperation, and particularly the self-appointment of the G20
grouping of leading economies as a steering committee for the world economy, those “shareholder”
governments have proved themselves fickle, self-interested and disunited.
The International Monetary Fund, above all, is the obvious institution to step forward during
global financial turmoil. The Fund (as insiders, in a slightly Orwellian fashion, call it) was set up at
the international monetary conference in Bretton Woods, New Hampshire, in 1944, to oversee a
system of fixed exchange rates and controls on international movements of capital. The Bretton
Woods exchange rate system was supposed to bring stability by anchoring the value of other
currencies to the dollar and the value of the dollar to the price of gold. But the mechanism collapsed
in the early 1970s as the USA started creating too many dollars, not least to fund the war in Vietnam.
Inflation started to take off, the dollar’s link to the price of gold was broken, and the global economy
entered the era of largely floating exchange rates and free movement of money across borders.
The IMF, which had previously lent mainly to Western European countries (its first loan was to
France, in 1947) to enable them to cope with shortfalls in their balance of payments, has since
transmuted into an all-purpose government crisis lending institution that until recently mainly dealt
with poorer countries. Essentially a credit union—a lending institution owned and controlled by its
members—it is funded by money put on deposit by its shareholder countries and bails out any of those
governments that are at risk of going bankrupt. Being backed by governments, its lending is cheap, at
low interest rates, but generally comes loaded with tough conditions to restore solvency by cutting

public spending and raising taxes. And from the 1980s onward IMF loans were often made
conditional on implementing controversial so-called “structural reforms” such as privatizing stateowned companies, reducing import taxes and getting rid of controls on food prices and exchange
rates.
By the time the credit crunch hit in 2008, the Fund, though its membership was pretty much
universal, with 187 shareholder countries, was an institution looking for a purpose. It had seen a
flurry of rescue lending in the late 1990s with the Asian and Russian financial crises, followed by the
ongoing disaster of Argentina, which defaulted on its government debt in 2001 despite massive IMF
assistance, and a couple of notable successes staving off default in Turkey and Brazil in the early
2000s. But half a decade of rapid global economic growth, confident investors and buoyant financial
markets had left it with little to do. A cartoon in The Economist in 2006 nailed it perfectly: IMF staff
were a bunch of bored firefighters sitting around an idle fire engine.


Despite subsequent events in hotel rooms in New York City, the IMF was fortunate to have
Dominique Strauss-Kahn (“DSK”) as its managing director when the global financial crisis hit.
Strauss-Kahn, a former French finance minister and one-time economics professor, had the unusual
combination of political clout, negotiating guile and intellectual credibility. Simon Johnson, a former
IMF chief economist, described DSK as “Metternich with a BlackBerry”—referring to the
legendarily wily nineteenth-century diplomat of the Austrian Empire. The Fund swung back into
action in 2008, bailing out a succession of mainly Central and Eastern European countries to which
foreign banks had lent heavily in anticipation of their joining the euro.
Since the Fund’s resources had stayed constant while the global economy and its financial
markets had grown, Strauss-Kahn—with the help of one or two other political heavyweights such as
Tim Geithner, U.S. Treasury secretary, and Gordon Brown, then UK prime minister—seized the
moment to raise fresh contributions and triple the size of the Fund’s war chest. By 2010, the IMF had
found a bunch of fires to put out, had by and large doused the flames successfully, and had restored
itself to a dominant position in rescuing small- to medium-size countries in crisis.
That, however, was about as far as it could go on its own. When the Western European economies
started to implode in 2010, with Greece followed by Ireland and Portugal, DSK managed to get the
Fund involved in the rescue effort, overcoming initial resistance from the European Central Bank. But

its firepower was not big enough on its own. Greece alone (with an economy, let us recall, only the
size of Rhode Island) required an initial bailout of €110 billion, which would have used more than a
third of the IMF’s entire lending capacity. Funding the Irish and Portuguese rescues would have
cleaned out its war chest completely.
The IMF joined the eurozone bailouts only as a junior partner, providing around a third of the
money for Ireland and Portugal and a slightly smaller share for Greece, with the rest coming from
eurozone governments. The conditions for the loans were set by the so-called “Troika” of three
institutions—the IMF, the European Commission and the European Central Bank. (Someone was
either ignorant of history or had a dark sense of humor: “troika” was also a name given to kangaroo
courts of three judges in the former Soviet Union that ordered executions of innocent men on the word
of the secret police.)
When the Troika started making bad decisions in 2010, the IMF was dragged along. During
negotiations over the Irish bailout and the Irish banks that had been nationalized, the idea was
(rightly) mooted of those banks forcibly reducing their debt payments to the foreign banks and
financial institutions that had foolishly lent to them. Officials involved in the negotiations said that the
Fund appeared somewhat amenable to the idea. (The image of the IMF as a kinder, gentler crisis
lender was one that a lot of people took time to accept.) But the ECB blocked the plan, not least
because many of those lenders were elsewhere in the eurozone. In Ireland, the ECB was widely seen
as a debt collector for feckless French and German banks.
As the Greek economy weakened and the rescue plan slid off track in 2011, the IMF watched with
intense frustration the dithering and disunity of the two other members of the Troika. But for the IMF
to pull the plug and refuse to authorize payments in the bailout program would have precipitated
government default and opened the Fund to the accusation that it had created chaos in the eurozone.
This was a familiar dilemma for the IMF, but worsened in the eurozone by its junior financing
role. When it becomes highly unlikely that a borrower country can avoid bankruptcy, the best course
of action in the long run is to stop lending and reduce or “restructure” the government’s debt rather
than loading it up with more loans, thus worsening the default when it comes. But at any given point, it
is easier to keep doubling down on bets than to admit that the game is up. It was this that kept the IMF

lending to Argentina for far too long before that perennially troubled country finally slid into chaotic
default in 2001. It was politically even harder to stop lending in the eurozone when the Fund was only
a minority partner.
Not only that, but the eurozone’s influence over the IMF itself was, well, considerable. The Fund
is, after all, a credit union: it is owned and controlled by its member governments, with their voting
power roughly reflecting their importance in the global economy and international trade. And despite
long—and, frankly, bureaucratically tedious—struggles to shift power toward the emerging
economies, its governance structure still mainly resembles the world of the 1940s. The USA is the
largest shareholder, with 17 percent of the votes on the IMF’s executive board—in fact rather smaller
than the U.S. share in the global economy—but European countries collectively hold around a third of
the votes. Until a reform in 2008, Belgium had a bigger share than India.
Since its inception, European countries have also had a gentleman’s agreement that they in effect
get to nominate the head of the IMF, while the USA appoints the president of the World Bank. The
deal was originally supposed to ensure that the European countries that were the Fund’s first
borrowers felt it was a cooperative institution rather than an American-run debt collector. Since
Europe and the USA between them have nearly half of the votes on the IMF’s board, this sordid little
deal has been relatively easy to maintain.
Despite Europe’s shambolic management of the eurozone debt crisis, its governments have
insisted on this tradition continuing. The gentleman’s agreement produced the IMF’s first female head
when another former French finance minister, Christine Lagarde, was appointed managing director in
July 2011 to replace the disgraced DSK. In other words, as Paulo Nogueira Batista, the Brazilian
representative on the IMF’s board, put it to me: “The debtors are in charge of the bank.”
It is hardly surprising it kept lending.
* * *
Despite its partial return to relevance as a crisis lender since 2008, the International Monetary Fund
has struggled to extend its influence to other areas. Although conspiracy theorists persist in seeing the
IMF as an embryonic world economic government, its ability to direct the overall global economy
has proved minimal.
But it was not through want of trying. One of the IMF’s other functions, alongside bailouts, is to
act as a center of expertise on economics. It makes forecasts of economic growth—though generally

no more accurate than other forecasters’ predictions, which is to say not very accurate at all. And,
under the Fundspeak term “surveillance,” it monitors and offers advice on running its members’
economies and financial systems.
The surveillance function, like everything else in the Fund, can be subject to intense political
lobbying. Gordon Brown, who chaired the IMF’s ministerial steering committee while he was UK
chancellor of the Exchequer, was a strong supporter of a prominent role for IMF surveillance—
except when it came to criticizing his own handling of the UK’s economy, whereupon he embarked on
an aggressive campaign of lobbying bordering on intimidation to get Fund officials to pipe down.
If the institution showed bias toward the eurozone in lending, it leaned toward the USA and the
UK in its thinking, and particularly in its support for “light-touch” financial regulation. Despite its
minority shareholding, the USA has generally played a dominant role in directing the organization, not
least because the U.S. Treasury is four blocks from the IMF in downtown Washington, D.C.
The IMF managed spectacularly to miss the global financial crisis coming, saying inaccurately
and ungrammatically in the summer of 2008 that “the U.S. has avoided a hard landing” and “the worst
news are [sic] behind us.” A report by the IMF’s watchdog Independent Evaluation Office in 2009


was sharply critical. It concluded: “The IMF’s ability to correctly identify the mounting risks was
hindered by a high degree of groupthink, intellectual capture, a general mindset that a major financial
crisis in large advanced economies was unlikely, and incomplete analytical approaches.”
Indeed, far from spotting the dangers in the U.S. financial system, the Fund spent most of the years
running up to the crisis trying to do the USA’s work for it. And yet, revealing another of its big
weaknesses, it failed.
During the 2000s the USA recruited the IMF to its long campaign of persuading China to let the
renminbi rise in order to curb its import growth and—so the U.S. belief went—to rebalance the
world economy. China resisted, and the dispute turned into a mighty and prolonged bureaucratic war
of attrition during which much ordnance was exchanged, but which achieved a net outcome that was
pretty much nil.
The USA tried to use the IMF’s artillery against China in several different campaigns. First it
organized a “multilateral consultation” exercise inside the IMF involving itself and China, wheeling

in Japan, the eurozone and Saudi Arabia to maintain the facade that this was a broad consultative
process. China politely declined to be surveilled into accepting the U.S. view that its exchange rate
was an important contributor to global current account imbalances.
In 2007, just before the credit squeeze began, the USA then tried an even more direct route,
successfully pressing the IMF to conduct special direct surveillance on exchange rates. The drive was
controversial even within the IMF. Raghuram Rajan, another former IMF chief economist, later said
that the decision to focus on currencies was “an unmitigated disaster” that made the Fund look biased.
The USA raised the stakes by trying to get the IMF to name China as a “currency manipulator”—a
politically loaded description that would imply that Beijing was undermining the spirit of
international cooperation. China objected so violently that Strauss-Kahn dared not bring any
discussion of China’s economy to the Fund’s executive board for more than three years—they are
supposed to happen annually—for fear of the diplomatic explosion that might ensue.
These and other efforts to use the IMF as a global currency enforcer all failed, and yet the USA
has kept trying. In 2009 it got the G20 to commission the IMF to conduct a so-called “mutual
assessment process,” and tried to set targets for individual countries’ current account deficits and
surpluses, which would have put pressure on Beijing to allow renminbi appreciation in order to
reduce its surplus. China fought back strongly in the G20, and the campaign stalled. Separately, the
IMF started to publish its own “spillover reports,” which detailed how policies such as China’s
intervention to hold down its exchange rate affected other countries. With no sanctions for ignoring
them, they dropped dead off the presses. There remains no effective international constraint on
governments’ currency policy.
What all these efforts show is as follows. The IMF has substantial power over small- to mediumsize countries to which it is lending money, as it can force them to follow policies or cut them off
from finance, but not over anyone else. Your mother can try to stop you smoking through moral
suasion, but she is much more likely to succeed if she can take away your pocket money.
As a technocratic institution, the IMF is ideally placed to do analysis, though it does not
necessarily get it right. But as a political institution, it is badly placed to arbitrate or even mediate
disputes such as that of China with the USA. In that intractable dispute, the IMF’s management found
itself caught between the global economy’s current hegemon and its possible future one; between its
current biggest shareholder and potentially its biggest shareholder down the line.
Dominique Strauss-Kahn, speaking after the largely unproductive Seoul G20 summit in 2010,

said, tongue imperviously lodged in Gallic cheek: “I am happy when I see that people are expecting


the IMF to become a kind of dictator of the global economy.” But then he added wistfully: “That is
not going to happen . . . we have no teeth, no police, no army to send to countries.” The IMF
criticizing the major economies rather resembles the old Robin Williams stand-up routine about an
unarmed British policeman trying to apprehend a fleeing suspect: “Stop! Or . . . I’ll shout stop again!”
The IMF has regained a role as a crisis lender: it does not, however, run the global economy.
* * *
There is a similar story across the street—as in literally across Nineteenth Street in Washington, with
an underground passageway between the two buildings—at the World Bank. Set up and directed by
governments, much like the IMF, it was originally created to make longer-term loans to rebuild
shattered countries after the war. Like the IMF, its first customer was France. Gradually, like the
IMF, it transmuted into an organization focused mainly on developing countries, though unlike the
IMF it has not found the need to go back into Western Europe. The World Bank, like the IMF, seized
the opportunity of the global financial crisis to enlarge itself: it increased its capital base to allow it
to borrow more on the open markets and continued to increase contributions from its richer donor
countries to enable it to give grants and very low-interest loans to the poorest countries.
All fine, but as the global economy has grown, and with it the ability of low- and middle-income
countries to borrow from international private investors has risen, so the bank finds itself playing a
less important role in filling financial holes. Indeed, during the 2000s one of the biggest threats to its
preeminence was an emerging-market country itself. China, seeking sources of raw materials and new
export markets, invested heavily around the developing world and particularly in Africa. Over 2009
and 2010, the Chinese agencies that give loans and grants to middle-income countries were larger
than their counterparts at the World Bank. And in any case, since the global financial crisis was
concentrated in the rich countries, the demand for external finance from the developing world rose
after 2008 but it did not skyrocket.
And so to the World Trade Organization. Rarely can there have been an institution with a bigger
gap between critics’ perceptions of its overweening power and the mundane reality. When it became
one of the hate objects of the anti-globalization movement in the 2000s, the WTO was regarded as

both sinister and omnipotent. The charge sheet was as follows: the WTO was undemocratic and
secretive, with deals stitched up by the rich countries while the poor ones were shut out; the WTO
snatched medicines out of the hands of Africans by enforcing patents for Western pharmaceutical
companies; the WTO destroyed whole swaths of industry and the livelihoods of millions of farmers
by subjecting them to the vagaries of global competition; the WTO let multinational corporations
secretly run the world economy.
Not all of those criticisms are complete nonsense, but most are. One of the least understood
aspects of the WTO as an organization is how small it is and how little power it has. Protesters
turning up to its headquarters in Geneva expecting a towering edifice of global capitalism are
generally taken aback to encounter a drab gray building about the size of a smallish comprehensive
school.
The central organization housed in the building, known prosaically but accurately as “the
Secretariat,” has very little power of its own. Unlike the IMF—an organization with some executive
powers, albeit guided by its executive board of shareholder countries—the WTO is, as the stock
phrase has it, “a member-driven organization.” The organization has 153 such countries, and a
cartoon popular with WTO staff shows a car having careered into a ditch, the caption explaining it is
a member-driven vehicle.
In fact, the WTO was a minimalist Plan B created once the main Plan A had been rejected. The


Bretton Woods conference that created the IMF and the World Bank also proposed a counterpart
International Trade Organization, but it foundered on multilateralism fatigue in the U.S. Congress and
concern that an ITO would end up interfering in members’ domestic economies.
Instead, the world wound up with a limited treaty, the snappily named General Agreement on
Tariffs and Trade. GATT finally managed to transmute into an actual organization, the WTO, in 1994.
But it remained a weak one. Mainly, the WTO is there to host negotiations over rules about the global
economy. In GATT days these were mainly about taxes (tariffs) on imported goods. Increasingly, a
“round” of WTO talks has multiple strands that are supposed to be negotiated more or less
simultaneously and then come together in a single agreement. The lengthening list of issues reflects the
increasing complexities of globalization: export controls and quotas, agricultural subsidies that

distort trade, intellectual property rights, trade in services, rules about being able to block imports of
goods that have been unfairly subsidized or are being sold below cost, and so on and so forth.
As we have seen, the WTO’s negotiating function ground to a halt during the 2000s during the socalled “Doha round” of talks that began in the Qatari capital in 2001, not least because of the round’s
sheer size and complexity. Though many governments have yet to admit it—and continue to waste
their travel budgets and their civil servants’ careers, throwing good time and money after bad—Doha
will be the first failed round since the GATT crawled into existence in 1947.
Repeated clashes between the same governments over the same issues—often the USA trying to
get its agricultural exports into developing countries, and those countries trying to get the USA to cut
farm subsidies—had given the Doha talks something of the air of Waiting for Godot, or Groundhog
Day. A meeting of trade ministers in Geneva in July 2008 collapsed without agreement for the third
summer in a row, and the round was effectively dead.
Given the way it makes decisions, it is surprising this hasn’t happened before. WTO officials and
trade negotiators laugh hollowly at accusations that it is undemocratic. The WTO system is in fact so
democratic it can hardly move. Deals require not just majority agreement but unanimity: every
member country must acquiesce to every agreement within every round. This system was aptly once
described by Pascal Lamy, the WTO’s current director-general, during his earlier days as the EU’s
chief trade official, as “medieval.”
Any single government, however small, can block a WTO deal. Agreements were driven through
in the past—and this is where criticisms of secrecy have some validity—by the “Quad” grouping of
four rich economies (the USA, EU, Canada and Japan), who stitched up a deal between themselves
and then bullied everyone else into accepting it. Now that emerging economies such as India and
Brazil have been added to the core negotiating group, talks are more representative but also less
productive.
The failure of the Doha round does not bode well for future attempts at multilateral trade
liberalization. The alternative to the WTO is not to have no trade deals. It is more likely a future
where the global trade system splinters into hundreds of separate bilateral and regional pacts that can
complicate commerce as much as liberalize it—and where, in fact, rich economies are much more
likely to be able to go back to bullying poor countries into one-sided agreements.
This would be a pity. Unable though it is to write new rules, the WTO has been surprisingly good
at holding countries to existing ones—surprising because its enforcement mechanism is slow and

bureaucratic and has limited sanctions at its disposal.
The WTO’s “court,” which rules on cases where one member country accuses another of having
broken existing WTO law, is an institution with another snappy title—the Dispute Settlement Body.
The Secretariat has very little power over the quasi-independent DSB. Its judicial panels and appeal


bodies are staffed with current and former trade officials and lawyers. The DSB’s only power is
permitting wronged countries to impose limited trade sanctions on the wrongdoer. As this also means
depriving themselves of cheap imports, which hurts their consumers and any companies that depend
on imported supplies, most trade economists regard this as roughly equivalent to being granted
permission to shove rusty spikes through their own feet.
And yet, by and large, governments tend to comply with its decisions. At the same time that the
Doha round was sputtering, China agreed to eliminate a number of illegal state subsidies, and the EU
reformed its rigged sugar market after DSB rulings. Even the USA, not a big fan of being bound by
international agreements, has a fairly good record at complying. The WTO may, in fact, be the last
major multilateral institution by which the USA allows itself to be bound—having, for example,
pulled out of the International Criminal Court and rejected the Kyoto Protocol on climate change.
There is not much more sacred to the U.S. Congress than tax—“no taxation without representation”
and all that—but it twice rewrote part of its corporate tax code after a WTO panel ruled it was
tantamount to an illicit subsidy for exports.
And through the first three years of the financial crisis, though it may not have produced the
breakthrough in Doha that was promised, WTO agreements held up pretty well. Like the IMF and the
World Bank, the WTO did what it could. (And like the IMF, amusingly enough, it was run during the
crisis by a French Socialist, Pascal Lamy.)
When, for example, the U.S. Congress tried to restrict government spending to American
companies as part of its 2009 stimulus package—the so-called “Buy American” clause—a quiet
cough from the White House reminding Capitol Hill of WTO law was enough to have them modify it.
Unlike the 1930s, there has been no widespread return to protectionism during the global financial
crisis. Both the WTO and the World Bank set up monitoring operations to watch for signs of
widespread protectionism, but on most measures this has remained much lower than in previous

postwar recessions, let alone the Great Depression.
What actions there were, such as the string of decisions that broke the G20 protectionism pledge,
were regrettable but limited—and permitted under current WTO agreements. In truth, the WTO’s
problem is not that its rules are ignored but that there aren’t enough of them. There remain a swath of
ways in which countries can interfere with trade—licenses and regulations, controls on raw material
exports to divert them to domestic companies, implicit subsidies to state-owned enterprises—that
WTO agreements cover inadequately, if at all. These more insidious forms of distortion—sometimes
called “murky protectionism”—have been rising over the past few years, without laws and treaties to
stop them. Some skeptics go so far as to say that the WTO does not prevent protectionism at all—it
just forces governments to be more creative about it.
* * *
It should have become obvious by this point that simply having institutions isn’t enough. What matters
is the political will to give them powers and to implement what they say. Without a shared sense of
purpose and a degree of consensus about how the world should be run, the governments that direct
these institutions are hardly likely to be keen on being bound by them.
Traditionally, the three institutions described here—the IMF, World Bank and WTO—were run
by small informal cliques of rich countries. The WTO, as we have seen, was driven by the Quad of
advanced economies. The steering group for the Bretton Woods institutions, most of the time, was
composed of finance ministers from the Group of Seven, or G7. The G7, which sometimes describes
itself as a club of rich democracies, started life as the G5 in 1975 (USA, UK, Japan, France and West
Germany) before later adding Italy and Canada. Their heads of government also met annually, and at


heads of government level the G7 became the G8 in the 1990s, Russia being invited on the
overoptimistic assumption that it, too, would soon become a rich democracy.
Throughout the 1990s and up to 2008, the IMF’s two sets of meetings a year—one in the spring
and the full annual meeting in the autumn—were inevitably preceded by a joint pronouncement from
the finance ministers of the G7, and it was rare that their view did not eventually prevail. The G7 may
not have been particularly representative, but it was a manageable group of usually like-minded
nations.

But during the 2000s, as China and other middle-income countries emerged, the trade-off between
nimbleness and accountability began to shift in favor of expanding the charmed circle. Accordingly,
the middle years of the 2000s were marked by endless conversations about which countries might be
invited to widen the grouping. These interminable discussions over the optimal constellation of
countries suddenly began to produce results during the global financial crisis. The rich countries
recognized that it would look absurdly out of touch first to let a global problem emerge from their
financial systems and then to refuse to invite rapidly growing emerging economies to be part of the
solution.
In the autumn of 2008, the USA decided to call a summit of heads of government. But whom to
invite? They could have tried to work out a new set of important countries, ensuring geographical and
economic balance, with all the unbelievable amount of detail (and lobbying for inclusion) that that
would have involved, like a giant game of geopolitical Sudoku. Instead, they pulled off the shelf a
ready-made solution—the “G20” of big economies, including the larger “emerging market” countries
such as China, India, Brazil, Turkey and South Africa. The G20 had been created during the previous
burst of enthusiasm for global governance changes following the Asian financial crisis of 1997–98,
but had thereafter been left to wither, with increasingly junior officials having increasingly pointless
discussions.
But as we have seen, though it was heralded as the dawn of a new age, the G20’s achievements
were much more spin than substance. Increasingly its role was to provide a peripatetic gladiatorial
arena for the latest round of intractable international disagreements—over fiscal policy in 2009, over
currencies in 2010, over the eurozone crisis in 2011.
The reason for the G20’s weakness goes to the heart of what international institutions are for, and
why some work and some do not. There are essentially two functions that international government
institutions perform. The less controversial one is to act as a repository of specialized knowledge: the
World Bank, for example, is a global clearinghouse of expertise about water management in
developing countries. The second is to help to coordinate different governments when everyone
knows it is in their best interest to cooperate, but at each point there are strong domestic pressures not
to. The classic example is fishing quotas: everyone knows it is in everyone’s long-term interest to
maintain fish stocks by limiting catches, but no one wants to be the mug government that voluntarily
restrains its own fleet while others vacuum the oceans clean.

For such a coordinating function to work, there first has to be agreement on what the actual
problem is. For many of the issues the G20 addresses, there is not. In theory, for example,
coordination would be possible between the USA and China on economic policy. The USA would
rein in its long-term fiscal and trade deficit, thus reducing the need to borrow from China, and Beijing
would allow the renminbi to appreciate faster, thus buying more exports from the USA to replace the
fall in government demand. But China simply does not agree that its manipulation of its currency has
much to do with the USA’s trade deficit, and many in Washington do not think that long-term fiscal
consolidation will do much to reduce trade deficits. In areas such as this, the problem is not one of


coordination—it is of a fundamentally different analysis.
Even where there is agreement on the underlying aim, such as the need to prevent rising
protectionism, the international institutions only work if they are sufficiently credible to be a decisive
factor in domestic policy decisions. So, when the White House wanted the Congress to drop the “Buy
American” provisions in the stimulus bill, it was much easier to argue that it had to be done because
of the USA’s commitments under the WTO—and because the USA itself benefited from the rules in
the WTO system to give its exporters access to other markets—than it would have been to argue the
case on its own merits.
But designing institutions like this is difficult, takes time and works much better when countries
are bound into a formal system of rules than when they are simply making commitments in principle.
The inability of the G7 and G8 to hold governments to promises had already been on display. In 2005,
Tony Blair, then UK prime minister, used the G8 meeting he chaired in Gleneagles, Scotland, to make
a grand gesture toward development in Africa by getting attendees to sign up to a set of promises to
increase overseas aid by 2010. Mr. Blair had the eight leaders solemnly and personally sign the
communiqué to hold them accountable.
But in truth, there was no real sanction (and no genuine threat of a domestic political backlash) if
those promises were broken—as indeed, for the most part, they duly were. In fact, of the eight heads
of government who signed the communiqué, the only one to be back in office in 2010 when the pledge
became due was Silvio Berlusconi in Italy—and it was Italy that had most blatantly broken the aid
promises made at Gleneagles. Since there was no sanction for reneging on promises and no

reciprocal benefit for keeping them, there was insufficient incentive for countries to spend money and
political capital doing so. Perhaps to his own disappointment, Mr. Blair found that his moral
indignation—along with that of the campaigning coterie of rock stars and other celebrities who
congregated around the G8—was not sufficiently compelling to stop the aid pledges being broken.
The same was true of the G20, only more so, since with more countries and more diversity of
politics and economies, there was even less of a sense of common purpose to bind the group together.
When the G20 leaders signed up to the no-protectionism pledge in November 2008—the one that
lasted less than thirty-six hours—it was quite clearly without consulting their ministers or imagining
what this meant or how it might work. On the very day of the summit I called a trade ministry in one
G20 economy to try to find out what the specifics of the pledge meant. I got a big gust of frustration
down the line. “Alan, this pledge is not aimed at people like you who know what they are talking
about,” my interlocutor said. “This is a gesture.”
Gestures are not enough. The G20 promises did not intervene significantly in domestic debates
over protectionism or anything else. First rule of global governance: never mind what people say,
watch what they do. Governments’ lack of faith in the G20 to quell the currency wars in 2010 was
evinced by a string of unilateral interventions to weaken their currencies or keep out rapid capital
inflows. By late 2010 some big emerging-market countries whose cooperation was vital to make it
work—India, Turkey, Brazil—were already complaining in public that the grouping was ineffectual.
I have never heard a G20 pledge cited as the reason why a serious amendment to policy was
made—no equivalent to Congress amending the “Buy American” provision because of WTO rules.
The U.S. Congress actually makes a reasonably good stab at implementing decisions taken by a
grown-up organization such as the WTO, anchored in U.S. law and treaty obligations, but it knows the
distinct difference between a legally binding agreement and a group hug.
Still, sometimes, you hear debates go on about how the grouping might be made more effective.
Should it have its own secretariat? Is it too big, or are the wrong countries in it? Should it kick out


Argentina, a country that has broken most norms of international economic policymaking over the past
decade? Should more financial centers—such as Switzerland or Singapore—be introduced?
This debate almost entirely misses the point. Global governance needs more political will, not

technocratic tweaking. Those organizations that have actually achieved something during the global
financial crisis—even if limited in size and scope—are those that have clear aims and the financial or
legal authority to bind their member countries into decisions they may not like.
When Dominique Strauss-Kahn noted in mock regret that the IMF had no army to enforce its
decisions he was, consciously or not, echoing Joseph Stalin. Someone once told Stalin that the Pope
would disapprove of his suppression of the Catholic Church in the Soviet bloc. “The Pope?” Stalin
replied. “Screw the Pope. How many divisions has the Pope got?”
In the aftermath of the Great Depression and the Second World War, the architecture of the global
economy was entirely redesigned. So far, the global financial crisis has involved allowing two of
those inherited institutions to begin to catch up with the huge growth in the global economy, and for
agreements negotiated nearly twenty years ago to be, in the main, respected. But beyond that, nothing
effective or durable has been created. A second Bretton Woods this certainly is not.


3
Partisan paralysis and polder politics
Why the USA can’t lead and Europe doesn’t work
In the eurozone we have seventeen national parliaments. Here you
seem to be having enough trouble with just one.
Francois Baroin, September 2011, Washington, D.C.
Touché, Monsieur Baroin. Touché. It was Harold Macmillan, the UK prime minister in the 1950s and
1960s who watched U.S. power rise as the British Empire crumbled, who famously said that Britain
would play Ancient Greece to the USA’s Rome. These days, the modern-day Rome seems to be
declining, too. After a century in which the USA first became one half of a Cold War duopoly and
then rose to be the undisputed global hyperpower, the crisis has severely undermined its ability to
provide international leadership.
This might have provided an opportunity for the Old World to strike back. The European Union,
which has long envied the USA’s wealth, unity of purpose and self-assurance, has been trying to
assume the economic, diplomatic and even military trappings of a great power.
But the ambitions of both to run the world now look forlorn. Both are constrained, in different

ways, by political cultures that make them woefully incapable of dealing with the extraordinary
challenges that the last few years have thrown up. The USA has become gridlocked on taxes and
spending and its domestic divisions have weakened its international economic policy. Meanwhile, the
eurozone has found itself unable to stem a spreading sovereign debt crisis that threatens to plunge the
world into recession.
And with the USA and its housing and credit bubble having kicked off the first leg of the crisis of
capitalism, and the EU having played a central role in the latest episode, the intellectual authority of
both on economic policy has sunk to its lowest level since the Great Depression.
Why have the decision-making processes proved so dysfunctional?
The USA has slid toward a political culture of gridlock, as long-established trends of polarization
and interest group influence have interacted with the financial crisis. In the EU, a modus operandi that
evolved to cope with the slow, organic growth of the European project has proved itself to be
spectacularly unsuited to the task of running a badly designed single currency. And in both cases, out
of the confusion and the stasis, misguided ideologies and wrongheaded solutions have dominated.
The USA’s political problem is that, while the letter of the law has remained largely the same, the
spirit needed to animate it has dissipated. The U.S. Constitution, written in the eighteenth century, was
based on a suspicion of centralized power and designed to force compromise. Born out of the
rejection of a centralized colonialism in the form of the British monarchy, it was created from scratch
to put severe limits on the exercise of arbitrary power.
The familiar mistake that non-Americans make when looking at the USA is to assume that the
president is a particularly powerful figure. He, perhaps one day she, is not. Critics of powerful
British prime ministers such as Margaret Thatcher and Tony Blair who bemoaned their ambitions to
run a presidential government should have been so lucky. Two fractious legislative houses akin to the
U.S. House of Representatives and the Senate, elected separately on a different basis to each other
and to the prime minister, together with a powerful judiciary able to strike down laws they deemed
unconstitutional, would have severely circumscribed Thatcher’s and Blair’s powers.
The House of Representatives is elected by something close to a popular vote, with congressional
districts of roughly equal size. The Senate elects two senators per state, giving disproportionate
power to the smaller states. It also has a web of arcane regulations and rules of procedure with which