Phoenix Risen: The Resurrection of Global Finance

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Review Article

Benjamin J. Cohen

Of all the many changes of the world economy in recent decades, few have been nearly so dramatic as the resurrection of global finance. A half century ago, after the ravages of the Great Depression and World War II, financial markets everywhere-with the notable exception of the United States-were generally weak, insular, and strictly controlled, reduced from their previously central role in international economic relations to offer little more than a negligible amount of trade financing. Starting in the late 1950s, however, private lending and investment once again began to gather momentum, generating a phenomenal growth of cross-border capital flows and an increasingly close integration of domestic financial markets. Like a phoenix risen from the ashes, global finance took flight and soared to new heights of power and influence in the affairs of nations.

How can we explain the remarkable globalization of financial markets of recent years, and what are its economic and political implications? Such questions have lately spawned a veritable cottage industry of popular commentary, some of it frankly sensationalist if not downright alarmist in tone. ¹ Even otherwise levelheaded scholars have at times allowed themselves to be carried away by gnawing fears of instability and chaos. ² A new generation of political economists, however, is beginning to focus its attention on the phenomenon, casting the cool eye of objective analysis on both the causes and consequences of financial globalization. A survey of this emerging literature, including the five books under review here, ³ suggests just how much can be learned about such a topical issue from more serious and substantive scholarship.

The aim of this article is both to summarize present understanding of the political economy of global finance and to identify key elements of an agenda for future research. For our purposes, global finance is assumed to encompass all types of cross-border portfolio-type transactions--borrowing and lending, trading of currencies or other financial claims, and the provision of commerical banking or other financial services. It also includes capital flows associated with foreign direct investment--transactions involving significant control of producing enterprises. Financial globalization (or internationalization) refers to the broad integration of national markets associated with both innovation and deregulation in the postwar era and is manifested by increasing movements of capital across national frontiers. The more alternative assets are closely regarded as substitutes for one another, the higher the degree of capital mobility.

The scope of financial globalization should not be exaggerated. As much as capital flows have grown, it is still premature to speak of a single, world financial market. In the words of Jeffry Frieden, "International investment is by no means yet a seamless web." ⁴ Careful econometric studies demonstrate that even for the most liquid of monetary assets, capital mobility remains imperfect because of inherent country and currency risks. ⁵ Market segmentation persists, both within states (among different sectors) and between them. Debt instruments are less transferable than cash, long-term claims are less substitutable than short-term, and equity markets are less integrated still. The scope of globalization, however, also should not be underestimated. Though frictions between markets remain, they are far fewer and weaker today than they used to be; both domestically and internationally, functional and institutional linkages have greatly increased. The trend in finance has been toward ever higher levels of global interdependence.

This survey will begin with a brief synopsis of the five books under review, highlighting the core concerns and conclusions of each. Though individually quite diverse, the five as a group constitute a reasonably representative sample of work currently under way in this specialized subfield of international political economy. The following sections will then take up three of the most critical questions posed by the globalization of financial markets: How did it happen?

What does it mean for economic performance or policy? What can governments do about it? Answers vary considerably, suggesting much room for further research, particularly on implications for the central political-economy dialectic between politics and markets. At a minimum, financial globalization has put governments distinctly on the defensive, eroding much of the authority of the contemporary sovereign state. At a maximum, it may have irreversibly altered the meaning of geography in the world economy today. The phoenix has risen. Does it also rule the roost?

The Globalization of Finance

Recent scholarship, as indicated, has addressed both the causes and the consequences of financial globalization. The question of causes is taken up by Eric Helleiner and Andrew Sobel in two admirably detailed historical studies. Both agree on the key role played by states, particularly the major industrial powers, in deregulating domestic markets and liberalizing external controls. They disagree sharply, however, on how to explain the policies they observe.

For Helleiner, the story lies in a combination of structural and ideational factors. At the systemic level, "competitive deregulation" by governments maneuvering unilaterally to attract the business of mobile financial traders was reinforced as early as the 1960s by policy initiatives from the two leading financial powers of the day, the United States and Britain, both with a strong interest in promoting a more open international order. At the cognitive level, an ideological shift from postwar Keynesianism to a neoclassical or neoliberal policy framework gained strength from the preexistence of a sophisticated epistemic community of central bankers based around the Bank for International Settlements (BIS). The bulk of Helleiner's discussion is an account of the role played by each of these factors in the resurrection of global finance over the postwar period.

For Sobel, by contrast, the process is best explained by purely domestic considerations--competition between organized interests within national political economies that has spilled over to affect the international environment. Focusing specifically on recent developments in the securities markets of Britain, Japan, and the United States, Sobel rejects structural or ideational interpretations of globalization, which he labels "outside-in" explanations. "In these explanations, the primary stimulus motivating change arises outside the domestic political economy, but compels changes that impact the domestic political economy" (p. 15). Sobel prefers instead an alternative "inside-out" explanation, which he defends with extensive evidence of persistent national distinctions and "home bias" in bond and equity markets. "Paradoxical inconsistencies in behavior across the three markets pose dilemmas for outside-in explanations" (p. 15). ⁶ Incomplete convergence, he argues, suggests that "the international outcome is solidly rooted in domestic policy dilemmas and distributional debates" (p. 19). ⁷

Consequences rather than causes are the principal concerns of the remaining three authors, again with strikingly divergent results. All three concur that financial globalization has indeed put government on the defensive, but they part company on what policymakers can do about it.

A fairly pessimistic view is represented by Paulette Kurzer, who sees rather little scope for effective state responses to global finance. Kurzer's densely textured comparative study examines the fate in the 1980s of tripartite distributive arrangements between business, labor, and government in four small European democracies: Austria, Belgium, the Netherlands, and Sweden. In all four countries, traditional policies of "social concertation" have recently been abandoned. The timing of these changes varied across the countries, which may be explained by differences in such factors as business preferences, administrative rulings, and the historical stance of foreign economic policies. But the overall outcome ultimately was the same in each and may be attributed, Kurzer insists, to a single cause--financial globalization: "As business and finance became more mobile, their power resources increased, and those of labor decreased. [T]he greater mobility of capital and deepening financial integration corroded social concertation" (p. viii). As a result, Kurzer concludes grimly, "governments have lost the ability to carve out national economic strategies and to sustain social accords" (p. viii).

An alternative, rather more sanguine view is proposed by Ethan Kapstein in an informed and insightful survey of regulatory responses to the internationalization of commercial banking over the postwar period. Focusing in particular on prudential and supervisory agreements that have been negotiated by major central banks through the BIS, Kapstein identifies a formula, "international cooperation based on home country control," which, in his view, has enabled governments to mount an effective response to the challenges of financial globalization. Though imperfections remain, he argues, a workable framework for governing global financial markets has been created and may even suggest a "generic policy solution" to the conflicting demands of systemic and societal forces in other issue-areas as well: "International cooperation based on home country control provides a way for states to enjoy the benefits of interdependence while maintaining national responsibility for the sector in question" (p. 180).

Finally, a third view is offered by John Goodman in a highly instructive comparative analysis of central banking practices in three big West European economies: France, Germany, and Italy. Goodman's primary concern is with the role played by institutional differences, particularly differences in the degree of central-bank independence that "govern the extent to which domestic political pressures influence national monetary policy" (p. 221). His discussion, however, is distinguished from most institutional studies in its assumption not of a closed economy but rather a context of deepening financial interdependence. The globalization of finance, he argues, drives states voluntarily to limit their own monetary autonomy by means of cooperation--in Europe, his specific area of focus, up to and including the possible creation of a full monetary union. Authority may be lost at the national level but might be regained through a convergence of policies at a higher level. In effect, therefore, Goodman strikes a middle ground between Kurzer's pessimism and Kapstein's optimism. Governments have not necessarily lost the ability to carve out effective economic strategies, but cooperation based on home country control is unlikely to prove sufficient. If they are to be successful, states must do the job collectively.

How Did It Happen

As the contrasting views of Helleiner and Sobel suggest, little consensus exists concerning the causes of financial globalization. Not that this is particularly surprising. Historical interpretation is never easy, even in a field as well documented as international finance. The discord, however, is significant insofar as the past may be assumed to have some impact on the course of events in the future. One does not have to hold a particularly rigid view of path dependency to recognize the extent to which tomorrow's choices may be delimited by yesterday's actions. An understanding of antecedents does matter.

Competing hypotheses may be categorized in any number of ways. Helleiner contrasts two classes of causal interpretation--those explanations that see globalization as a direct product of "unstoppable technological and market forces [that] discount the role played by states" (p. 1); and those, like his own, that stress instead the central role of government policies. Sobel, on the other hand, distinguishes three types of interpretation. Two are his so-called outside-in explanations, one positing change "as a response to systemic conditions that affect all states" (p. 14), including technological developments and ideological shifts; the second viewing liberalization and internationalization as "a foreign policy outcome" (p. 15) reflecting the direct exercise of state influence. The third is his preferred inside-out interpretation. Yet another classification is proposed by Philip Cerny, a frequent contributor to the globalization literature, who also distinguishes three types of explanation: (1) market-based explanations; (2) institutional-technological explanations; and (3) political explanations, which in turn are subdivided into interpretations that, like Sobel's, stress internal political processes, or, like Helleiner's, stress the autonomous state. ⁸ The organization of inquiry seems to be treated very much as a matter of personal taste.

If historical interpetation is to be of much value to social scientists, however, it should, ideally, be framed to facilitate the closest possible comparison with prevailing theoretical perspectives and approaches--in effect, to offer a form of empirical test of alternative analytical models. In the IPE field today three broad paradigms dominate most discussion, the familiar three levels of analysis: the systemic (or structural) level of analysis, the domestic (or unit) level, and the cognitive. ⁹ Specific theories tend to represent a variation on one or more of these general themes. It would seem preferable, therefore, as a general principle, to organize inquiry into the sources of financial globalization along the same lines.

This suggests a taxonomy of four main hypotheses for investigation. At the systemic level, two variants can be identified, replicating Helleiner's distinction between the contrasting roles of market forces and government policies. One variant, with roots in standard neoclassical economics, stresses the powerful impacts of competition and innovation in the financial marketplace. It also emphasizes advances in communications and information technologies, which have literally swept away institutional and legal barriers to market integration and the free flow of capital. This variant might be labeled the "liberal model." The second, more consistent with an older tradition in international relations theory, emphasizes the determining role of policy rivalry among governments in an insecure world, each calculating how best to use its influence and capabilities to promote state interest. Call this the "realist model." A third approach, pitched at the unit level of analysis characteristic of most comparative political economy, corresponds to Sobel's inside-out explanation, highlighting the role of domestic politics and institutions in driving international developments. This may be labeled the "pluralist model." A fourth approach, embodying Helleiner's ideational factors, underscores the role of belief systems and epistemic communities as catalysts for change. Call this the "cognitive model."

The question is: What does the historical evidence suggest about the relative utility of each of these four models? Which comes closest to actually explaining the resurrection of global finance? And what are the linkages among them?

Each model has its champions. The liberal model, not surprisingly, is the personal favorite of most economists. Typical is Ralph Bryant, a well-known international monetary specialist, who confidently asserts that "technological nonpolicy factors were so powerful that they would have caused a progressive internationalization of financial activity even without changes in government separation fences." ¹⁰ On the political science side, the case has been put equally firmly by David Andrews, who emphasizes both the degree to which capital mobility appears to have increased independently of changes in national regulatory frameworks and the degree to which liberalization at the national level has seemingly occurred in response to market pressures at the systemic level. ¹¹ Appearances, however, can be deceiving. An approach that causally links an outcome (globalization) to its own defining characteristics (competition and innovation) borders on the tautological. It also leaves no room for politics in an arena, the interstate system, that is inherently politicized.

A possible antidote is offered by the realist model, which is nothing if not political. Reversing the arrow of causation, the approach is best represented by Helleiner. "The contemporary open global financial order," he argues, "could never have emerged without the support and blessing of states" (p. vii). Capital mobility may have been facilitated by innovations in financial instruments and advances in communications and information technologies. Without explicit policy decisions by governments, however, national markets would have remained as insulated from one another as ever. Political authorities promoted the resurrection of global finance by granting more freedom to market operators, refraining from imposing more effective controls on capital movements, and acting to prevent or manage international financial crises.

Three issues, however, are raised by the realist model. First, if states were so pivotal in the globalization process, could they also turn back the clock if they wish? Reversibility would appear to be a logical corollary of the realist model. Certainly this is the conclusion drawn by Helleiner, who in more recent commentary has argued quite forcefully that since "financial globalization [was] heavily dependent on state support and encouragement a reversal of the liberalization trend is more likely than is often assumed." ¹² Others, however, attack the implication, insisting instead on a kind of hysteresis in financial market development. Globalization has progressed so far, it is said, that capital mobility must now be regarded as tantamount to an exogenous feature of the international system. In the words of David Andrews, "The constraints imposed on states by capital mobility are structural in nature, or at a minimum can usefully be construed as structural by analysts." ¹³

In fact, both sides of this debate seem too categorical. Central to the issue is an implicit calculation of the costs, economic or political, that would be associated with any attempt to restrict capital mobility. Reversibility would not appear to be ruled out in principle. In practice, however, limits seem likely only insofar as governments are prepared to pay the requisite price. As Louis Pauly has contended,

Capital mobility constrains states, but not in an absolute sense. Analysts should therefore be cautious when interpreting the current dimensions of international capital flows as constituting an exogenous structure that irrevocably binds societies or their states. A collective movement away from capital decontrol may be undesirable, but it remains entirely possible. ¹⁴

We will return to this crucial point below.

A second issue has to do with matters of power and hegemony in the globalization process. Helleiner and Sobel alike stress the role that American and British leadership played in opening up financial markets. To borrow from the language of Scott James and David Lake, ¹⁵ however, we may ask which "face" of hegemony was at work here: the first face of direct government-to-government influence, exercised through positive and negative sanctions; the second face of market power, altering incentive structures; or the third face of ideas and ideology, shaping the climate of opinion. Except in the special case of Japan, neither Helleiner nor Sobel suggests much evidence of overt inducements or threats by Washington or London to compel liberalization by other governments. ¹⁶ Indeed, as indicated, Sobel explicitly rejects any explanation positing direct exercise of state influence. They differ sharply, however, about which of the other two faces mattered more in this context.

For Helleiner, it was the second face--initially, the pressures created by U.S. and U.K. policy decisions facilitating creation of a foreign-currency deposit market, the Euromarket, in London. "When these two states supported growth of the Euromarket foreign financial centers were forced to follow the lead of Britain and the United States by liberalizing and deregulating their own financial systems" (p. 12). For Sobel, by contrast, it was the third face, exhibited in particular by the United States--the privileging of American-style rules, institutions, and trading technologies in foreign securities markets:

Through innovation and invention of financial and regulatory technologies, U.S. actors established the agenda and boundaries of changes in other markets. This embedded influence produces an outcome generally consistent with U.S. actors' preferences, as others choose options already enacted in the U.S. market, reducing transaction costs for American firms and professionals overseas, and at far less cost than direct pressure. (pp. 151-52)

In fact, there is nothing inherently contradictory about these two views; they are complementary rather than mutually exclusive. They do suggest, however, different inferences about the comparative importance of government policies versus market forces, and thus ultimately about the explanatory power of the realist versus the liberal model. More detailed empirical studies to help disentangle the two forms of influence would clearly be useful.

A third issue, finally, has to do with the motivations for state behavior suggested by the realist model. Were states operating as classic rational unitary actors, single-mindedly competing within systemic constraints to maximize some objective measure of national interest? Or were other, more subtle forces at work to shape government preferences and perceptions? This, of course, is the issue posed by the pluralist and cognitive models, both of which effectively open up the black box of public policy.

Sobel's inside-out explanation offers a prime example of a pluralist model. His view that "internationalization [was] motivated domestically" (p. 155) is echoed by such scholars as Ron Martin, who asserts that globalization was in fact "politically engineered a reassertion by the state of an underlying disposition towards financial interests." ¹⁷ Similarly, Helleiner's references to ideological shifts and epistemic communities exemplify well the main elements of the cognitive model, also echoed by others. The former element, the role of ideas, is highlighted as well by Cerny, who stresses "an ideological backlash against state economic interventionism" as a key part of the dynamic driving market deregulation. ¹⁸ The latter element is highlighted as well by Stephen Gill and David Law, who in quasi-Marxist language stress international patterns of elite interaction [which] are explicitly concerned to foster a shared outlook among the international establishments of the major capitalist countries [and] to produce a transnational capitalist class or class fraction with its own particular form of "strategic" class consciousness. ¹⁹

Plainly, the array of potential influences behind state policy is both diverse and complex.

So how did globalization happen? Amidst the cacophony of voices championing one or another version of events, the relative utility of the four models and the interrelationships among them remain unclear. Most sources, wary of monocausal interpretations of history, appear to concur with Cerny's assertion that "it is impossible to rely on any one form of explanation." ²⁰ Many seem tempted to fudge the issue simply by citing multiple factors more or less indiscriminately. With their carefully executed historical studies, Helleiner and Sobel stand as worthy exceptions to more general practice. Yet even their treatments fall rather short of the demands of complete and formal comparative analysis. Helleiner, while stressing the role of government policies, may certainly be faulted for failing to go behind observed decisions to explore fully alternative motivations for state behavior. Sobel, meanwhile, intent on proving his inside-out hypothesis, appears to understate greatly the role that external forces undoubtedly played in eroding internal resistance to change. Sobel also appears to contradict himself by insisting on the significance of residual distinctions between national markets even while simultaneously alleging homogenization of financial technologies through the embedded influence of U.S. actor preferences. Given such gaps and inconsistencies, it is evident that we are still far from resolving the central question of causation.

A fuller explanation would focus on dynamic linkages among factors highlighted by the four models, particularly as they influenced state calculations of interests over time. A hint of what this might look like is suggested by John Goodman and Louis Pauly, who note a powerful dialectic at work in the relationship between market forces and public policy--government actions in one period leading to increases of capital mobility that in turn have generated pressures for widening liberalization in subsequent periods. ²¹ A prime example was the Interest Equalization Tax imposed by the United States in 1963 in an effort to stem foreign-bond sales in New York. One consequence was the stimulus this provided to growth of the Eurocurrency market in London, which in turn eroded the effectiveness and raised the cost of existing restrictions on financial flows and eventually led governments to grant even more freedom for private operations. "In this sense," Goodman and Pauly write, "the diminishing utility of capital controls can be considered the unintended consequence of other and earlier policy decisions." ²² What we need now is more rigorously detailed study along such lines, not just to compare alternative hypotheses but, more importantly, to explore the complex underlying connections among them.

What Does It Mean

Even less consensus exists concerning the consequences of financial globalization. As the divergent results of the remaining books make clear, views range from the hopeful to the hopeless. Some economists, with their faith in neoclassical theory, might argue optimistically that the resurrection of global finance represents, in effect, the best of all possible worlds. Other observers, more pessimistically, might simply nod their heads sadly in agreement. At issue is the role of markets versus governments in the management of international capital. Are we better off if the phoenix rules the roost? Or do we simply have no choice?

Analytically, the consequences of globalization may be addressed at two very different levels--at the macro level, with implications for aggregate economic performance and the effectiveness of national stabilization policies; and at the micro level, with implications for domestic distribution and the role of public policy in structuring private activity. Sensationalist sources tend cavalierly to compound the two. "Governments at all levels have lost the vestiges of unchecked economic sovereignty," says one; ²³ "politicians these days have no doubt where the power lies," asserts another. ²⁴ The distinction between the two levels, however, is critical to a full understanding of practical consequences.

The Macro Level

The core issue at the macro level, long familiar to economists, is best summarized in terms of what I have elsewhere labeled the "unholy trinity"--the intrinsic incompatibility of exchange-rate stability, capital mobility, and national policy autonomy: ²⁵

The problem simply stated, is that in an environment of formally or informally pegged rates and effective integration of financial markets, any attempt to pursue independent monetary objectives is almost certain, sooner or later, to result in significant balance-of-payments disequilibrium, and hence provoke potentially destabilizing flows of speculative capital. To preserve exchange-rate stability, governments will then be compelled to limit either the movement of capital (via restrictions or taxes) or their own policy autonomy (via some form of multilateral surveillance or joint decisionmaking). If they are unwilling or unable to sacrifice either one, then the objective of exchange-rate stability itself may eventually have to be compromised. Over time, except by chance, the three goals cannot be attained simultaneously. ²⁶

As capital mobility has increased, so too has concern about its implications for the effectiveness of independent monetary and fiscal policies. ²⁷ Goodman's study, though focused on central banking alone, is typical. With accelerating financial globalization, he suggests, a government's room for maneuver is necessarily reduced. In effect, the stringent logic of the unholy trinity imposes an increasingly stark trade-off on policymakers. Autonomy of national policy can be preserved only by giving up some degree of currency stability; an independent exchange-rate target can be maintained only at the cost of reduced control over domestic macroeconomic performance. Over time, states begin to pay a higher price for divergent behavior owing to the risk of capital flight. Ultimately, the cost of defending policy independence may simply become too high to bear. In Goodman's view, these developments have therefore "increased the overall pressure for monetary convergence [and] created new incentives for monetary policy cooperation" (p. 217). Andrews, concurring, calls this the "capital mobility hypothesis": ²⁸ "The central claim associated with the capital mobility hypothesis is that integration has increased the costs of pursuing divergent monetary objectives, resulting in structural incentives for monetary adjustment." ²⁹

How serious is the challenge of the capital mobility hypothesis? Certainly examples abound that would seem to testify to the strength of the constraint imposed on governments. Goodman cites the case of France in 1983, where at a time of sluggish growth in Europe a new socialist administration was compelled to abandon its agenda of unilateral expansion by a speculative run on the franc (pp. 126-39). More recently, beginning in late 1994, much the same happened to Mexico when foreign as well as domestic investors lost confidence in the country's economic management, forcing incoming President Ernesto Zedillo to introduce an austerity program of unprecedented severity. Once Mexico's bond rating was marked down by agencies like Moody's Investors Services, the handwriting was on the wall. Policymakers had to do whatever they could to restore their own credibility. As one commentator observed:

That makes Moody's one powerful agency. In fact, you could almost say that we live again in a two-superpower world. There is the U.S. and there is Moody's. The U.S. can destroy a country by leveling it with bombs; Moody's can destroy a country by downgrading its bonds. ³⁰

In reality, however, the discipline of the financial marketplace may be less than it appears for at least three reasons. In the first place, there are limits to just how much can be accomplished by independent monetary and fiscal policies even in the absence of a high degree of capital mobility. The challenge to policy autonomy matters only to the extent that available policy instruments (the money supply or government budget) can be assumed to have a genuine influence on "real" economic variables like output and employment. In effect, there must be some sustained trade-off between unemployment and inflation-technically, a negative slope to the Phillips curve. Today, however, the conventional view among economists, inspired by so-called rational-expectations theory, is that there is no such trade-off, at least not for long--no permanent slope to the Phillips curve. Over relatively extended time horizons, policy is more apt to be neutral with respect to real output, influencing only prices or interest rates. Monetary or fiscal initiatives may have a significant impact on aggregate performance, but their effects are not likely to be lasting. Insofar as policy autonomy continues to matter, therefore, it is mostly for the short term.

Second, it is also important to recall the still limited scope of financial globalization in the contemporary world. The power of Moody's to destroy a country is effectively contained to the extent that capital mobility remains short of absolutely perfect. As Sylvia Maxfield has pointed out, moreover, not all international investors are equally sensitive to monetary or fiscal changes in host countries. ³¹ Governments thus still retain some room for maneuver to pursue independent policy objectives.

Finally, it is important to recall that, within limits, a trade-off continues to exist between policy autonomy and currency stability. Even if a capital flight does develop, officials have some choice-to sacrifice either domestic targets or the exchange rate. Investors anxious to switch out of local assets must, collectively, find buyers for their claims. Unless the central bank steps in as residual buyer of its own currency, however, the impact of a loss of confidence will be seen in asset prices and the exchange rate rather than in the government's own programs. In other words, economic policies at home need not be fatally compromised as long as the authorities are willing and able to tolerate a degree of currency volatility abroad.

In practice, to be sure, this is a luxury that not all economies are able to afford. The insulation provided by a floating exchange rate is partial at best: most countries find it difficult to protect themselves completely from all the negative consequences of currency instability. For economist Barry Eichengreen, this means that the logic of the unholy trinity has now in effect eliminated the policy-autonomy trade-off altogether. Governments, he argues, can no longer hope to contain market pressures by means of contingent exchange-rate rules. In the future, "countries that have traditionally pegged their currencies will be forced to choose between floating exchange rates on the one hand and monetary unification on the other. The middle ground of pegged but adjustable rates and narrow target zones is being hollowed out." ³² But this conclusion rests on an unspoken, and highly debatable, judgment about the political calculations involved. Eichengreen asserts that "the capital mobility characteristic of the late twentieth century" makes pursuit of independent policy objectives "extremely costly and potentially unsustainable politically." ³³ Note, however, that it does not make national autonomy impossible. The option continues to exist, albeit at a price. How can we be sure what price will turn out to be unsustainable politically?

Thus while the challenge of the capital mobility hypothesis is obviously serious, and no doubt growing, governments do not appear in fact to have been wholly deprived of macroeconomic authority--at least, not yet. The interesting question, therefore, is not whether financial globalization imposes a constraint on sovereign states; it most clearly does. Rather, we should now be asking how the discipline works and under what conditions. What accounts for the remaining room for maneuver, and why do some countries still enjoy more policy autonomy than others? These issues point the way for future research in this area. It is time to move beyond broad generalizations about the logic of the unholy trinity to more disaggregated analysis of the complex linkages between global finance and domestic performance.

On these linkages, only a few intriguing hints can be found in the literature to date. Goodman, for example, stresses the role of central-bank independence in enhancing the credibility of a state's macroeconomic policies. A monetary authority that is legally distinct from the elected government can give greater assurance that decisions will be insulated from domestic political pressures. The argument appears to have something of a catch-22 quality about it, since it suggests that the only way to avoid speculative capital flows is to do what the market wants; in effect, to save policy autonomy, it must be surrendered. There may nonetheless be an important insight here, if reputation today provides some room for maneuver, if needed, tomorrow. The degree of central-bank independence, along with structural differences in relations between private banks and industry, is also stressed by Randall Henning as a crucial determinant of national-policy choices involving the exchange rate. ³⁴ Along somewhat different lines, Goodman and Pauly emphasize "generic types of external pressure," ³⁵ which are identified with persistent current-account surpluses or deficits in the balance of payments. Since in standard monetary theory such imbalances are understood to reflect an economy's underlying saving and investment propensities, this amounts to suggesting a systematic difference between capital importers and capital exporters in their respective vulnerabilities to market forces. Andrews, meanwhile, mentions size and openness as factors that may help account for variations in state willingness to tolerate trade-offs of currency volatility for policy autonomy. ³⁶

Plainly, more could be done to explore linkages of these kinds. Particular use might be made of the contemporary theory of optimum currency areas (OCAs), well developed by economists, which highlights the advantages or disadvantages, as seen from a single country's point of view, of abandoning monetary sovereignty to participate in a currency union or an equivalent regime of irrevocably fixed exchange rates. ³⁷ OCA theory identifies a number of key characteristics that may be regarded as instrumental in a government's decision to surrender authority over its exchange rate. In addition to a country's size and openness, these include such economic variables as wage and price flexibility, factor mobility, geographic trade patterns, the degree of commodity diversification, inflation trends, and the source and timing of payments disturbances. These particular characteristics are singled out because they may be assumed to influence, to a greater or lesser extent, the degree of insulation afforded by a floating currency. To this list one might also add political variables such as state capacity, electoral politics, and foreign alliance or treaty commitments. The number of conditions that might influence the preferred trade-off between policy autonomy and exchange-rate stability is quite large. What is needed is more careful applied investigation of how each works in today's financially integrated world.

The Micro Level

The core issue at the micro level is the familiar one of whose ox is gored: who wins and who loses? As Frieden has reminded us, increased capital mobility may be "expected to have a significant impact on the interests of various domestic economic interest groups." ³⁸ It is also likely to influence government's ability to structure economic activity by remaking political coalitions and changing the pattern of lobbying over national policies. ³⁹ Here too increasing concern is expressed about possible barriers to the attainment of politically determined social goals. In Paulette Kurzer's words:

The growth of financial activities and the availability of many different kinds of financial instruments are major stumbling blocks for governments that desire to induce an increase in production or investments or a change of prices. High capital mobility and deepening financial integration prompt governments to remove or alter institutions and practices objectionable to business and finance. (pp. 7, 245)

The key, of course, is the financial sector's increased ability simply to take its money elsewhere. Recalling the language of Albert Hirschman, the bargaining strength of different groups in an economy may be thought to depend on the relative availability of the options of exit, voice, and loyalty. ⁴⁰ The greater a group's capacity to evade the preferences of public officials (exit), the more likely it is to give voice within the political system to promote its own desires and objectives. The government's ability to command loyalty will be correspondingly weakened. Financial globalization clearly enhances the leverage of investor interests by reducing barriers to exit. Owners of mobile capital thus gain influence at the expense of less fortunate sectors, including so-called national capital as well as labor. As Gill and Law put it, "The impact of increased capital mobility has worked to the advantage of large-scale transnational capital, relative to national capital and to labor, especially in the core capitalist states. These changes can be interpreted as signs of the emergence of a new regime of accumulation." ⁴¹

The result, many scholars fear, is likely to be both a dramatically more regressive income distribution and an effective veto over public policy. Wages will tend to fall relative to returns on capital, eroding the living standards of many citizens. ⁴² Even worse, governments will increasingly find themselves hostages to financial-market sentiment, compelled to take account of investor concerns at every turn. More than a decade ago Robert Bates and Da-Hsiang Lien explained how, historically, increases in the mobility of taxable property have always obliged political authorities "to bargain with those who possessed property rights over the moveable tax base and to share with them formal control over the conduct of public affairs." ⁴³ Today, with the resurrection of global finance, that imperative seems stronger than ever. Redistributive strategies are out; tax relief for financial interests is in.

Certainly Kurzer's study would seem to confirm the validity of such fears. In each of the four countries she examines, the abandonment of policies traditionally associated with social democracy--including numerous entitlement programs; redistributive incomes policies; and consensual tripartite exchanges among business, labor, and government - clearly appears linked to the postwar internationalization of finance. "This mobility allows business and finance to move with ease across borders into different money-making ventures and away from arrangements considered inflexible and outdated" (pp. 4-5). Ultimately, in all four countries, officials concluded that the cost of policy independence had become more or less unacceptable. None wished to provoke a major capital flight. Jonathan Moses offers a similar interpretation of the parallel experiences of Sweden and Norway:

Despite the fact that Sweden and Norway can be said to have relied on different strategies for meeting social democratic objectives, both strategies have proved ineffective in the new international economic environment. A new international economic regime, characterized by increased levels of capital mobility, has made traditional tools for government steering ineffective. [A]ll participants are subject to an iron law of policy. ⁴⁴

Broad evidence suggesting such an iron law can also be found in the recent evolution of national tax regimes, not only in Europe but in many other countries as well, including the United States. During the 1980s, which has been described as the "decade of tax reform," governments on every continent initiated major revisions in their tax codes designed inter alia to reduce marginal tax rates on capital and to restrict the use of tax policy as an instrument of economic management. Most specialists agree that a principal cause of these moves has been the fear of investor exodus made easier by the growing integration of financial markets. In the words of Sven Steinmo, "The battle for progressive (if not redistributive) taxation has been a difficult one. But as the power resources available to capital increase with its growing internationalism, it may be that the difficult battle will become a futile one." ⁴⁵

In practice, however, here too the discipline of the marketplace may be less than it appears. The indictment of global finance seems extreme. First, factors other than capital mobility may also have contributed to the outcomes described by Kurzer and others. To single out financial internationalization alone may be to mistake correlation for causation. ⁴⁶ Even with greater options for exit, moreover, capital's veto is not absolute. The globalization of finance obviously has increased pressures for general policy convergence toward an agenda set by investors. But a closer look suggests that room may still exist for implementation or preservation of distinctive national strategies and structures. Geoffrey Garrett and Peter Lange, for example, stress the role of more selective supply-side programs, such as policies targeted to shape investment incentives or labor-market practices, which have enabled "governments of the left" to maintain traditional redistributive and welfare goals while simultaneously adjusting to the demands of investor interests. ⁴⁷ Financial-market integration has not made separate social goals impossible, they argue. Rather, it "has altered the policy instruments through which governments can pursue their partisan objectives." ⁴⁸ Likewise, Pauly has emphasized the extent to which diversity in national financial structures persists despite increasing international mobility of capital. ⁴⁹ The iron law would appear to be less of a handicap than commonly thought.

Hence once again the interesting question is not whether financial globalization imposes a constraint, but how and under what conditions. Here too it is time to move beyond broad generalizations to a more disaggregated analysis of the diverse relationships at work. One key might lie in the distinction between national and transnational capital, which could help to explain observed differences in pressures for convergence at the sectoral level. As Frieden has noted, "Inasmuch as capital is specific to location, increased financial integration has only limited effects on policies targeted at particular industries." ⁵⁰ Other keys might be located in domestic institutional variations of the sort examined by Kurzer or in differential interest-group pressures as emphasized by Helen Milner. ⁵¹ These could be thought to affect the ability or willingness of political authorities to bear the costs of policy independence. At the micro level no less than at the macro level, more careful applied investigation is needed to see how any of these linkages might actually work.

What Can Governments Do about It

The practical consequences of financial globalization thus seem rather more nuanced and contingent than they appear at first glance. Increases of capital mobility have clearly diminished the effective autonomy of states. On the other hand, public officials still retain some room to pursue independent policy agendas. Across countries as well as over time, outcomes may vary considerably depending on an identifiable range of economic and political factors. From a political-economy perspective, therefore, it would seem important to ask what governments can do, if anything, to promote outcomes more to their liking. Even if it does not rule the roost, the phoenix can make life difficult for policymakers. Can it be tamed?

This brings us back to the issue of reversibility. To relax the constraint on policy, capital mobility would have to be reduced significantly, or at least managed more successfully. This would no doubt be both difficult and costly. Are governments prepared to pay the price? Two broad strategies seem possible, one unilateral and one collective. Neither is without problems.

The first approach would be the more direct. States would simply seek to limit capital mobility on an individual basis. In principle, any government has the means available to reverse the process of financial integration for its own economy. All it requires is the will to impose new taxes or controls of sufficient severity to effectively eliminate opportunities for substitution between domestic and foreign claims. As Pauly suggests, "states can still defy markets" if they so desire. ⁵² The costs involved, both economic and administrative, are apt to be quite high, however, unless all governments are prepared to act in concert. In practice, therefore, comprehensive unilateral initiatives would seem unlikely except in the most dire of circumstances, such as a foreign-exchange or national-security crisis.

The alternative, collective approach would seek to promote policies of active collaboration to ease or eliminate the constraints imposed by financial integration. This is the path advocated by both Goodman and Kapstein. While disagreeing on specifics, both scholars concur on a general need for political governance to catch up with global finance. In Kapstein's words, "The idea of globalization challenges public officials, who are responsible to their societies for ensuring economic welfare and national security. In an international system which lacks any higher authority, citizens must look to the state for the protection of their well-being" (p. 1). Governments thus must be prepared to merge selected elements of their sovereignty to preserve their capacity to fulfill established responsibilities.