Long-Term Implications of the Financial Crisis

Taking a step back from the fear gripping global financial markets, many analysts are starting to grapple with the long-term implications of the 2008 credit crisis. The financial breakdown, which originated in the United States, coincides with what many see as a shift from U.S. geopolitical dominance to a multipolar international framework. Here, Anne-Marie Slaughter, the dean of Princeton’s Woodrow Wilson School of Public and International Affairs, discusses what she sees coming of the turmoil.

Slaughter, a member of CFR’s Board of Directors, says she doesn’t see any city taking over as the world’s financial superpower, even if New York loses its financial preeminence. Rather, she foresees a more integrated network in which financial firms do business in many different regional financial hubs. In terms of U.S. geopolitical influence more broadly, she fears a fiscal pinch will lead to reductions in U.S. foreign aid, with potentially harmful side effects both for U.S. security and overall strategy. She also discusses rising global protectionism and a backlash against globalization, calling it "the biggest threat we face." She adds, however, that this backlash is most visible in developed economies, and that countries like India and China tend to take a more positive view of globalization.

For some time now, New York has arguably shared the distinction of being the world’s financial capital with London. But there are also smaller, regional financial hubs popping up and vying for influence. To what degree do you think the current financial turmoil will accelerate this shift, and what do you see as the implications for U.S. power?

I think on this one it’s what Fareed Zakaria calls the rise of the rest. I lived in Shanghai for the last ten months, and Shanghai is booming, and Hong Kong is booming, and Singapore is booming. London was already growing enormously so I would have said that London and New York together were the greatest concentration of global capital. That trend will continue regardless of this financial crisis. The problem is that it’s wrong to think that any one city can possibly be the source of global capital. If you look at the people who work in those cities, who work in New York, they spend their time hopscotching from one center to another. It makes much more sense to think of a network of global capitals that you can get capital from. All the major firms or the hedge funds or private equity firms operate in all of them.

So presumably you don’t think there’s any one city that’s ready to take on this financial superpower mantle, should New York fall.

There’s certainly no one city that’s going to do it, absolutely not.

Would that result in a more splintered financial system? What would be the geopolitical implications of that?

The global financial system is the most integrated part of the world. It is way ahead, certainly, of any kind of global political integration, but [it’s] even [ahead of] global social or global economic integration if what you’re talking about is movement of labor. Capital is the easiest thing to move. Think about what Sam Palmisano, the head of IBM, calls the globally integrated enterprise. ArcelorMittal, the steel company, doesn’t have a global headquarters. They meet in different countries around the world. That’s already this notion that it is a combination of cities and countries that are the global financial system, and no one is going to be so dominant that you can talk about it in those terms.

Given that dynamic, and presumably that interdependence--certainly one of the lessons of what we’ve seen over the last year has been of interdependence, at least of stock markets, maybe less so economies--how do you see the future of financial governance internationally?

There’s a difference between interdependence and integration. Interdependence, you’re still two distinct entities, and you each depend on the other. Integration, you are one entity. Part of my point is that we are seeing globally integrated companies, financial houses, and we are seeing increasingly a globally integrated financial system. Within that, to me what has been most important of this crisis in terms of global governance, has been the ability--now twice--for central bankers to operate very quickly together. That’s because they were the first network--I call them government networks--the Basel Committee was out there first. The central bankers were meeting each other on a regular basis. Were coordinating their positions. Were developing relationships of trust and knowledge. And just imagine where we’d be right now if we didn’t have that. The IMF [International Monetary Fund] can’t do anything because the IMF is an international entity. What we need is precisely coordinated action on the part of all those financial centers. I suspect what we’re going to see is a greater emphasis on formalizing those kinds of networks, tying them into international entities, and building on what’s already there as a function of the integration of the financial system.

And accounting standards as well?

Absolutely. Accounting standards, securities regulation, all of it.

Beyond finance, assuming the financial crisis brings some kind of fiscal pinch in the United States, and assuming there’s some pinch as well in what we spend internationally, what areas of spending do you think would be the most affected, and how would you see that playing out in terms of broad geopolitical influence?

I was very struck watching the vice presidential debate when Joe Biden [D-DE] was asked what would we cut back on, and the first thing he said was foreign aid. Of course, politically, that’s the first thing to go. Americans believe we spend up to 15 percent of our GNP [gross national product] on aid, when of course it’s tiny, it’s .02 [percent] or .03 percent. Politically, that would be easy to jettison. That would be truly terrible. One of the bright spots of the Bush administration has been the amount that it’s poured into key countries in Africa. From my point of view, as a security matter, as a strategic matter, this is not the time to cut back on foreign aid.

Other things--the most obvious is Iraq. We’re spending enormous amounts of money, and that’s already an issue. So in a time of fiscal constraint, it will probably also affect what we think we can sustain in Afghanistan, although again I don’t think that’s going to be a choice. We have to be in Afghanistan. But in terms of how we structure, what we can do, how long we can be prepared to stay, how we work with NATO [North Atlantic Treaty Organization], I can imagine that being a factor.

Overall, it’s going to force us to work with partners, which is what we should be doing anyway. We couldn’t even do it all by ourselves when we were economically as flush as we’ve ever been--in the early part of this decade. We’ve proved that we couldn’t do it ourselves. This is going to force us to consult and to work with others, and we need to be doing that.

International institutions--the United Nations, the World Bank, the IMF--obviously get a lot of funding from the United States. Is that something that could be pared back? And if so, what happens to them?

We’ve once again run up a very big debt to the UN. Many hope that a new administration, particularly if it is an Obama administration, but even if it’s a McCain administration, would start by paying off that debt. Now that looks less likely. A billion dollars to the UN at a time of fiscal crunch is going to be a hard political sell. That will just continue the budget crisis that the UN almost perennially finds itself in. I’m not certain that’s going to further diminish our influence in these organizations. The real problem is that these organizations are losing influence because they’re not actually able to do anything about these kinds of economic crises. Nor are they able to do anything about the kinds of political crises we’re seeing. The UN couldn’t really do anything in Georgia when Russia invaded Georgia. It was not in a position to do anything. It’s not in a position to send troops into Darfur to do the kind of work that you really need.

And economically, what everyone points out is that the IMF is almost invisible in this crisis. It’s just not a player. That’s in large part because after the Asian financial crisis, the Asian countries decided that they were not ever going to rely on the IMF again, and that’s when they started building their reserves. So the greater problem for these institutions is that, at least for some of them, they’re becoming increasingly irrelevant. What needs to happen is major reform, bringing in new voices, much more representative of the power structure of the world today. And then some reforms which in my view ought to include connecting up to these networks of national government officials who can operate much more quickly and much more flexibly.

You’ve also, in the past, recommended the idea for a new institution, a concert of democracies, which is an idea that John McCain has now parroted. Given a lack of U.S. economic dominance, an institution like that would presumably have to rely more financially on other countries that might have less strong democratic credentials. Could this undermine such a project?

John Ikenberry and I, who formulated the concept in the Princeton Project on National Security, are both on record--we wrote an op-ed in the Financial Times this summer--saying that this concert was never going to work if it was proposed by the United States. It was a nonstarter from the beginning. So from my point of view, the fact that the current financial crisis makes it even harder for us to think about that, that’s great. The only way this was ever going to work was if it came from countries like India, South Africa, Brazil, Indonesia. Interestingly, the Indonesians are starting--they’ve just launched--an organization of democracies in Southeast Asia. But it includes China. And I always say, China describes itself as a democratizing country, and I’d never want to be in a situation where you redivide the world and you have China on the other side. So the concept--this is not the right time for it, and it was never the right time for it as a U.S. priority. In terms of watching what’s happening in other parts of the world and supporting them tacitly to the extent that they’re working with fellow democracies, that’s great.

The one thing I would point out--Morgan Stanley just did a deal with a Japanese bank, a Japanese company, rather than a Chinese company. In times of financial crisis, the relative transparency of democracies is very important. It is not because democracies are better countries in some moral hierarchy. But what is critical to their being able to cooperate more closely is that each can see what the other is doing. That means that you’re much more willing to enter into agreements, particularly in times of trouble.

Globalization already faces some serious challenges--resource nationalism, protectionism--but if a worldwide recession is essentially blamed on globalized capital markets, does that serve to further undermine the popularity of the idea? And if so, what then?

That is the biggest threat we face--that this crisis will trigger global protectionism, global retreat. Politically you’re seeing this already in Europe, with various countries talking about possibly pulling out of the Euro. Protectionist sentiment was very strong in the United States even before this most recent crisis. You can well imagine various countries saying, "Look, this has not helped us."

On the other side, the major growth engines of the global economy--China and India and the rest of Asia, countries like Vietnam, Indonesia--there you don’t have a backlash against globalization. Those countries are very aware that whatever prosperity that has been coming in has been coming in because of their connection to the global economy. So we’ve got political battles to fight, but it’s more in the developed countries. It’s more to keep our markets open, and not start protecting particular groups or industries. If we can do that, I don’t think you’re going to have a global backlash against globalization. I think quite positively--while there are many people around the world who are saying, "This shows that the American economic model is not the right model to follow"--the notion of globalization being the same as Americanization, you don’t hear that as much. Globalization is something that China supports, it’s something that India supports, that many African countries that are doing well support, so I’m less concerned about a global reaction against globalization.