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The Return of Political Economy

Saturday 14 May 2016

By Antonia Colibasanu

September 22, 2015

The second decade of the 21st century has been marked by the return of political economy, as realpolitik has replaced the globalization theme in the framework of geopolitics. Considering the key events in 2014 - the Ukraine crisis being the most prominent, but also the fall in the price of oil and the struggles of the eurozone - relative standing in the global economy is now one of the most important factors in the relations between major geopolitical actors.

Military alliances are reinforced by economic linkages among the allied countries. Regional integration efforts take into account market opportunities and risks as well as security challenges. Two agreements currently under negotiation - the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership - have the potential to create a new level of coordination between the United States and its partners. The accords would not only impact trade, but also aim at regional regulatory harmonization. The two partnership blocs, covering the Atlantic and the Pacific, would add political ingredients to economic interdependencies, positively influencing security coordination among partner states.

The return of political economy for global interdependencies

In the post-Cold War period, globalization was defined through diminishing trade and investment barriers. This created growing interdependencies among nation states, suggesting that liberalized markets and open democracies were the recipe for prosperity. Statistical data observed in both trade and investment stands as proof of how markedly global integration developed from the early 1990s until 2008. Eastward expansion of NATO and the European Union, coupled with the secure dominance of the world’s oceans by U.S. naval forces, seemed to create the framework for a world dominated by Western values. It was a framework for complete peace - a peace guaranteed and supported by the integration of the global economy.

The processes that developed in the 1990s convinced everyone that global integration was not only achievable, but would also provide the needed support for global sustainable development. In that spirit, in 2001 the World Trade Organization launched the Doha Round of talks.

Members convened in Qatar, hoping to spur developed and developing countries to compromise on conflicting trade policies. It was high time for true globalization, and the participating countries hoped to free up markets in agriculture, manufacturing, and services. The deadline of January 2005, set in Qatar, was never reached, while signs of failure began to show as early as 2003, when participants started missing deadlines on deals, and a September WTO meeting in Cancun, Mexico, collapsed.

The financial crisis of 2007-2008 further illustrated the vulnerabilities created by interdependencies. Finally, as the Ukraine crisis unfolded, 2014 affirmed the dominance of the political in "political economy" - a return to the realpolitik game of power. With the West having enough problems of its own, it took awhile for Europe to enforce sanctions. Once they are installed, it was a political decision, one that marked a return to hard economic competition at the global level. There’s also the speculation around the oil price drop and the so-called currency wars, but it was the sanctions that essentially showed that everything is political after all. The dream of a closely integrated world driven by market forces - the main ideological trend of the 1990s - has shown its limitations, as recent events revealed that the nation-state remains a key player in international affairs.

In the second decade of the 21st century, we entered into the post-post Cold War period, and the nation state is reaffirming itself as the core actor in the global system. Adam Smith and David Ricardo are required reading once again, with the insights they provide on the links between politics and economics - and ultimately, societal well-being. While the "invisible hand" seemed to work best during the 1990s and the beginning of the 2000s, showing that efficient markets can be the outcome of individual decision-making processes, what became evident from the financial crisis of 2007 is that those choices were framed by the political systems in which they were made, just as the political systems were shaped by economic realities. This is a recurring theme of Smith’s "Wealth of Nations." In similar fashion, Ricardo’s competitive advantage theory appears to stand at the core of international negotiations both within and outside the alliance framework. Taking into account the three power pillars for nation-states - politics, economics and military - classical economists teach us a great deal about the relationship between political and economic life, improving our understanding of the security fundamentals that set the basis for military strategies.

2005-2008: A Pivotal Triennial

Multilateral negotiations on global trade and investment regulation have been put to a halt since 2008, when the Doha round talks in Geneva ended with no result. Instead, regional integration initiatives have picked up. After consultations that began in 2005, the United States and the European Union in April 2007 signed the Framework for Advancing Transatlantic and Economic Integration, the document which led to the first version of the Transatlantic Trade and Investment Partnership, or TTIP, in 2011. In November 2009, U.S. President Barack Obama announced Washington’s intention to join negotiations for the Trans-Pacific Partnership, or TPP, an initiative launched in July 2005 as an expansion of the Trans-Pacific Strategic Economic Partnership Agreement by Brunei, Chile, Singapore, and New Zealand. Ironically, both TTIP and TPP are ideas from the year 2005, the presumed and failed deadline for the Doha Round. Negotiations for regional integration have slowly replaced those for global integration, leaving some of the ideals of globalization behind.

In 2008, the financial crisis crossed the Atlantic, first into Europe and then on to Asia. While the crisis was felt more strongly in Europe in 2009-2010, it was in 2008 that it evolved from a national crisis to a global one. It was the aftermath of the financial crisis that installed political economy as the new realpolitik. At its core, the financial crisis was in fact a legitimacy crisis, bringing the financial and the political elites under question for their roles in the capital market. The current evolution of the crisis on the Eurasian continent is shaping geopolitical dynamics. The origins of the financial crisis stand in the risks created by interdependencies. The financial markets being interdependent, the crisis spread very fast - until 2008, no one thought interdependency and global markets could be something bad, because globalization was basically taken as a positive phenomena. However, globalization, especially in the financial markets, meant low or no regulation, and therefore no protection for local and national economies.

The origin of the financial crisis - the subprime meltdown in the United States - has appeared as a consequence of the financial system generating paper assets whose value was dependent on the housing prices, assuming that the prices would either always rise - or whose value, even if fluctuating, could still be calculated.

Instead, when the price of housing declined, the paper asset became indeterminate. The financial crisis broke out in the United States, and, because EU financial institutions also bought the paper assets, it spilled over the Atlantic. The financial elite was perceived at the time as violating principles of social and moral responsibility in its pursuit of profit. At the same time, the political establishment was seen as incapable of setting up the needed regulations to prevent the financial elite from manipulating the financial system to its own benefit in an uncontrollable manner. Thus in the aftermath of the crisis, the legitimacy of the financial and political elite is under scrutiny.

In addition, the management of the crisis, involving government intervention and bailouts, with direct consequences both on sovereign debt levels and on state power, has prompted new considerations on the link between politics and economics. For Europe, the political crisis was also deepened by the disproportionate economic problems within the European Union. Europe did not act as a single unit to deal with European banks, working instead at the national levels and through the European Central Bank. As the crisis deepened and the recession generated more problems for peripheral countries such as Greece, two narratives evolved. One is the German version, holding that Greece fell into a sovereign debt crisis because its government maintained social welfare programs far exceeding its scope for funding, and now the Greeks were expecting the European Union to bail them out. The narrative shared by Greece and other peripheral European states is that, through Europe’s free trade zone, Germany created captive markets for its goods, while the importing countries, members of the same monetary club, couldn’t devalue their currencies. Furthermore, it seemed that the European Central Bank favored Northern Europe in general, and Germany in particular, during the first stage of the financial crisis on the Continent, considering its focus on keeping inflation low.

The debate over solutions for the eurozone crisis has underlined the different political approaches of the member states. As discussions have devolved into a blame game between southern and northern countries, the risk of fragmentation of the European Union has further increased.

Recession in the United States and Europe affected Asian economies, particularly China and Japan. Considering the export market dependency of those countries on both Europe and the United States, the Chinese government faced a possible unemployment crisis, as low exports could have slowed production, an eventuality followed by layoffs and factory bankruptcies. This could have led to massive social instability in the country.

Beijing averted the crisis through two main policy lines. The first was to keep production steady by encouraging price reductions, and the second was to extend unprecedented credit lines to enterprises facing default on their debts in order to keep them in business. The side effect of such policies was inflation, to which China responded (again) by increasing wages. This, in turn, again increased the cost of goods exported, making China’s wage rates less competitive. The global financial crisis has forced Beijing to seek out and speed up structural reforms, putting household private consumption at the core of the new economic model China seeks to implement. All this has in fact increased the government’s political control over the economy.

Japan, already facing economic problems at the end of 2007, has had to deal with both the effects of a strengthened yen, which already made its exports expensive, and with the global slowdown. Ultimately, Japan’s response was the three-part plan called Abenomics promoted by Prime Minister Shinzo Abe. The plan aims to revive Japan’s economy through structural reforms that also serve to frame a new economic model for the country. Part of the plan is making use of the Trans-Pacific Partnership to launch strong domestic reforms.

For Russia, 2008 was the year of war with Georgia - an event Moscow used to make its resurgence visible at the global level. Moscow’s goal was to show former Soviet states seeking alliances with the European Union and NATO that the West could not back up its security commitments.

The root of the Georgian conflict is found in the West: the expansion of the European Union and NATO into Eastern and Central Europe was undermining Moscow’s influence, and the Kremlin decided it had to do something about it. The West’s recognition of Kosovo’s independence from Serbia - a traditional ally of Russia - in early 2008 set the process of war in motion. Between 2000 and 2007 Putin’s priority was to "clean house." The Kremlin recentralized the country politically under a pro-Putin political party, and socially by rallying nationalism. Economically, the Kremlin recentralized the majority of business and financial drivers in the country by creating state champions for energy, banking, and other sectors. As the Kremlin’s control over Russia intensified, Moscow turned its attention to its periphery and to the growing pro-Western movement on the edge of the Russian sphere of influence. The pro-Western revolutions in Georgia in 2003 and in Ukraine in 2004 served as a wake-up call for Moscow. In the early 2000s, Russia used energy as the primary tool to influence Europe and penetrated European business circles. It also sought to understand and use to its advantage the European Union’s socio-political problems, and the incomplete integration of the Union. The Europeans have since followed through with some of their plans for energy diversification, and Russia is facing increased economic problems, also as a result of the sanctions imposed by the West; Moscow’s tools for influencing the EU have thus also weakened.

Interdependencies mean, under these circumstances, that countries can use economic policies as foreign policy and security tools. Political economy has been used at the global level to rebalance power among the resurging world’s regional leaders. Aversion to the risks involved in establishing global interdependencies leads to regional capital constraints, both on trade and investment. At the same time, increased regional integration through the establishment of smaller clubs for trade and investment leads to the existence of competing trade and investment regimes. Still, such clubs facilitate more effective coordination among member states; they create trade rules that serve the states’ interests and increase their outward relative power.

The meaning of partnerships

The Trans-Pacific Partnership, as well as its so-called companion, the Transatlantic Trade and Investment Partnership, are adding a new dimension to regional integration. They aim to create a common market among the participants, not just a free trade zone. The proposed partnership would establish a unified set of regulations that not only address the tariff and non-tariff trade barriers but also formulate the investment rules, creating solid, long-term links among countries. This way, the established partnerships are looking to balance political relations among countries in order to alleviate any future geopolitical and security dilemmas.

For Asia, post-Cold War globalization meant an increase in regional trade interdependency, particularly with China, while maintaining a constant pace of trade links with the European Union and the United States. While dependencies on China increased, those on the European Union and the United States decreased. ASEAN - the Association of South East Asian Nations - has been one of the catalysts for growing regional cooperation. Integration, however, did not follow. To answer the need for more coordination and market access, the Trans-Pacific Partnership was conceived in 2006 by Singapore, New Zealand, Chile, and Brunei, out of the foreseeable failure of the WTO Doha round. The United States became officially involved in 2009, after the Doha round collapsed.

The TPP is designed to increase trade in Asia but it is also a response to growing Chinese economic ties in one of the most economically vibrant regions of the world. While speculation that China may join negotiations has bounced around in the media, Obama clarified the relationship between the TPP and China in an interview with the Wall Street Journal in April 2015. He said that if the "U.S. doesn’t enact a free-trade deal with Asia, then China will write the rules in that region". The United States wants to create a framework across the Pacific that will become the reference point for any future big regional trade liberalization initiatives.

In this sense, the TPP truly became a grouping of global relevance in 2013, when Japan joined negotiations. Tokyo’s decision followed Sino-Japanese diplomatic tensions over the disputed Diaoyu/Senkaku island chain in 2012, and it came after Japan lost the title of world’s second largest economy to China at the end of 2010. It has also been presented as a component of Abenomics. The TPP negotiations on trade liberalization represent for the Japanese government an opportunity to use external pressures to implement reforms in important domestic sectors such as agriculture, healthcare, and finance. From a strategic viewpoint, the TPP represents a new level of cooperation with the United States, at a moment when tensions may rise further with China, taking into account the very different positions of the two countries in their developmental history and in East Asia’s balance of power.

The incentives for the other countries considering to join the Pacific partnership revolve around the eased access to the U.S. market as a supplement to China’s, at a time when, after the financial crisis, the United States is experiencing a more robust recovery than is occurring elsewhere in the world. At the same time, the countries in the region seem to share the common strategic prerogative that while it is good to maintain economic ties with China, they need to have strong security ties with the United States. And TPP, through the large set of items being negotiated, is creating the bridge for a new level of coordination between Washington and its partners. A similar dynamic is at play with TTIP for the EU-U.S. relationship.

It is not by chance that both TPP and TTIP became "serious plans" in the very same year. They share an ambitious agenda, involving more than just trading goods. The pacts refer to more structural issues, such as services and investment. The currently negotiated partnerships - covering the Atlantic and the Pacific - are in fact bringing inter-regional integration to a new level, aiming to set a higher bar for all countries interested in doing business with the partners belonging to the club. They add political ingredients to economic interdependencies, making improvements in security coordination possible in the future. BRICs - the entity formally set up in 2008 (another interesting coincidence on the timeline) between Brazil, Russia, India, and China, and later taking on South Africa in, is being left out of both the TTIP and TPP discussions. The group will ultimately have to decide whether or not to join a market dominated by the two grand partnerships, or to continue developing alternatives to the Bretton Woods institutions.

If the TPP aims to establish a framework for competing against Chinese dominance in the region, TTIP is set to bring Transatlantic relations to a new level, at a time when the European Union is struggling with structural problems and with a resurgent Russia to its east. Considering that China and Russia are likely to enhance their political and economic cooperation in the future, these trade and investment partnerships mean to work as a Western, U.S.-led force for rebalancing global power. The instruments of geo-economics such as productivity, trade balances, or foreign investment are well-linked to military power, geography, and demographics in an era of inter-regional integration and competition - all at work using the realpolitik principles of classic political economy.

See online: The Return of Political Economy