In rejecting the use of force in Syria, the British parliament did more than deal a blow to U.S. efforts to organize an international coalition against the deployment of deadly chemical weapons in Syria. Last week’s unexpected development also confirmed a phenomenon that has been clear in economics and finance for a while: countries are turning more insular, even when there are good reasons to believe that collective international action would dominate individual domestic responses. In turn, this has contributed to a global economy that continues to operate below potential and faces renewed risks of financial instability.
The post World War II period was one in which the West recognized the power of coordinated responses, and acted on it. They wisely used structure to do some of the heavy lifting, forming a network of multilateral institutions and processes. This was supplemented by periodic summits that, unlike today, were driven more by substance and less by public relations – most notably among the G-7 (led by the U.S. and consisting of Canada, France, Germany, Italy, Japan and the United Kingdom). And bilateral relationships were anchored not just by common values and aspirations, but also by a unified assessment of external threats.
This Western-dominated architecture contributed in consequential ways to economic, political and social achievements. It also proved mostly effective in countering unexpected shocks.
Recall how the West catalyzed most of the world to counter Iraq’s invasion of Kuwait; and, on the economic front, the coordinated response to the financial crises of 1994/95 and 1998/99, as well as earlier collective action to deal with major currency mis-alignments within the G-7.
More recently, the architecture proved useful in encouraging the multi-country policy response that proved instrumental in preventing a disastrous global depression in the aftermath of the 2008 financial crisis. Indeed, the overall effectiveness of the April 2009 G-20 meeting in London now constitutes the peak of recent global economic coordination.
Over time, however, the West has found it hard to evolve this architecture to keep up with major global realignments, let alone get ahead of them. Steadfast adherence to outmoded historic entitlements and stubborn mindsets were major hindrances, as was the erosion in western countries’ global economic power and influence (particularly relative to the economic breakout performance of emerging economies).
Unusually high unemployment, increasing income inequality and persistently sluggish growth imparted a heavy domestic bias to the policy narrative in the West. Meanwhile – and especially with multilateral institutions consistently handicapped by obvious representation, voice, governance and legitimacy deficits – there were few effective ways to channel and incorporate the growing influence of emerging economies.
It is therefore not surprising that Western policy formulation has paid little, if any attention to global spillover effects. It is also not surprising that global economic outcomes have fallen short of both historic achievements and, more tragically, what is needed, feasible and desirable.
Whether it is the overwhelming domestic bias of unconventional monetary policy in Japan and the U.S. or the loss of momentum in trade negotiations, the ex-post rationalization in the West has relied on some combination of three distinct arguments: It is legitimate to use domestic measures to pursue domestic objectives; the rest of the world would end up better off by adopting measures that are focused on improving Western economic performance; and it is the responsibility of emerging economies to adjust to what the West is doing.
The rationalization in emerging economies has been more diverse. Having said that, there is a common perception – that of an unequal global standards, with the West failing to internalize the importance of more equal voice and representation, starting with multilateral institutions such as the International Monetary Fund. Also, having acquired systemic importance quite suddenly, some countries find it hard to reconcile their new global responsibility with their domestic situations.
Each of these arguments has merit on a standalone basis. Yet, as the world has been finding out when it comes to dealing with shared economic challenges, the aggregate result is an overly narrow and excessively-insular characterization for today’s global realities.
Traditional Game Theory provides useful insights on why legitimate individual actions can lead to outcomes where welfare is neither maximized for each of those involved nor for the group as a collective. It also helps with understanding what is needed to improve outcomes.
Consider in particular the now-famous formulation of the “prisoners’ dilemma” that speaks to the rational decision making of two prisoners subject to individual interrogation. Unable to coordinate and lacking the mutual assurances that would enable each of them to opt for the unambiguously superior result, each prisoner ends up rationally opting for suboptimal outcomes in both the individual and collective sense (i.e., neither Pareto optimal nor Pareto efficient).
Consider this dynamic when you think about four of the major economic shortfalls of the recent past:
· For years, widespread recognition of the imbalanced nature of global demand has been reflected in little action to address a problem that restrains economic activity and increases the risks of financial instability.
· Efforts to enhance the regulation and supervision of the financial sector are being undermined by an increasing number of countries opting for home-grown standards rather than internationally-coordinated ones.
· Too many creditor-debtor relationships (most notably in Europe but also inside the U.S.) are undermined by the inability of both sides to deal decisively with excessive debt overhangs. Debtors are thus forced to behave in ways that reduce their creditworthiness further and damage growth prospects. This also erodes the net present value of the legal claims that creditors hold.
· Efforts to counter widespread environmental degradation are diluted by the inability to assign cross-border responsibilities effects and deal with externalities.
The main difficulty in each of these cases is not the lack of “engineering” solutions. They exist and, in most cases, command sufficient technical consensus. The problem is the lack of political cooperation needed to ensure proper formulation and sustained implementation.
Countries find it hard to agree on collective action when there are uncertainties about proper enforcement and mutual accountability. It becomes even harder when domestic political constituents pull in opposite directions. It is then rendered virtually impossible when the role of global conductor falls victim to weak multilateralism and what Ian Bremmer has labeled the G-zero phenomenon.
The combined impact of such factors is to frustrate individual countries – and the global economy as a whole – from fulfilling their considerable potential. The consequences extend beyond the alarmingly high levels of unemployment facing today’s generation and foregone prosperity. They are also gradually undermining the opportunities open to future generations.
The latest twists and turns of international efforts to address Syria’s sad and deepening tragedy, including the heart-wrenching suffering of innocent civilians, confirm that the insights of Game Theory are not limited to today’s global economy. Indeed, many of the underlying contributors are similar.
Let us hope that the combination of skillful politics and credible deterrence will prove more effective than economics and finance have been in overcoming today’s challenges of poor coordination and inadequate collective action.