Comparative and International Political Economy and the Global Financial Crisis
Summary and Keywords
The 2008 Global Financial Crisis (GFC) and subsequent European Debt Crisis had wide-sweeping consequences for global economic and political stability. Yet while these twin crises have prompted soul searching within the economics profession, international political economy (IPE) has been relatively ineffective in accounting for variation in crisis exposure across the developed world. The GFC and European Debt Crisis present the opportunity to link IPE and comparative political economy (CPE) together in the study of international economic and financial turmoil. While the GFC was prompted by the inter-connectedness of global financial markets, its instigators were largely domestic in nature and were reflective of negative externalities that stemmed from unsustainable national policies, especially those related to financial regulation and household debt accumulation. Many in IPE take an “outward looking in” approach to the examination of international economic developments and domestic politics; analysis rests on how the former impacts the latter. The GFC and European Debt Crisis, however, demonstrate the importance of a (CPE-based) “inward looking out” approach, analyzing how unique policy and political features (and failures) of individual nation states can unleash economic and financial instability at the global level amidst deepened economic and financial integration. IPE not only needs to grant greater attention to variation in domestic politics and policies in a time of closely integrated financial markets, but also should acknowledge the impact of a wider array of actors beyond banks and financial institutions (specifically more domestically rooted actors like households) on cross-national variation in the consumption of foreign credit.
It is well acknowledged that that 2008 Global Financial Crisis (GFC) was not a good one for the economics profession. Even Queen Elizabeth, during a November 2008 visit to the London School of Economics, was puzzled as to why the credit crunch took the field by surprise. To the discipline’s credit, its scholars have slowly re-evaluated how they approach the analysis of economic crisis, while some of its leading thinkers have worked with policymakers to promote new independent institutes and think tanks (the Institute for New Economic Thinking being the most notable example) that encourage greater heterodoxy in the study of markets.
There is less of a consensus as to whether the GFC was a bad crisis for the field of international political economy (IPE). Mosley and Singer (2009) highlight that IPE scholars are not “in the business of predicting financial recessions” (p. 420). Others have been more critical, outlining that either IPE was not effective in anticipating crises in general and the GFC in particular (Cohen, 2009) or the profession had “surprisingly little to say” about the causes and consequences of it (Drezner & McNamara, 2013, p. 155). Hay and Green (2015) provide further criticisms of the discipline’s failure to wholeheartedly engage with the crisis, noting that internal divisions within it, between the American School (which concentrates on a positivist approach, underlined by the scientific method) and the British School (which assumes a more holistic, systematic approach), have diverted the field’s intellectual energies.
While IPE may be (comparatively, to the field of economics) off the hook in failing to predict the GFC and its aftermath,1 this crisis has outlined shortcomings in IPE’s approach towards financial booms and busts. Even though this crisis was a global one, IPE has been ineffective in accounting for the variation in crisis exposure across countries, especially those within the developed world (which will be the focus of this article). IPE and the economics profession more broadly highlight that the GFC and European Debt Crisis was the result of gaping global imbalances (Obstfeld & Rogoff, 2009), but aside from the United States, they fail to provide a more systemic account of what national features distinguish the crisis-exposed from the crisis-sheltered. Some developed countries (the United States and United Kingdom for the GFC, and Greece, Ireland, Italy, and Portugal for the European Debt Crisis) were hit particularly hard by crisis, while others (Germany and its corporatist, small-state satellites2) have fared comparatively well. This paper highlights how the field of IPE has important lessons to learn from the field of comparative political economy (CPE), which focuses on national political and institutional diversity, and, among other things, the shortcomings of ineffective and unstable national economic policies. In other words, in order to fully understand and appreciate the consequences of the 2008 GFC on nation states, IPE (whose emphasis is largely on international financial and trade developments) and CPE (whose emphasis is largely on national politics and policy) must be merged together.
The onus of IPE is to explain how financial liberalization, financial innovation (including securitization), international capital flows (including foreign and direct investment), and trade arise and how they impact domestic economies and domestic politics. There is a general consensus that while trade and international financial flows do not completely inhibit governments in the developed world from pursuing redistributionary policies (see Mosley, 2000), they do constrain governments’ policy and political decisions (Cooper, 1985; Milner & Keohane, 1996; Friedman, 1999; Rodrik, 2000; Boix, 2000). These IPE scholars take an “outward looking in” approach to international economic developments and domestic politics; analysis rests on how the former impacts the latter. The 2008 GFC and subsequent European Debt Crisis, however, have emphasized the importance of an “inward looking out” approach, analyzing how unique policy and political features (and failures) of individual nation states can unleash economic and financial instability at the global level amidst deepened economic integration. After all, though securitization and proliferation of cross-border financial flows exacerbated the transfusion of the GFC across borders, its lynchpin ultimately lay in the bursting of the U.S. housing bubble (Helleiner, 2011, p. 69), which itself was based upon domestic policies aimed at promoting homeownership and easing bank lending regulations regarding the extension of mortgages (Congleton, 2009).
In merging and IPE and CPE understandings of the “global financial order,” this article argues that the GFC and European Debt Crisis were crises of negative policy externalities in the midst of increasing interdependency. In other words, policy failures within individual nations were able to spread to other countries given their financial and economic interdependencies, unleashing economic havoc across the developed world. Taking an “inward looking out” approach, this essay highlights that these two crises came to pass because increased financial and economic integration caused the costs of poor and unsustainable policy choices within individual nation states to spill over into countries with which they shared trading and financial relationships. This argument rests upon two premises: greater attention should be granted to variation in domestic politics and policies in a time of closely integrated financial markets; and greater attention should be granted to domestic households in their roles as consumers of credit and domestically rooted actors more generally, rather than merely global banks and financial institutions. By highlighting these national institutional and political features that lead to economic instability, CPE can help IPE better understand the chain of events that led to the GFC and European Debt Crisis, and their financial fallout.
This article proceeds as follows. It first provides a brief summary of the events that led to and followed the GFC and European Debt Crisis. It then outlines how IPE currently perceives these events and the interaction between international markets and domestic governments more broadly. This follows with a discussion on how the CPE literature has addressed IPE’s national crisis-exposure variation puzzle, focusing first on works that explain diversity in credit consumption within housing and financial markets (which contribute to the debate on the GFC), and then on works that explain diversity in capitalist systems more broadly (which contribute to the debate on the European Debt Crisis). This article concludes with a discussion of the need to upload CPE insights into IPE’s core domain of international economic interdependency.
IPE and the Developed World’s Twin Crises: An Overview of the GFC and European Debt Crisis
In his March 2009 speech to the Council of Foreign Relations, U.S. Federal Reserve Chairman Ben Bernanke claimed that “it is impossible to understand this crisis without reference to the global imbalances in trade and capital flows that began in the latter half of the 1990s.” These imbalances partially stemmed from the wake of the 1997 East Asian crisis, and the International Monetary Fund’s (IMF) disastrous policy response to it (Rajan, 2011, p. 13). After a traumatic experience with financial and economic collapse, governments in Southeast Asia’s former tigers, along with China, abandoned projects that were dependent upon foreign capital, targeted industrial policy towards the export sector, and accumulated large foreign exchange reserves in order to ensure that they would be better protected from immediate capital flight and would not require the Fund’s assistance in the future. Along with Japan, Germany, and Northwest Europe’s small, corporatist states, these countries accumulated a wealth of savings that found investment outlets in credit-hungry countries such as the United States and United Kingdom, as well as the European Economic and Monetary Union’s (EMU) peripheral economies (Italy, Greece, Spain, and Portugal).
The growth of external imbalances between Asia and the EMU North, on the one hand, and the United States and the EMU South, on the other, was made possible because of long-term developments in international financial markets over the previous four decades. Financial liberalization, the removal of capital controls, the harmonizing of financial rules, and steady declines in nominal interest rates across the developed world since the 1970s increased the volume and decreased the price of foreign credit. The abundance of cheap credit, coupled with the erosion of regulatory standards pertaining to leverage and the withdrawal of the state from capital allocation decisions (Fuller, 2016), provided financial firms with expanding profit-seeking opportunities. These opportunities spurred financial “innovation” and the rise of securitization, the bundling of various debt obligations into individual securities. Asset-backed securities (ABS) in general, and (U.S.-based) mortgage-backed securities (MBS) in particular, proved to be the investment instrument of choice (see Helleiner (2011) for an excellent account of the rise of securitization in the United States).
MBSs, first created in the United States in the 1970s by the Federal Home Loan Mortgage Corporation (colloquially known as “Freddie Mac”) and the Federal National Mortgage Association (colloquially known as “Fannie Mae”),3 and collateralized debt obligations (CDOs), divided and repackaged versions of MBSs, were intended to provide a win-win opportunity for banks and investors; the former could move illiquid mortgages (and the risk of default) off their balance sheets, while the latter were provided with a long-term financial instrument whose returns were likely to be higher than that of government and corporate debt holdings. Originally, MBSs, at least those issued by Freddie Mac and Fannie Mae, consisted of typical prime loans. After 1992, however, both government-sponsored enterprises were encouraged by policymakers in the United States to expand loans to lower income households (making homeownership more affordable), causing their issues of MBSs to include an ever increasing proportion of subprime loans (by 2005, non-prime lending in the United States surged to 1 trillion, according to the U.S. Financial Crisis Inquiry Commission (2011), p. 13). The presumption of MBSs as a profitable but also safe investment instrument relied upon three conditions: their proper risk evaluation (by credit rating agencies); the lack of systemic default risk in their portfolio,4 which became more problematic with the infiltration of (American) subprime mortgages into these securities in the mid-1990s and pre-crisis 2000s; and most importantly, the continual rise of (American) housing prices. The bursting of the U.S. (subprime) housing bubble in 2006 compromised each of these conditions and, ultimately, the global financial system. Falls in housing prices and widespread default on mortgages led to a series of failures (starting with New Century Financial, Bear Sterns, Countrywide Financial,5 and then to Freddie Mac and Fannie Mae) among banks and lenders that were highly exposed to mortgage-related financial products, particularly those that included non-traditional loans (i.e., subprime, interest-only and stated income loans, among others). Thanks in part to the diffusion of U.S. MBSs across the financial holdings of major investment banks and financial institutions around the globe, these bank failures set off a chain reaction of panic and losses, which reached its apex in September 2008 with the declared bankruptcy of Lehman Brothers.
The 2008 GFC was precipitated by concerns about the solvency of major financial institutions. However, by 2009, this crisis precipitated further concerns about the solvency of developed nations. Bank bailouts in the wake of the 2008 GFC led to significant increases in public debt and deficits across EU countries—with perhaps the most extreme example coming in 2010, when Ireland’s annual public deficit rose to over 30% of its GDP due to the government’s decision to guarantee all customer deposits and bank borrowings in the Irish banking system (Carswell, 2010). Despite a series of jeopardizing bank failures in Iceland and Ireland, Greece proved to be the more problematic epicenter of the European Debt Crisis. In January 2010, the Greek government admitted to the European Commission and Eurostat that it had falsified data for its public accounts, grossly understating the true value of government borrowing (Barber & Hope, 2010). While market concerns about Greek public debt were already present in 2009 (the “big three” credit rating agencies—Standard & Poor’s, Moody’s, and Fitch—downgraded Greek bonds a total of five times in 2009 (Barta & Johnston, 2015)), this admission lead to a wave of market panic. The announcement prompted a further series of downgrades by the “big three,” yet it was S&P’s April 27 downgrade of Greek debt to junk status that precipitated German Chancellor Angela Merkel to agree to the creation of an EU bail-out facility (the European Financial Stability Facility (EFSF)) for fledgling Eurozone countries (Schneider & Slantchev, 2014). In addition to Greece and Ireland, Portugal, Spain, and Cyprus endured heavy market speculation and required the use of the EU’s EFSF.6 Although speculative panic towards these countries’ sovereign debt has subsided since 2012, the economic consequences of this panic, and the austerity terms of the EU’s resulting transnational bailouts, continue to strain the populaces of the EU’s periphery.
IPE, Domestic Politics, and Financial Crisis Exposure
While the 2008 GFC reflects one major strand within IPE—the causes and destabilizing effects of globalized capital (see Frieden, 2006; Singer, 2007; Abdelal, 2007; Deeg & O’Sullivan, 2009)—it also highlights a major shortcoming of one of IPE’s traditional cornerstones—the (“outward looking in”) study of how nation states, or at least those that integrate themselves into the global financial and trade systems, are confined by international markets. Established debates within IPE are not entirely clear as to how international markets constrain governments of developed sovereigns. One school of thought emphasizes that international trade and finance places governments into a “golden straitjacket” (Milner & Keohane, 1996; Frieden & Rogowski, 1996; Friedman, 1999; Rodrik, 2000). If governments choose to engage with the global economy in order to access foreign capital or provide export markets for domestic firms, their fiscal and regulatory decisions will not only be constrained by the preferences of foreign investors via capital flows (and capital flight), but also by the competitiveness of foreign firms.7Mosley (2000) further conditions the severity of globalization’s golden straitjacket upon a country’s economic development: While market actors watch governments in developing countries more closely, they provide developed sovereigns with greater “room to move.” Nevertheless, though Mosley notes that markets are less critical of the welfare/taxation mix that governments in developed economies undertake, she does acknowledge that markets prioritize deficit, debt, and inflation targets, implying that if fiscal and monetary policy stray too far from these benchmarks, governments risk succumbing to speculative pressure.
Other IPE scholars acknowledge that international markets constrain governments in developed countries, but some governments are more constrained than others. Katzenstein (1985) notes that international markets place more intense pressure on politics within small trading nations (i.e., the Nordic countries, Austria, the Netherlands, and Switzerland), which has caused these countries to adopt consensus-based, corporatist approaches to policymaking in order to flexibly respond to external economic shocks. Drezner (2007), on the other hand, highlights that large states (the United States, United Kingdom and increasingly the EU, or what economists commonly refer to as “interest rate setters” in global financial markets) have not lost their influence within markets and have considerable weight in shaping market rules. Culpepper and Reinke (2014) provide support for this argument in their examination of major bank bailouts in the United Kingdom and United States following the GFC. The authors note that one reason why U.S. financial regulators hold considerable sway over big banks is due to their “structural power”—the U.S. domestic market occupies a significant proportion of (American) big banks’ market share, and consequently they cannot easily threaten to exit if regulatory rules become too constraining.8 In other words, though most major U.S. banks are global, their consumer base remains concentrated within the United States, which limits their capacity to “regime shop” in other countries.
While the extent to which markets constrain government is still widely debated within IPE, the discipline has been less cognizant of how (unstable) domestic policies within individual nation states produce negative externalities that can undermine international markets and countries’ economic positions within it.9 After all, while financial liberalization and securitization increased countries’ exposure to risks ingrained within international credit markets, it is generally national economic crises, and national economies’ incapacity to manage significant capital inflows, that prove to be the lynchpin of global economic crises. Thailand’s bubble economy, created because of heavy reliance on foreign borrowing, and the collapse of the Thai baht, precipitated the 1997 East Asia Crisis. U.S. regulators’ greater toleration of higher levels of leverage amongst the country’s financial institutions, as well as the end of its housing bubble, initiated the series of events which ultimately produced the 2008 GFC (Helleiner, 2011, p. 69). Greece’s fiscal problems marked the start of the European Debt Crisis. Major global economic crises within the past two decades demonstrate the consequences of unrestrained global finance, but, just as importantly, they also demonstrate how domestic governments’ regulatory flaws and policy deficiencies within their own borders can unleash economic misfortune upon their neighbors (Pettis, 2013, echoes this sentiment in his discussion on why policy decisions taken by national elites have stunted global economic “rebalancing” after the GFC).
Some IPE scholars have recently acknowledged the importance of understanding diversity within national policies; Mosley and Singer (2009) note that the examination of cross-national variation in financial regulation remains a crucial blindspot in IPE and that “IPE has generally not appreciated the fact that cross-national differences in domestic financial regulation can have international repercussions” (p. 421). Given the clear distinction between the crisis’s winners (the EMU “core”—Austria, Belgium, Finland, France, Germany, and the Netherlands) and losers (the EMU “periphery”—Greece, Ireland, Italy, Portugal, and Spain), scholars of the European debt crisis (Schelkle, 2013; Jones, 2015; Matthijs & Blyth, 2015; Johnston, 2016; Schelkle, 2017) have been more attuned to cross-national variation in macroeconomic policy management and how this variation impacts countries’ exposure to international financial shocks. Yet in regards to study of the 2008 GFC, a more comparative systemic analysis of how diverse national policies interact with the rise of global finance has been considerably lacking within IPE.
Comparative Political Economy as IPE’s Missing Link?
The field of comparative political economy (CPE) has long been occupied with understanding cross-national variation in politics and policy. Traditional studies of comparative political economy explaining how national policies and politics shape countries’ engagement with the world largely focused on international trade (Katzenstein, 1985; Rogowski, 1989; Hall & Soskice, 2001; Hiscox, 2002). More recently, however, CPE scholars have conducted similar systemic analyses in regards to how national policies and politics shape countries’ engagement with international finance (Schwartz & Seabrooke, 2008; Mian & Sufi, 2015; Fuller, 2015, 2016). What sets these recent works apart from earlier (and current) CPE research is their unit of analysis: Rather than focusing on how states and firms engage with the global economy, these scholars focus on consumers of credit and the originators of private debt within (debt-based) financial securities—households.10
Comparative Household Finance and the 2008 GFC
Until the mid-2000s, IPE and CPE had failed to appreciate the role of households in national debt accumulation and formation. Fuller (2015) notes that “households and banks have increasingly displaced non-financial businesses and governments as the primary debtors in modern capitalist economies” (p. 2). IPE insights on the GFC have devoted much attention to the role that banks played, but less attention has been devoted to households’ contribution to the crisis in their role as capitalists.
The biggest financial liability that shapes how households, and their accumulation of debt, engage with international credit markets is mortgage debt. While households do not access credit for their real estate purchases from international markets directly, they indirectly have been influenced by trends within global financial markets via the rise of mortgage securitization. Securitization provides banks with the capability to expand credit lines to households, not just for mortgages (and the re-financing of them) but also for other durable goods, by allowing them to offload risks of default onto longer-term private investors who purchase their MBSs. Along with general reductions in nominal interest rates across the developed world since the late 1970s, mortgage securitization has not only increased the amount of credit volume that banks can extend to households, but also, thanks to lower default risk, has reduced the costs of credit. These processes more intricately connected household finances to the global financial system and, by extension, national policies and regulations (or the lack thereof) that governed households’ accumulation of debt. The aftermath of the collapse of housing bubbles not only in the United States and United Kingdom, but also in Ireland and Spain revealed how securitization internationalized private household debt within countries, which in turn, internationalized the economic consequences of these (domestic) debts’ unsustainability.
Though financial liberalization, financial innovation, and the growing cross-border nature of capital facilitated the rise of cheap credit across the developed world, levels of private household debt (and housing inflation) exhibited considerable cross-national heterogeneity in the run-up to the 2008 GFC (see Figure 1). More puzzling for CPE, household indebtedness does not conformed to preconceived notions of the structure of countries’ welfare states (Esping-Anderson, 1990) or their systems of capitalism (Hall & Soskice, 2001). Households in the Nordic countries have the highest debt levels in the developed world, despite their generous welfare state and comprehensive collective bargaining institutions. By contrast, Italy and Greece, two “fiscal villains” of Europe’s debt crisis, have the lowest levels of private debt in the Organisation for Economic Co-operation and Development (OECD).
The works of Herman Schwartz, Leonard Seabrooke, and Greg Fuller have provided important insights as to why countries’ households accumulate and use debt differently. These scholars acknowledge the important impact of the internationalization of finance on rising household debt levels, but they also note that domestic policies governing credit access are just as important, if not more so, when determining whether countries experience a private debt (or housing) bubble. Schwartz and Seabrooke (2008) identify a “varieties of residential capitalism” typology to explain variation in household debt and national owner-occupancy rates, which helps to explain heterogeneity in housing inflation. By attempting to identify why housing finance systems in developed countries are controlled (Germany, Austria, Italy) or liberalized (the United Kingdom, United States, the Netherlands), the authors note that mortgage securitization and the depth of the internationalization of mortgage pools demonstrate remarkable heterogeneity across advanced democracies, which IPE fails to consider.11 Though the United Kingdom and United States conform nicely to an IPE-tinted account of the internationalization of finance, other countries suppress, or in the cases of Austria, Belgium, and Portugal, do not allow, mortgage securitization (Schwartz & Seabrooke, 2008, p. 251), which has caused banking in these countries to follow historical household finance models that require a substantial down payment and provide shorter duration mortgages. As a consequence of not being able to move mortgages loans on to the books of long-term investors, banks in countries where securitization is repressed must hold mortgages until term and consequently ration credit to households, reducing the likelihood of debt bubbles.
Schwartz (2009b) provides a deeper analysis of the U.S. housing market’s exceptionality, which made it particularly ripe for crisis. The intensity of mortgage securitization in the United States was fueled by an array of policy oversights, including mortgage lenders eagerness to extend housing loans to higher-risk customers (due to the profits they could make by securitizing them), U.S. regulators’ failure to limit banks’ (and Freddie Mac and Fannie Mae’s) leverage ratios,12 credit rating agencies’ failures to properly assess the risk of MBSs, and national regulators’ failure to heed warnings from state officials and non-profit housing consumer interest groups about the pervasiveness of risky and illegal lending practices (see also U.S. Financial Crisis Commission, 2011).13 The constellation of these regulatory failures was uniquely American. Internationalization of finance and the spread of securitization across borders certainly exacerbated the repercussions of the United States’ reckless policies, but in line with an “inward looking out” approach to the financial crisis, Schwartz’s work emphasizes that the policy failures that eventually led to the 2008 GFC were more national (American-based) rather than international in nature.
Fuller (2015) builds upon the examination of how national regulatory approaches interact with securitization, focusing on policies that governments use to directly incentivize or reward their citizens to become homeowners, independently of the actions of banks. Fuller acknowledges IPE’s argument that financial liberalization changed the way that all developed economies could control the distribution and regulation of private credit, because capital mobility increased the opportunity costs of repressing credit growth, and financial corporations possessed the expertise to minimize these opportunity costs in their global operations. However, he also notes that, while the supply side of finance increasingly moved beyond government control, governments still retained power over how “financial demanders” (households) accessed credit. Because it is more difficult for households to cross borders in order to secure a better mortgage deal—at least on a home within their country of residence—governments have greater leeway on promoting credit-encouraging or credit-mitigating regulations within consumer markets. In addition to variation in the size of secondary mortgage markets for household debt (which includes securitization), Fuller notes that governments can also control households’ use of credit via interest rate restrictions, capital gains taxes, regulations on maximum loan-to-value ratios, and tax subsidies for mortgage interest payments. Fuller’s analysis introduces two helpful innovations that assist political economists in understanding variation in exposure to the GFC: First, he considers a wider constellation of factors that influence a substantial proportion of the demand side of global finance (households and other private entities); and second, he highlights further modes of policy discretion that governments have available to exacerbate or restrict the growth of private debt in the midst of the proliferation of cross-border capital flows, namely the tax code.
These household-centric works fill an important gap in IPE’s current conceptualization of the 2008 GFC. Not only do they address the “divergence puzzle”—that the GFC did not affect all countries equally—but they also focus on the demand side of the credit market, rather than on big banks and international financial corporations and institutions. IPE does acknowledge the importance of national policies in precipitating the crisis (although, as Mosley & Singer (2009) argue, not strongly enough), but narratives that detail national experiences are largely limited to the United States (and United Kingdom). As the origin of the crisis itself, the United States is an obvious focus for national policy peculiarities. However, emphasis on the United States is also detrimental for IPE as its lax credit regulation on both the demand and supply side of the market is virtually unmatched throughout the rest of the developed world (the United Kingdom is perhaps the only exception). As a consequence, the United States is almost a “token” debtor state in analysis about a crisis that has demonstrated the dangers of unsustainable private debt accumulation. Though IPE scholars on the 2008 GFC point to China and the East Asian tigers as the sponsors of America’s debt binge, they notably neglect to conduct a more systemic analysis of creditor nations and the domestic features that caused them to be net external lenders during the 2000s.14 Creditor nations, however, have received far greater attention in IPE and CPE literature on the GFC’s sister crisis, the European Debt Crisis, whose general debates are discussed below.
CPE and IPE Accounts of the European Debt Crisis and Lessons for IPE’s Understanding of the GFC
Literature on the European Debt Crisis has provided a more inclusive account of the international financial crisis, examining the plight not only of the EMU debtor “peripheral” states (Greece, Ireland, Italy, Spain, and Portugal), but also its creditor “core” nations (Austria, Belgium, Finland, Germany, the Netherlands, and to some degree France). Though Greece is acknowledged as the epicenter of the debt crisis, remarkably, very few general works in European political economy—outside of Hellenic area studies—focus solely on this country when dissecting the roots of the crisis, in contrast with IPE’s almost exclusively U.S.-centric analysis of the GFC. Because the crisis itself was so symmetrical between debtor and creditor states, in regards to the building of external imbalances between the EMU core and periphery (see Figure 2), it would be almost impossible to discuss Greek (or other peripheral economies’) external borrowing trends without acknowledging that this borrowing was made possible by net savings within the Eurozone core (Gros, 2012).
The academic literature on the origins of the European debt crisis is dominated by three competing hypotheses. The first is the fiscal hypothesis (see Buiter & Rahbari (2010) for a general overview). Because the crisis stemmed from Greece’s fiscal mishaps, this account attributed the origins of the European debt crisis to the over-extension of public borrowing in Southern Europe, which the GFC made worse by requiring sovereigns there to bail out domestic banks. Various political economists noted how EMU’s institutional environment was conducive to greater government borrowing in the periphery—although they do not necessarily accuse solely the public sector in the overconsumption of credit—due to the fact that nominal interest rates declined dramatically in the run-up to Euro’s introduction in 1999 and markets had not properly valued default risk amongst the Eurozone’s peripheral sovereigns in the pre-crisis 2000s (Hodson, 2011; Lane, 2012). Empirically, however, the fiscal hypothesis has largely been discredited (see Johnston, Hancké, & Pant (2014) for a fuller analysis), although it remains popular in some policy circles within Northern Europe, the European Commission, and the European Central Bank.
The competitiveness hypothesis explains the European Debt Crisis more holistically by focusing on the rise of current account (the biggest component of which is a country’s trade deficit/surplus with the outside world) imbalances between the Eurozone core and periphery (Obstfeld & Rogoff, 2009; Wihlborg, Willett, & Zhang, 2010; Belke & Dreger, 2011; Giavazzi & Spaventa, 2011). According to this narrative, financial crisis within the European periphery was fueled not by fiscal solvency, but by its total solvency (which includes debt accumulation and composition in the private sector). The periphery’s lack of solvency was indicated by its sizable and persistently rising current account (and trade) deficits vis-à-vis Northern Europe (see Figure 2). Current account deficits in Southern European required external borrowing to finance them; foreign borrowing largely stemmed from household savings and banks’ investment from Northern Europe (Gros, 2012). Of course, the presence of current account deficits, on their own, does not mean that a country’s external borrowing will risk its future solvency. However, if a country’s external borrowing is not properly channeled into sectors of the economy that can reverse these current account deficits (such as the export sector), markets may hold doubt as to whether countries can reduce their current account deficits, and hence their reliance on foreign borrowing, over time. This, the competitiveness camp argues, was the fate that befell the Eurozone periphery—external borrowing was channeled into non-tradable sectors (the public sector for Greece and Italy, but the private sector—construction and real estate—for Ireland and Spain) which failed to reverse these countries’ current account deficits, or quell their need for foreign capital.
European (comparative) political economists within the competitiveness camp have identified national institutional features that set the EU’s debtor countries, and their comparatively higher inflation rates, apart from its creditor states, thus providing an “inward looking out” foundation for understanding crisis divergence within Europe. A Varieties-of Capitalism (VoC) based strand of this literature has highlighted the important role of labor markets in exposing countries to, or shielding them from, the European Debt Crisis (Hall, 2014; Hancké, 2013; Johnston et al., 2014; Hӧpner & Lutter, 2014; Regan, 2015; Johnston & Regan, 2016; Johnston, 2016).15 The argument here is that the crisis of the Eurozone was a consequence of uniting two different types of labor markets—corporatist and non-corporatist—under a common currency. Because corporatist labor markets (which cluster in the EMU core) produce lower inflation than non-corporatist labor markets (which cluster in the EMU periphery) on average, EMU’s removal of the nominal exchange rate allowed Germany and her corporatist satellites to persistently undercut the real exchange rate competitiveness of their Southern neighbors.16 Like CPE studies on household credit access, these works highlight how the income growth of households and the diverse labor market institutions that impact them, can lead to radically different outcomes in domestic borrowing and savings, which in turn impact whether countries are net external lenders or borrowers. While all Euro-area sovereigns had access to cheaper and more plentiful credit within international financial markets, households (and governments) were subject to unique national conditions and institutions—notably those that governed the growth of incomes—that led to divergence in trade and net external lending flows, and in turn, financial crisis exposure.
The third origins story of the European Debt Crisis is the financial hypothesis. Scholars advocating this argument (Gros, 2012; Schelkle, 2013; Jones, 2015, 2016; Copelovitch, Frieden, & Walter, 2016) dispute whether EMU peripheral countries were uncompetitive, claiming that export performance and trade imbalances did not change much for EMU’s current debtor states after 1999 (Gros, 2012) or that “push” export growth in Southern Europe either exceeded or was similar to that in EMU’s core (Gaulier, Taglioni, & Vicard, 2012). Rather, these scholars argue that the crisis woes of the Eurozone South can be better attributed to divergence in cross-border capital flows, which the creation of a monetary union helped to magnify. EMU peripheral economies’ sudden access to cheap and plentiful foreign capital caused them to borrow more from abroad, leading to significant capital account surpluses, which were ultimately undone by the sudden stop in these capital flows in 2009. In other words, this is the competitiveness argument in reverse—it was not current accounts that caused imbalances in external borrowing, but rather divergence in external borrowing (i.e., capital accounts) that caused current account imbalances.
The financial account of the Eurozone crisis is perhaps most aligned to IPE explanations of the GFC, given its strong emphasis on foreign capital flows and financial integration more broadly. However, like IPE’s “outward looking in,” it fails to provide an argument as to why Southern European countries proved to be net importers of foreign capital, while Northern European countries largely exported their domestic savings. The financial account is attuned towards national idiosyncrasies that likely precipitated divergence—most notably, it argues that a common interest rate across the Eurozone implies that countries with higher inflation rates (i.e., the European periphery) would automatically have lower (or negative) real borrowing costs than countries with lower inflation rates (i.e., the Eurozone core). If national central banks were able to control the setting of their own national interest rates—introducing greater variation in nominal interest rates across the Eurozone—the relative comparative advantage that the South had in real borrowing costs, due to its countries’ higher inflation rates, may not have been so pronounced. Nevertheless, wider causes behind divergences in national inflation in the Eurozone are not adequately tackled in this literature, aside from suggestions that this was driven by catch-up growth in the South.17
The European Debt Crisis literature has important lessons to teach IPE literature that concentrates on the GFC, and the phenomenon of financial crises in general. It demonstrates that though international finance can have destabilizing effects, it is not similarly destabilizing for all countries that are integrated into the global financial system. National political and institutional diversity are the important flip side of the financial crisis coin, and greater attention must be paid not only to how countries are exposed to the international economic system but more importantly, how they engage with it. This requires a move beyond the analysis of familiar international actors (financial firms, multinational corporations (MNCs), and international organizations) that are common subjects of study in IPE. Domestic elites have received their fair share of analysis, but other domestic actors (which include not only regulators, but also unions, employers, households, and other special interests) that impact income and wealth dynamics within countries, which credit and debt accumulation are components of, deserve greater attention.
The European Debt Crisis literature, as well as comparative accounts of household finance, also fills another missing link in current IPE study on international economic crisis—how the idiosyncrasies of nation states can upset the global economic order among greater integration. As emphatically demonstrated with the U.S. property market and Greek fiscal policy, national policy failures can have big repercussions for other countries if their destabilizing effects are quickly dispersed across borders. International finance, arguably more than trade, makes this possible, given that capital and investment flows exhibit more immediate and erratic changes (i.e., sudden stops) than movements in goods and services. Though the 2008 GFC and the subsequent European Debt Crisis confirmed IPE’s “outward looking in” accounts of the destabilizing effects of financial integration, they also demonstrate that nation states remain acutely diverse in their approaches to the use and regulation of finance, and that this diversity may enable unique national policy failures to precipitate international financial crises themselves.
Current IPE approaches to the global financial crisis reflect wider trajectories of the field of international relations itself. International Relations has increasingly questioned whether international economic and political integration are leading to the end of the nation state. As markets and polities increasingly assume international identities, borders begin to lose their authority. However, as comparativists argue, some actors are not easily mobile, and while they may be exposed to economic and political integration, they are more beholden to the laws of their nation states. Hence, while international market (and non-market) actors can challenge the authority and autonomy of national governments through threats of exit and flight, citizens and non-mobile actors grant national governments (partial) power to shape policies in unencumbered ways.
The events of the 2008 GFC nicely depict the need to balance IPE’s “outward looking in” approach with CPE’s “inward looking out” theories when explaining events that lead to financial crises and the fallout afterwards. The GFC and the European Debt Crisis were international in nature, but also somewhat national in origin. Cross-border capital flows and the internationalization of (mortgage-backed) securitization allowed policy failures (loose and predatory lending practices, greater tolerance of higher levels of leverage, and lax regulation governing the extension of credit to households) within the United States’ financial sector and mortgage market to spread the crisis that they precipitated to countries whose regulatory institutions lacked these shortcomings. Not all countries suffered similar fates as the United States (and United Kingdom), and some of this can be attributed not only to their different domestic approaches to regulating finance and income growth, but also to their experiences with equally devastating financial crises in the past that allowed them to make the necessary reforms to better cushion them from the current one (as seen in Sweden’s and Denmark’s reactions to their own financial crises in the 1990s). IPE scholars (notably Helleiner, 2011) have called upon their colleagues to move beyond identifying partial causes of the 2008 financial crisis and attempt to combine the “macro story of global imbalances” with the “politics of micro-level market and regulatory failures” (p. 85). Importantly, the latter requires comparative approaches to domestic policy diversity, and a better understanding of how national idiosyncrasies interact with global markets in precipitating, or avoiding, crisis.
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(1.) This article takes a more holistic approach to the crisis by covering not only the 2008 GFC, but also the subsequent (2009) European Debt Crisis.
(2.) These include Austria, Belgium, Denmark, Finland, the Netherlands, Norway, and Sweden.
(3.) Freddie Mac and Fannie Mae remained the largest issuers of MBSs in the United States up until they went into conservatorship; in 2000, these two government-sponsored enterprises alone issued 70% of MBSs in the United States, worth $2.4 trillion (Congleton, 2009, p. 293; U.S. Financial Crisis Inquiry Commission, 2011, p. 40).
(4.) The failure to properly gauge systemic default risk also severely threatened the financial health of major investment banks and insurers (such as AIG) that issued considerable volumes of credit default swaps, which in turn further increased instability and the contagion of the U.S. housing bubble crash.
(5.) Countrywide had one of the largest shares of nontraditional loan issuances of all U.S. banks before the crisis; nontraditional loans made up 59% of the bank’s mortgage loan originations. By contrast, nontraditional loans made up only 18.3% of Bank of America’s mortgage loan issuance (U.S. Financial Crisis Commission, 2011, p. 20).
(6.) Italy also endured speculative panic but, due in part to the efforts of Mario Monti’s technocratic government to curtail public borrowing, did not formally access the EFSF.
(7.) This theme has also transferred to the comparative welfare state literature, which examines how globalization has impacted partisan differences in welfare spending (see Boix (2000) and Cusack (1999), who outline that globalization, and the market constraints that accompany it, has blurred typical left and right distinctions in welfare state expansion and retrenchment over time).
(8.) The authors note, however, that the same cannot be said of the United Kingdom, whose banks are more international in nature and rely less upon U.K. consumers for revenues.
(9.) Schwartz (2009a, 2009b), who outlines that divergences in household financial markets drives divergence in the strength of global currencies and the direction of global capital flows, is a notable exception here, although as outlined below, his work on household finance is largely rooted in a comparativist perspective.
(11.) Schwartz and Seabrooke also consider variation in countries social housing policies; however, their analysis on housing finance and securitization speaks more directly to IPE.
(12.) In 2007, Bear Stearns, Goldman Sachs, Lehman Brothers, Merrill Lynch, and Morgan Stanley had leverage ratios as high as 40 to 1, which meant that only one dollar of capital was left to cover loss in $40 worth of assets. A ratio this high meant that less than a 3% decline in asset value could bankrupt a firm (U.S. Financial Crisis Commission, 2011, p. xix).
(13.) This became more difficult by the April 2007 U.S. Supreme Court ruling that the Office of the Comptroller of the Currency, the federal office that regulated national banks, was the only public agency that could regulate mortgage lending. This case was brought forward by Wachovia, the American Bankers Association, and the Mortgage Bankers Association, in an effort to evade the state of Michigan’s attempt to enforce stronger mortgage lending regulations within its borders (U.S. Financial Crisis Commission, 2011, p. 13).
(14.) Breslin (2011) provides a detailed account of the Chinese model of development, and how it not only influenced its exposure to the GFC, but also how it provides an alternative economic model for the developing world, relative to dominant neo-liberal models promoted by the IMF.
(15.) These works also addressed IPE gaps within the VoC literature, which has not been entirely attentive to broader trends in European integration, and financial integration more broadly
(16.) A country’s real exchange rate is the nominal exchange rate multiplied by the ratio of the domestic to foreign price level. Because the EU’s common currency equalized the nominal exchange rate among Eurozone countries, real exchange rates between countries within EMU were solely a function of relative inflation. This meant that whichever country had the lowest inflation rate would also have the lowest (and most competitive) real exchange rate.
(17.) Copelovitch, Frieden, and Walter (2016, p. 821), further reinforce Mosley and Singer’s (2009) suggestion to take heterogeneity in financial regulation across (Eurozone) countries seriously, but they do not specifically define how regulatory practices in current EMU debtor states systematically diverge from those in EMU creditor countries.