British Foreign Secretary, David Miliband has responded to Alex’s post questioning the wisdom of drone attacks in Pakistan. Citing David Kilcullen, Alex’s argument was that drones killed too many civilians, contradicting basic counterinsurgency doctrine, which is, above all, to secure and serve the population.

Miliband (cautiously) agrees:

The threat to US and Pakistani (and UK) interests is real, the danger and damage of civilian casualties serious, and the range of options limited.

US technology is vitally important, but Pakistan is fighting its own struggle against violent extremism. The drone attacks have undoubtedly hurt the core of AQ, but I see the dangers. The first best solution is obviously to build up Pakistan’s capacity, but first best solutions are not always immediately available.

Miliband’s is right, I think, but there are, unfortunately, much deeper and darker questions to address. As I argued in August last year, Pakistan’s “struggle against violent extremism” has been mounted very much at the America’s behest – and its urgings have been wrong-headed at best, disastrous at worst.

Last summer, the Pakistani Prime Minister was given “an earful” by the White House and told to sort the border regions out. All well and good, except that the United States was pushing the Pakistan military towards a conventional encounter with the militants, something that it’s own manual on counter-insurgency advises strongly against.

The pattern was similaar in 2004, when General Musharraf was persuaded to attack the tribal areas. That led to fury among tribesman, forcing them into the arms of the Taliban. It also led to humiliation for the army, with one poor Colonel taking shelter in a mosque and then emerging to beg for mercy with the Koran on his head. Tribesmen stripped him of his uniform and sent him on his way.

Now, in 2009, we have a massive attack on the Swat valley, which has killed some militants – sure – but has led to the forceful displacement of 2.5 million people, “an exodus that is beyond biblical,” according to the Independent. In the long run, will this campaign contribute to Pakistan’s security? Time will tell, but I suspect not.

I am not, in way, pleading for tolerance for extremism. But I am demanding that we – the Americans in particular – start to stand account for the counterproductive nature of their Pakistan policy since 9/11.

Throughout its time in office, the Bush administration seemed intent on showing it could push a functioning state to the brink of failure. Pakistan’s complicity in arming and supporting the Taliban was ignored by the Bush administration. Instead, it pursued its short term goals in the war on terror with little care for the long term impact on a nuclear armed state with a young, fast-growing, and deeply frustrated population.

In his time in office, Bush hosed billions on the Pakistan army, but dedicated only around 1% of total aid to non-military purposes. America’s political strategy has been non-existent. Its influencing strategy even weaker. It really beggars belief that so much money could be spent only to achieve the reverse of the desired result.

Now, the Obama administration wants to engage in nation building, but it continues to focus efforts on the country’s most unstable zones, rather than supporting a comprehensive, nationwide response from the government. It is also arriving with its cheque book open, only to find that neither it nor the Pakistan government has much idea as to how or where the money should be spent.

Above all, it’s unclear whether – unlike in Iraq at the beginning of the surge, where there was a doctrinal revolution – the protagonists have truly accepted just how badly they have got things wrong. The US counterinsurgency manual describes insurgencies as ‘learning competitions’. If so, I fear that the best that we – the West – and the various arms of the Pakistan state can hope is some kind of consolation prize for taking part.

Meanwhile, the Pakistani people are abandoning hope for the future. The country faces massive and growing demographic pressure. Its population is young, uneducated, and will grow by more than the population of the UK over the next twenty years.

The country’s cities are broken. The power is off in most of them for hours every day. Energy demand will grow fourfold by 2030. Water will probably go beyond scarce and climate change is going to hammer the country hard.

Institutions too are broken. The army, in particular, is corrupt, having taken control of large swathes of the country’s economy. The money shovelled on it by the West has simply made a bad problem worse. In my experience, Western governments will do anything to avoid upsetting senior officers – with today’s security co-operation trumping any and every long term goal.

So…As David Miliband says, Pakistan must fight its own struggle against extremism – and we should support it. But only if every dollar and pound we are spending on its military is devoted to helping officers understand how to fight an insurgency. God knows, after the balls up in Iraq and Afghanistan, we have plenty of lessons to teach.

It’s true, too, that the “first best solution is obviously to build up Pakistan’s capacity” – but this must be interpreted in its very widest terms. Pakistan needs to reboot its entire society, while the international community needs to come to terms with how woefully inadequate its tools are for supporting a very frail state. We (the outsiders) must change as much as the Pakistanis, in other words.

And as for the Foreign Secretary’s final point that “first best solutions are not always immediately available,” I interpret that as meaning we must be prepared to take short term actions that may not be ideal in the long term, just because the situation has grown so bad.

Maybe. But what about turning this on its head? I suspect the Swat exodus is storing up a whole new round of problems against which the Pakistan state will struggle in years to come.

It’s part of a pattern where the need to do something in the short term makes matters worse in the long term – though we feel better, because at least we’ve kept busy. In Afghanistan and Iraq, Col H.R. McMaster, one of General Petraeus’s closest advisers, concluded that:

A short-term approach to long-term problems generated multiple short-term plans that often confused activity with progress.

I fear we’re still confusing activity with progress in Pakistan. And if I’m right, that’s something we’re all going to live to regret…

Unless the new US administration takes forceful steps to prevent any further suffering and slaughter of Palestinians, the peace process, the US-Saudi relationship and the stability of the region are at risk. Prince Saud Al-Faisal, Saudi foreign minister, told the UN Security Council that if there was no just settlement, “we will turn our backs on you” …

America is not innocent in this calamity. Not only has the Bush administration left a sickening legacy in the region, but it has also, through an arrogant attitude about the butchery in Gaza, contributed to the slaughter of innocents. If the US wants to continue playing a leadership role in the Middle East and keep its strategic alliances intact – especially its “special relationship” with Saudi Arabia – it will have to revise drastically its policies vis a vis Israel and Palestine.

Think that’s strong?  Try this:

Last week, President Mahmoud Ahmadi-Nejad of Iran wrote a letter to King Abdullah, explicitly recognising Saudi Arabia as the leader of the Arab and Muslim worlds and calling on him to take a more confrontational role over “this obvious atrocity and killing of your own children” in Gaza. The communiqué is significant because the de facto recognition of the kingdom’s primacy from one of its most ardent foes reveals the extent that the war has united an entire region, both Shia and Sunni. Further, Mr Ahmadi-Nejad’s call for Saudi Arabia to lead a jihad against Israel would, if pursued, create unprecedented chaos and bloodshed. So far, the kingdom has resisted these calls, but every day this restraint becomes more difficult to maintain …

Today, every Saudi is a Gazan, and we remember well the words of our late King Faisal: “I hope you will forgive my outpouring of emotions, but when I think that our Holy Mosque in Jerusalem is being invaded and desecrated, I ask God that if I am unable to undertake Holy Jihad, then I should not live a moment more.”

The FT followed Turki’s article up with a leader yesterday, observing that:

Anyone with a stake in the stability of the wider Middle East should take very seriously the warning set forth in the Financial Times last Friday by Prince Turki al-Faisal … The Saudis have emitted a crescendo of warnings, as Arab leaders over the past decade have lost faith in American leadership and signalled they may make their own arrangements: hostile to Israel, in detente with Iran, and turning their backs on the US – unless it can restrain its Israeli ally. 

Pretty sobering.  Also worth checking out this analysis from a retired US foreign service officer who was twice posted to Sauid Arabia.

You can download my talk here (with pictures, references etc) – or the text only is available below the jump. There’s a webcast too.

Headlines:

• It’s going to be a tough year. The financial meltdown has a long way to go, and the downturn is risking turning into a global depression.
• Trade is a bell wether. Protectionist pressures are already on the rise. If they gain traction, take that as a warning of a wider loss of confidence in global institutions.
• The unravelling of global economic imbalances could prove corrosive to the international order. If countries start to devalue to protect exports, expect a tit-for-tat dynamic to kick in.
• Scarcity issues (energy, water, land, food, atmospheric space for emissions) remain the key medium term driver of global change. Commodity prices will spike again as soon as there’s recovery.
• The downturn has stemmed the uncontrolled growth of emissions, but also lessened the chance of a robust global deal on climate.
• Economic bad times could well drive increased conflict. A major new security threat might be the fabled black swan – hitting just when the global immune system is already overloaded.
• If we experience a long crisis (or a chain of interlinked crises), we are likely to see either a significant loss of trust in the system (globalization retreats), or a significant increase in trust (interdependence increases). 
• You need to stretch time horizons to get the latter – shared awareness (joint analysis of risks and challenges), as a basis for shared platforms (loose coalitions of leaders), which can lobby for a shared operating system (a new international institutional architecture).
• 2009 sets a challenging agenda for the G20 (financial reform and economic recovery – but framed by a broader vision on climate, resources, security etc.)…
• …the G8 (caucus of rich countries able to tee up Copenhagen and kick start development assistance if developing countries begin to teeter)…
• …the UN (especially Ban Ki-Moon’s proposed high level ‘friend’s group’ on climate, but also as a fora for getting to grips with scarcity issues)…
• and the Bretton Woods institutions and the WTO (first of all ensuring they keep their heads above water, then looking to ‘save globalization from itself’).
• Oh and be ready for the backlash – people are angry and rightfully so, but that may well lead us down some populist blind alleys.

2009 – A Year for International Reform
Talk to the Reforming International Institutions – Meeting the Challenges of the 21st Century conference
David Steven, 21 January 2009 

Introduction

In the run up to November’s G20, I published A Bretton Woods II worthy of the name, a paper co-authored with my colleague, New York University’s Alex Evans.

In a nutshell, our argument was that leaders needed to respond to extreme global stress by:

• Becoming more ambitious in their attempts to reform the international system, despite temptations to focus narrowly on fire fighting a growing number of immediate problems.
• Focusing on the long-term in order to increase the basis for co-operation, thinking in decades where national interests tend to converge, rather than in years where often they will not.
• Working towards integrated solutions, and not imagining that a ‘global deal’ on finance could be divorced from the other big deals that must be struck on trade, security, climate and other resource issues.

This paper, prepared for presentation to the United Nation’s University and UK Foreign Office conference on International Institutions Reform in Tokyo, expands these points.

It has been written at the beginning of a critical year for the international system – a year of great peril, but also of some promise. Threats are building up globally, many of which are poorly understood and will strain our capacity for collective action. International institutions, as currently constituted, risk being overwhelmed. We could end the year confronted by a ‘new isolationism’.

But there are also opportunities to carve out an effective response. After all, a crisis always provides the conditions in which desperately needed reforms can best be achieved.

But policy-makers will find it much easier to work together if they focus on the big picture, or what Wittgenstein called ‘the single great problem’. Without ambition, long-term goals, and integration across issues, 2009 will go down in history as a year of lost opportunities – and possibly mark the point that a short-term international crisis turned into a much more deep-seated decline.

The financial crisis

So how can we expect 2009 to unfold?

First, it is a given that the financial crisis will continue to unravel, revealing some devastating economic consequences.

Japan knows better than most how pernicious a banking shock can be – and how long lasting. Her experience, however, is far from unique. On average, banking crises take around four to five years to unravel in a developed country, and cost around 12% of GDP to resolve – emerging economies tend to feel more pain, but get through the crisis slightly faster.

Their economic impact is also considerable. In a review of the fallout from past crises, Carmen Rheinhart and Kenneth Rogoff find that on average:

• 35% is lost from house prices and 55% from equities.
• Unemployment rises by 7% and output falls by 9%.
• Government debt increases by 86%.

The past does not predict the future, of course, but it should make us wary. The pattern, as Japan found, is for policy-makers to underestimate the seriousness of the problem and for financial institutions to spend years refusing to confront their predicament head on. The required psychological shift is a profound one.

Throwing money at the problem is, in many ways, the easy bit. Much more demanding is the process of unpicking and revaluing the poorly-understood risks that are at the heart of the financial sector’s difficulties. This is a process that has barely begun.

Back in April last year, I presented on multilateral reform to heads of state at the Progressive Governance summit. Then, bold action was promised to sort out the ‘bad’ from the ‘good’ banks, but nine months’ later that is only beginning to happen.

Instead, many countries have pumped money into their financial institutions, without having the tools to force these institutions to identify, value and dispose of toxic liabilities.

This mistake is likely to prove costly. As Ben Bernanke admitted last week, large quantities of “troubled, hard-to-value assets” have now become the primary obstacle to the financial system’s recovery. The UK and US are both now working on new mechanisms to tackle these toxic assets.

Meanwhile, the US Treasury’s Troubled Asset Relief Program (TARP) has been subjected to some fierce criticism. The Congressional Oversight Panel, for example, identified:

• ‘Significant gaps in Treasury’s monitoring of the use of taxpayer’s money’
•  A lack of clarity in asset evaluation, making it unclear whether the Treasury is able to distinguish between ‘healthy’ and ‘unhealthy’ banks, and
• ‘Shifting explanations’ of the fund’s purposes, leading the Panel to the conclusion that the Treasury does not have a clear strategy for spending the funds.

The situation in the US is not atypical; its system is simply unusually willing to wash dirty linen in public. Stimulus packages also pose risks, as they must be assembled and dispersed at high speed. Finding productive investment opportunities is a significant challenge.

We have already seen a massive market failure. The danger is that a similarly sized policy failure will now be layered on top.

The trade challenge

The trade system is also well worth keeping a close focus on.

It offers the best early warning system we have for any widespread loss of confidence in global integration. Protectionist pressures are already on the rise, as happens in every serious downturn. In 2009, will they overwhelm the will of governments to contain them?

If they do so, we may rue the opportunities that were missed on trade in 2008. In April, at the Progressive Governance Summit, there was genuine enthusiasm for returning to, and completing, the Doha Development Agenda. But the talks still collapsed in July, in a row between India, China and the US.

China thought the rich countries had been ‘selfish and short-sighted’, while Japan attacked the emerging economies for failing to recognise their new responsibilities. They had failed to think about the world economy as a whole, while pursuing narrow national self-interest.

At the G20 in November, Doha was back on the agenda, with heads of state promising a framework agreement by the end of the year. By mid December, however, Pascal Lamy had decided it would be dangerous even for ministers to meet, believing that an acrimonious failure could threaten not just the round, but the WTO system itself.

And the bad news spread beyond Doha. Russia, India, Indonesia, Brazil and Argentina – all G20 members, and key swing voters in the multilateral system – had announced restrictive trade measures within weeks of the G20, despite a promise to “refrain from raising new barriers to investment or to trade in goods and services.”

Doha, then, has become the ‘zombie’ trade round, staggering on, but never quite dying. Few expect that it can now be revived. But who knows? Given its resemblance to a B-movie, perhaps it will lurch back into life at the very moment when all hope appears to have been lost.

An alternative view is that the content of Doha doesn’t matter that much. As Paul Krugman has argued, “World trade is already so free, we’re really talking about stuff at the margins.”

But Doha has, at the very least, great symbolic importance. It is a yardstick for our ability to strike complex global deals; shows the extent of the world’s commitment (or otherwise) to developing countries; and – above all – acts as a bellwether for global confidence in free trade itself.

Global imbalances

If the global trade system is to come under a sustained attack in 2009, this will happen as global imbalances – built up over the past decade – unravel, revealing divergent interests between producer and consumer countries, and particularly between China and the United States.

Currency may well be the main battleground, with countries tempted by competitive devaluations as export markets shrink and domestic producers beg for protection.

Since the mid-1990s, we have seen:

• A ‘savings glut’ in Japan and old Europe, and more recently in China and the oil producing countries.
• A ‘money glut’ in the United States and a few other countries.

Effectively, US consumption was fuelled by a potent combination of cheap imports and cheap money, leading to a surge in consumption and debt. The causes for this were to be found both in the US and globally.

Within the US, monetary policy was lax (in part, as a response to previous economic shocks). From overseas came an avalanche of dollars, as China and other countries recycled their surpluses back into the US economy in order to stop their currencies from appreciating.

The debate as to who should be blamed for the imbalances – savers or borrowers – is a fruitless one. The arrangement was symbiotic, or to borrow language from those who treat addiction, an example of co-dependence.

More pertinent were two questions. Were the imbalances sustainable? And if not, could they be unwound in an orderly fashion? The answer to the first was ‘clearly not’. Much now depends on whether a gradual and controlled rebalancing is possible.

China is entering a critical period. The country has massive surplus capacity now the American consumer has stopped spending. Its exports have fallen fast and have much further to go. It is vulnerable to falls in the dollar, which will worsen its terms of trade while devaluing its massive dollar holdings ($1.94 trillion at the end of 2008).

Finally, there are signs that so-called ‘hot money’ may be beginning to flow out of the country, with analysts estimating that $120-140bn of capital left the country in the last quarter of 2008. China’s own banking system has significant weaknesses, despite recent efforts to address non-performing loans.

Some of the tensions can be seen in a fascinating interview in last month’s Atlantic magazine with Gao Xiqing, Chief Investment Officer at the China Investment Corporation, the sovereign wealth fund that manages the riskier part of China’s foreign exchange reserves.

Gao had harsh words for the Americans (“the simple truth today is that your economy is built on…the gratuitous support of a lot of countries”). He also provided an insight into how unpopular Chinese investment in the US can be at home. China’s citizens ‘hate’ its support of rich Americans (“people eating shark fins” at the expense of “poor [Chinese] people eating porridge,” he claims).

It seems unlikely that the Chinese can boost domestic consumption rapidly enough to soak up declining exports – though they must do what they can. A worrying prospect is that the Chinese government will devalue to prop these exports up. That would mean that Western stimulus dollars, euros and pounds were flowing to Chinese producers. It is hard to imagine anything more politically explosive in the current climate.

The US would almost certainly react to protect its producers, with Europe tempted to follow suit. The worst case would be the emergence of a nasty zero sum dynamic in the international arena – a series of tit-for-tat measures that are politically compelling in the short term, but lead to a marked, and even disastrous, loss of collective welfare over longer time scales.

The politics of scarcity

2009 will also see the world continue to grapple with the impact of a set of scarcity issues that are perhaps the most important long-term drivers of global change.

These issues have enormous geopolitical relevance (oil), are growing causes of poverty and conflict (food, water, land), and/or demand unprecedented levels of international collective action (climate change).

Neither can they be seen in isolation, as was shown by last year’s short, but pronounced, commodity boom. In the spring of 2008, oil prices spiked, reaching $147 dollars per barrel in July. Food prices also increased alarmingly, sparked to a large degree by the price of oil. Inputs such as fertilisers had risen in price, while biofuels were an increasingly strong competitor for productive land.

In rich countries, recent analysis suggests that higher energy prices were a significant factor in turning an incipient slowdown into a deep and painful recession. In poorer countries, rising commodity prices had seriously destabilising effects, with food riots across Africa and Asia.

The response: a wave of resource nationalism, with over thirty countries introducing export restrictions. Even with lower prices, countries have continued to try and protect their security of supply. Middle income food importers have signed long-term land deal with other – usually poorer – countries, while producers are re-examining the merits of self-sufficiency.

In the medium term, the drivers for commodities remain upwards. Population growth, economic development, underinvestment in supply, a lack of water, competition for land, and climate change are all likely to increase prices and volatility.

We therefore find ourselves in a damaging triple-bind:

• On the one hand, resource price shocks are likely when times are good, acting as a repeated challenge to economic recovery.
• On the other, political progress may prove hard in both good and bad times. When prices are high, national responses will be favoured. When prices are low, economies will probably be suffering too. Other priorities will thus seem more important.

Recent experience with climate change illustrates the problem. In the boom years, global emissions shot up, rising 2.9% a year between 2000 and 2006, compared to a figure of less than 1% that was assumed in the models that formed the basis of the Stern Review. Surveying this trend, analysts from the Tyndall Centre argued that “it is difficult to envisage anything other than a planned economic recession being compatible with stabilization at or below 650ppm.”

Now, of course, we have that recession – though it wasn’t planned. The IEA expects demand for oil to fall by around 0.6% next year, though the drop could be much more dramatic than that. Emissions will decline roughly in line with energy demand (though probably not as rapidly given substitution by dirtier forms of fuel). In theory, this should make emissions restrictions easier to swallow.

But yet, as we saw in Poznan, the reverse is true, with many governments arguing that a tough climate deal should be delayed until the economy recovers. At the same, investment in low carbon technologies (at least from the private sector) is also suffering.

The logic is insidious and, if unchecked, will have catastrophic long-term consequences, as countries persuade each other that it’s never a good time for a robust climate deal.

The security threat

Finally, with the economy on all our front pages, it is easy to disregard the potential impact of security threats on the world in 2009, and on prospects for international co-operation.

That would be a mistake. The situation in the Middle East again seems unsustainable, at a time when oil producer countries are coping with what was, for them, a very unwelcome decline in the oil price. Iran’s nuclear ambitions are a threat not just to Israel, but to many of its competitors in the Arab world, and indicate the ongoing threat from proliferation.

Key middle income countries, meanwhile, are experiencing extreme distress. Pakistan, for example, has been battered by fall-out from its highly ambiguous role in the Bush administrations ‘war on terror’; by the commodity price crunch which pushed large numbers of Pakistanis back into poverty; and by the credit crunch, which left it needing an IMF bailout.

Many other countries are feeling similar impacts. Higher food prices in 2008 are estimated to have pushed an additional 130-155 million people into poverty. That shock had barely worked its way through the system, before the financial crisis hit. The World Bank estimates that developing country growth will slow to 4.5% in 2009, well below recent levels. Many analysts are significantly more bearish.

2009 could see a wave of countries get into serious trouble. If so, the IMF may well struggle to cope, given that its reserves are only around $200bn. It can probably respond to a handful more crises in smaller, poorer countries. If a larger emerging market were to get in trouble, it would need new money and fast. Trouble for a major developed country would quickly take us into unknown territory.

Weak growth in the developing world is likely to fuel conflict and state failure, with poor countries facing a ‘demographic disaster’ if they fail to provide economic opportunities for growing numbers of young adults. There is a compelling link between income and civil war, while sudden income losses weaken the legitimacy of the state and exacerbate competition between groups for scarce resources.

The results are countries that are a threat to themselves, to their neighbours, and – as havens for terrorists – to the rest of the world.

Now is a good time to remember that Nassim Nicholas Taleb has said that the financial crisis is not a black swan, because it was too predictable that it would happen.

An unexpected security deterioration in one or more regions is precisely the kind of additional stress that could derail international efforts to tackle other problems. Terrorism is another potential threat that can be corrosive to international alliances, of course, while avian flu would see countries rush to close their borders, in a futile attempt to isolate themselves from the threat.

This, then, is not a time to lose focus on these risks. Instead, the question to ask is: how will global systems cope at a time when they are already compromised by a number of other serious stresses?

Lessons from Bretton Woods

Given the dramatic prospects we face in 2009, it’s tempting to look at past crises to see what historical precedents tell us about what is happening today.

In the run up to the G20 last year, a number of European governments became excited by the prospect of a grand redesign of the multilateral system. Gordon Brown and Nicolas Sarkozy were particularly enthusiastic about the prospects for Bretton Woods II – and have taken this energy into the G20 process.

The first Bretton Woods conference aimed, in the words of John Maynard Keynes, to find “a common measure, a common standard, a common rule” that would govern all parts of the economic system.

The impetus for agreement sprang from the exhaustion of the second world war; a decade of thinking and preparatory work by Keynes and others; and the ability of the United States – in its pre-Cold War period of undisputed hegemony – to impose agreement where necessary.

Today’s conditions are very different. Many policymakers are still in denial about the depth of the problems we face. There are few, if any, well-developed packages of solutions. And the United States is in no position to insist on a programme of global reform.

Perhaps then, a better example is the crisis that ended the Bretton Woods system – the so-called ‘Nixon Shock’ of 1971 when the US President broke the link between dollar and gold.

Although Nixon blamed speculators for his decision, in fact the problems were structural – global imbalances that are strikingly similar to today’s. Post-war European recovery had led to large US deficits and, with fixed exchange rates, the Europeans had little choice but to recycle dollars into US government debt, of which there was plenty, given America’s need to fund an expensive war in Vietnam.

The result was a series of runs on US gold reserves and growing pressure to devalue the dollar. Policy was made up on the hoof. Nixon’s shock decision to break the link with gold was taken with little preparation or forethought. The President spent less time on the policy itself, than he did on worrying whether he should interrupt a popular television programme to announce it to the American people, and the world.

So what happened? Predictably, the dollar went into a steep decline, losing around a quarter of its value against a basket of European currencies. And inflation was let loose, despite US attempts to control prices and wages. The resulting inflationary spiral was not tamed until the 1980s and only then through the ‘Volcker recession’.

Natural resources were also involved. The oil shock of 1973 can be seen, in part, as a response to the depreciation of the dollar, as Arab countries protected an oil price that, when denominated in gold, had seen a three-fold decline.

The Nixon shock illustrates the dangers of unilateral and reactive policy-making; and also the power of unintended consequences. In our response to a crisis, we often sew the seeds for the next breakdown, and can easily exacerbate not dampen volatility.

Stagnation in the thirties

For pessimists, however, comparison with the 1970s is not sufficiently dramatic. They prefer to reach for the stock market crash of 1929 and the subsequent ‘great depression.’

A few months’ ago, these were comparisons were regarded as distasteful, maybe even a little hysterical. In April last year, the IMF was predicting only a minor slowdown for Europe and a recovery in the US starting in 2009.

No longer. Now, rich countries are clearly all in a deep recession. The question is whether it will be U-shaped (deep but with a gradual recovery) or L-shaped (ongoing stagnation). As one economist quipped recently, it’s now too late to avoid 1929. Instead, we must focus on avoiding the mistakes of 1930, 1931 and 1932.

What were those mistakes? Deflation exacerbated by policy, of course. But also a tit-for-tit recourse to protectionism, as global trade came to a halt, and a series of sovereign debt defaults, leading to the collapse of the international financial system.

It is tempting to imagine that the period was a time of international policy paralysis, with policymakers simply unaware of the risks they were running. Far from it. There were plenty of attempts to tackle problems on an international level, culminating in a World Economic Conference in 1933 that brought 66 nations together.

The summit was supposed to launch a global ‘new deal’ – or, at least, that was what the Europeans were hoping for. But there was no shared platform to bind Europe, the UK and the US together. Franklin Roosevelt – just elected in a landslide – was focused on problems at home.

To European fury (and the discomfit of his own delegation), the new President derailed the summit with the so-called ‘bombshell message’, sent from a yacht where he was enjoying a vacation. It was to be the last attempt to forge a global approach to reform before Bretton Woods.

Surveying the conference’s wreckage, Keynes’s conclusion was a sobering one. 66 countries could never be expected to agree, he thought. Only a ‘single power or a like-minded group of powers’ could prevail – and only then if they were equipped with a new understanding of the world’s systemic problems, and a new toolbox with which to tackle them.

The first globalization

The 1930s offers salutary lessons to policy makers. However, it does encourage them to believe that our current troubles are purely economic in their nature – and can be solved through some deft re-regulation and a generous dose of stimulus.

This creates a real danger that other pressing issues will be kicked into the long grass for how ever long a recovery takes. This would be a mistake, especially given the strong links between economic and other global challenges.

To underline this point, it is worth looking back beyond the thirties, to the period before the First World War, when the world had its first experience with globalization and enjoyed unprecedented mobility of capital, goods and people.

It was then that Norman Angell argued in The Great Illusion that major wars were now almost inconceivably because of “the delicate interdependence of our credit-built finance.”

For Keynes, looking back, globalization then appeared “normal, certain, and permanent, except in the direction of further improvement.” But yet the forces that were to lead to war were already building:

The projects and politics of militarism and imperialism, of racial and cultural rivalries, of monopolies, restrictions, and exclusion, which were to play the serpent to this paradise, were little more than the amusements of his daily newspaper, and appeared to exercise almost no influence at all on the ordinary course of social and economic life, the internationalization of which was nearly complete in practice.

Rapid social, technological and economic development had brought about a new paradigm of ‘industrial war’. Countries were enmeshed in a system of diplomacy that was intricate in its operation, but in which levels of mistrust had steadily grown.

The result, in 1914, was the destruction of the European world order and a period of chaos that took two world wars and the intervening depression to resolve.

Today, the second period of globalization faces similar challenges and contradictions.

Modern economies are dynamic but unstable, as we have found out. Technological diffusion is putting unconventional weaponry in the hands of a growing number of states. Inevitably, non-state actors will also find some way of getting in on the act.

Power, meanwhile, is shifting to countries where most people are still poor, at a time when resource constraints are beginning to bite. Economies must decarbonise at a speed that will make the industrial revolution look pedestrian. Even so, the chances of disruptive climate change are now worryingly high.

The challenge then is to use the current systemic shock as an impetus for fundamental reform. The danger is that, as in 1914, the basis for international co-operation will disappear, just when globalization most needs to be ‘saved from itself’.

Signals from the future

Last year, in a paper for the United Nations University, I argued that international co-operation on climate depends on ‘signals from the future’.

Alex Evans and I have developed this work further, in a project for the UK’s Department for International Development that explores the radically different institutional architecture that will be needed to deliver a low carbon future.

One of our central arguments is that action taken on climate today is fundamentally influenced by expectations of what will happen in the future:

• If countries, companies and citizens expect a slow transition to a low carbon economy, then they have a strong incentive to block any climate deal, and to free-ride on carbon reduction measures implemented by others.
• On the other hand, if they expect the transition to happen rapidly, their incentive is to lead the change (in order to avoid misallocated investment, and to lead emergent industries), while supporting strong action against free-riders.

An effective climate deal, then, is something of a self-fulfilling prophecy. With strong signals from the future, policy-makers are likely to behave in a way that makes a deal easier to achieve. In contrast, weak signals will lead to a vicious cycle and intense zero sum competition.

This argument can, I believe, be applied more generally to today’s international challenges. Let us characterise current international co-operation as medium trust, with considerable commitment to globalization, but relatively weak institutional arrangements for controlling the global system.

If we experience a long crisis (or a chain of interlinked crises), we are likely to see either a significant loss of trust in the system (globalization retreats), or a significant increase in trust (interdependence increases). The status quo is not likely to be stable over the medium-term.

Which way we move depends, above all, on our time horizons. Do they shorten, as countries focus on immediate domestic political concerns? Or do they lengthen, as institutions are built that can last a generation or longer?

The three ‘shareds’

Lengthening time horizons requires countries to work from a comprehensive view of the risks and challenges the world faces, and its opportunities for solving them.

This is why we need a new diplomacy – one that focuses its resources not on bilateral relationships, but on multipolar responses to global threats and challenges.

This is a diplomacy of ideas, not one of narrow self-interest, and it should take us a long way from the old geopolitics. In the new paradigm, countries need to co-operate to build a vision for the international institutions that we need, not just today, but over the next generation. They need to identify and further shared interests.

The goals of this diplomacy, then, are to build:

• Shared awareness – a joint analysis of future challenges, one that is sufficiently broad to bring together economic, security and scarcity issues, and that has buy-in not just from governments, but from non-state actors too.
•  Shared platforms – coalitions of countries that begin to harmonise their domestic policies and commitments (whether on banking reform, or climate change, or investment in agriculture), and use this as the basis for lobbying for more fundamental international reforms.
•  A shared operating system – new global frameworks and institutions, with a mandate to deliver security and sustainable growth over the long-term.

As Alex and I argued in our paper for the Progressive Governance summit, we need to drive through a programme a multilateral reform that focuses on delivering results, not restructuring organisations.

 This means building an international system that:

• Aims, over the long term, to manage risk and increase resilience.
• Embeds national sovereignty in a deeper context, in which the need for cooperative action between states is recognised and acted upon.
• Overcomes fragmentation between silos and distributes, as widely as possible, the responsibility for creating global public goods.
• Rebuilds international organizations, making them much more flexible, responsive, and able to interface with non-state global networks.

Building the platform

So what might this look like in practice?

The first priority is for the US, Japan and Europe to start acting as if they have a shared interest in a more stable, equitable and sustainable future. We have been through a period of US overreach and unilateralism, coupled with muddle and passivity from its key allies. That has to end.

The Obama administration will clearly be a breath of fresh air. It can be expected to:

• Develop the US’s piecemeal and reactive bailout into something that has greater coherence and strategy.
• Signal a more co-operative and less confrontational security stance.
• Begin the process of legislating on climate change, with the US potentially matching European commitment on the issue.

This will create considerable diplomatic space – across the UN system; at the G20, of course; but also at the G8, which will have a reduced, but important, role as a caucus for richer countries.

For the rich countries, the priority is to use domestic delivery to build a basis for international agreement. This is true for financial reform, trade, and action on climate and other resource issues.

But, assuming positive moves from the US, will Europe and Japan respond in kind? Or will they take a ‘wait and see’ approach to Obama’s overtures? The question is critical to the ongoing relevance of the post-1945 alliance.

Even united, the world’s traditional powerbrokers cannot act alone. They will need China, India and the other emerging powers not as reluctant negotiating partners, but as substantive contributors to a new global order.

Broader involvement becomes more, not less, important should the BRICs find themselves in serious economic trouble as the financial meltdown proceeds.

This will require more established powers to show considerable (and uncharacteristic) humility. In East Asia, memories of the financial crisis of the late 1990s are fresh. Bailout packages then came with stringent conditions and much lecturing from the international community. Countries were told there was no gain without much pain.

Things are very different today, now that rich countries are in trouble. Stimulus is all the rage, not austerity. The doctrine of deregulation has also been shattered, but it is as yet unclear what will take its place.

2009 will be a year that heads of state spend more time together than ever before. This time will be wasted unless the intellectual spadework is done to prepare for their discussions.

That means creating a vision for where globalization goes from here. Built into this vision, we need a renewed emphasis on the resilience and coherence of global systems. We cannot simply ‘redraw the organogram’ – the need for reform is much more fundamental than that.

Good signs

I want to end by sketching out some sense of what would constitute progress in 2009. This is not a comprehensive agenda for the year, just some positive signals that countries are choosing a long term, high trust and co-operative approach, not slipping into tit-for-tat, reactive and protectionist responses.

We should expect the G20 to:

• Embed its work on finance and economy within a broader vision of global reform and not simply focus on technical issues.
• Make clear its expectations for a deal on climate at Copenhagen and set out some parameters for the ambition of that deal.
• Make a shared commitment to a green stimulus, with arrangements to quantify the impact of stimulus packages on carbon productivity.
• Mandate the IMF to monitor the re-pricing and allocation of toxic assets, improving cross-border visibility of the pace of financial restructuring.
• Agree that members should report, on a quarterly basis, steps they have taken to control the financial crisis.
• Begin to develop a ‘super sherpa’ system to improve the capacity of Heads of State to cope with their growing responsibility for global issues.

From the G8, meanwhile, we should expect:

• A clear signal from each member state as to what it is prepared to offer to ensure an effective climate deal.
• Equally clear signals from the ‘+5′ countries (Brazil, China, India, Mexico and South Africa) on how they plan to reduce emissions over the long term.
• A renewed pledge to meet development commitments, especially as poor countries suffer growing impacts from the financial crisis.
• Reporting on national delivery of key G8 commitments in area such as climate and trade.

From the United Nations, we require:

• Renewed leadership from the Secretary General on climate, especially through the SG’s high-level ‘Friends Group’.
• A concerted effort to explore the shape and content of a climate deal, using previous High Level Panels as a precedent.
• A process that explores the global institutions needed to deliver a post-2012 climate deal (this could build on the model provided by the Task Force on the Global Food Security Crisis).
• An exploration of how global stocks of food and other commodities can be increased, using the International Energy Agency’s co-ordination of strategic oil reserves as a model.
• An initiative by the Security Council to explore the security implications of financial instability and growing resource scarcity, as part of a renewed commitment to forging a new global security consensus.

This year could be an exceptionally tough one for the Bretton Woods’ institutions and the WTO. As a minimum, we should therefore look to:

• Strengthen the IMF and World Bank to ensure they can cope with the risk of a cascading series of national liquidity crises.
• Defend the current free trade system and maintain confidence in the WTO.

Looking forward, the Bretton Woods’ institutions must address their lack of legitimacy in large parts of the world, while developing:

• An enhanced global surveillance function (though this must incorporate a new openness about the limits of economic forecasting).
• Tough international norms for the regulation of financial institutions.
• A framework that allows debtor countries to restructure their debts in a controlled fashion.
• Enhanced arrangements for working with the rest of international system to improve resilience in the face of short and medium term challenges.

Finally from the WTO, we should look for:

• A renewed attempt to breathe life into Doha, perhaps as part of a broader ‘grand bargain’ on finance and climate.
• An analysis of the relationship between trade and scarcity issues, exploring action to discourage export barriers and related restraints to trade.
• An analysis of how the world trade system can best be integrated with a comprehensive framework for emissions control.

Human drivers

Finally, I want to close with a warning.

We will make a grave mistake in 2009 if we persist in treating the world’s challenges as primarily technical ones, and we neglect the underlying human drivers.

The world’s economic and financial problems have deep-seated psychological and behavioural dimensions. As Paul Krugman has argued, “the expectations, even the prejudices of investors, [have] become economic fundamentals – because believing makes it so.”

Our security challenges result from the fact that conflicts are now fought ‘among the people’ rather than just between nation states.

Scarcity issues, meanwhile, trigger powerful popular responses – and could easily lead to debilitating conflicts within and between countries over how limited resources can be fairly distributed.

But we live at a time when public trust in governments is being shattered.

In a recent international poll, only half of respondents believe their leaders are up to the task of designing a suitable response to the financial crisis. Confidence was lowest here in Japan, the country that has the longest experience of financial turmoil.

In this atmosphere, populist movements are certain to thrive. We ignore them at our peril, as they will rarely support international action and, even if they don’t attain power, they may exert a blocking vote.

That makes it vitally important that reforms are designed in the open, not cooked up behind closed doors. Whatever solutions we come up with, they must emerge from a new engagement with citizens and efforts to develop domestic political conditions that allow international commitments to be made.

That means a concerted attempt to:

• Reach out to influencers and opinion formers at a national level, to debate and make the case for a new multilateralism.
• Build a narrative and vision that will communicate to a wider public the need for international approaches to global problems.
• Develop social protection systems that will insulate citizens from international volatility and instability.

Ultimately, any international reform agenda must be about the needs of global citizens. Lose sight of this fact and, however attractive new policies appear in prospect, in practice, they will fail.

For references, see PDF version.

Phew. We can all stop worrying then. After all Kudlow’s stunning track record proves he really has his finger on the pulse of US economic performance. Let’s review some of the highlights from his analysis over the past couple of years:

Feb 2007: Praises Ben Bernanke for “laying the groundwork for what is virtually a runaway bull market” – one he assures us a few months’ later has guaranteed the US’s role at the epicentre of a “a global boom, marked by a spread of free-market capitalism like we’ve never seen before.”

Sept 2007: Warns us that “it’s very easy to be totally pessimistic and bearish right now, but that’s precisely why I will avoid falling into that trap. Optimists are winners. Pessimists are losers.”

Sticks to this creed throughout the quarter in which the recession got underway… October (“if things are so bad, why are they so good?”), when he says growth is accelerating…November (subprime is “just not that big a deal”)…and December (“the prophets of recessionary doom…have been proven wrong once again”)

In Feb and March 2008, admits that a mild recession is possible, but assures us that “Bernanke’s emergency machinations to fight the recession in housing and housing-related credit are starting to show very positive effects.” There is no “genuine, across-the-board credit crunch,” he tell us in April. As a result, any slump “could be over by late summer.”

In September (with summer a memory and the economic clouds darkening), swoons for Henry Paulson who has embraced the gales of creative destruction and promised “no more federal bailouts. Not for Lehman Brothers. Not for global insurer AIG.”

Three days later, however, swoons for Paulson again, this time for preventing what would have been an “unfathomable” – an AIG collapse. Bailouts, it turns out, are a simply wonderful idea – not only will they save capitalism from doom; for taxpayers they’re a “win-win-win-win.” The government is sure to get its money back – even better it’s highly likely to make “a handsome profit” – enough to “pay down the national debt.”

October 2008: Is appalled by the “fear and panic” that have gripped the economy. “It is one of those moments in history when people feel helpless, frustrated, and bewildered about what’s going on and why it’s happening.” But still assures us that “much good may ultimately come of this terrifying correction.”

November 2008: Is cock-a-hoop at the “economic-primer” George Bush has left for his successor-elect Barack Obama, who apparently now has “an outsized responsibility [eh?] to mend and revive the economy.” Obama needs to access Bush’s wisdom and follow his economic-growth model, one “that has worked so well and so long for this country.”

Yes – that’s right. Bush (“the top economic forecaster in the country”) and his administration have left the US poised for recovery. If it all goes wrong, we’ll all know who to blame – that “extremely liberal-left” guy who is just about to take over. But as long as the new President tries to do what Bush would have done, then everything – my friends – will be alright.

Blair, a 6th generation, Oxford-educated naval officer, occupies a number of teaching posts and once served as the first associate director of CIA for military support. He also ran the federally-funded Institute for Defense Analysis before being forced out after a conflict of interest dispute.

But it is his role as the Deputy Director of the Project on National Security Reform, a bi-partisan, Congressionally-funded reform initiative, that may say most about how, if confirmed, Blair intends to manage the U.S intelligence community. For despite the misgiving of some like Bob Baer, the former CIA analyst, Blair is both a manager and a reformer.

During my time in Washington, DC, I spent a little time with Blair, who struck me as a reformer with deep insights into how both soldiers and spies work and think. See this clip where he argues that the U.S government needs to work on the basis of “integrated, agile, collaborative, inter-agency teams” rather than the departmental stove-pipes currently in existence. Not the sound of a status-quo thinker.

Being reform-minded, however, will only go so far. Blair will need to will reform, demand reform, and pursue reform. For most intelligence-watchers believe that the Bush administration’s post 9/11 intelligence reforms were hurried and have created as many problems as they have solved. The current spy chief, Admiral Mike McConnell has done what he could to improve the situation, launching a 100-day initiative when he took over from John Negroponte, to improve “integration and collaboration” across the many intelligence agencies. Meanwhile Robert Gates has scaled down the Pentagon’s footprint on intelligence.

Yet most people believe the situation needs to improve further if the U.S is to get more for the $43 billion it spends annually on intelligence. The Office of the Director of National Intelligence has become a large bureaucratic contraption with hundreds of personnel camped out in a Washington airbase. Many staff are unclear about their roles vis-à-vis their CIA colleagues.

The DNI himself, though he briefs the president daily, has only limited authority over the 16 agencies in the intelligence community as the reform legislation did not give the spy chief the kind of budgetary muscle needed to lead the intelligence community. In spite of the efforts of Gates and McConnell the National Security Agency, the National Geospatial-Intelligence Agency and the National Reconnaissance Office remain under Pentagon’s command. 

Then there is the question of domestic intelligence. Many believe the U.S should create a domestic intelligence agency like Britain’s Security Service. But how to do so and avoid adding complexity to the intelligence system, slowing down rather than promoting information flows among the existing agencies, while respecting civil liberties? And who would run such an agency – the DNI, the Homeland Security Secretary, the FBI, the CIA?

Finally, there is a need to look again at Congress’ role. Oversight has deteriorated amid battles between different committees. The President’s Foreign Intelligence Advisory Board and the Intelligence Oversight Board have also atrophied in the last eight years while the Bush administration failed to create a Civil Liberties Board, despite being mandated to do so by Congress.

Blair seems well-placed to lead a reform process without allowing it to descend into something like the Church Committee hearings, which investigated intelligence-gathering by the CIA and FBI after the Watergate affair, but ended up encouraging many of the intelligence community’s bad traits. No doubt his confirmation process will drag up the conflict-of-interest case that forced him out of his last government-funded job, as well as his controversial role in opening diplomatic ties with Suharto’s Indonesia.

But the real question is: how ambitious will Obama be in leading changes in Congress; and reforms in the Executive Branch to ensure a well-functioning intelligence apparatus that can deal with foreign and domestic threats, produce politically-neutral assessments, work with other government departments and guarantee civil liberties. Obama’s choice of Blair shows the President Elect wants to reform, but also wants to keep the intelligence community on board.

Ghana is important not just because it is one of very few West African countries that is not mired in corruption, civil strife and abject poverty (although there is plenty of the latter and not a little of the former if you look hard enough). It is also one of only a handful of countries on the entire continent that has regular peaceful democratic elections (it has had five since 1992). After the debacles in Kenya and Zimbabwe in the last two years, and after the recent coups in Guinea and Mauritania, it is crucial that Ghana’s poll passes off peacefully.

So far, there has been relatively little unrest, but as Chris Blattman reports, tensions are rising by the day:

My friend Naunihal sends me this dispatch, cobbled together hastily this afternoon (he urges me to tell you):

The situation is starting to look like Bush v. Gore. The election commissioner just said that the opposition leads by 23,000 votes and that there is one constituency where there was no election for security reasons which has over 50,000 votes that will vote just after new years.

But it gets messier. The incumbent party (NPP) points out that 2 big constituencies in Kumasi (its key area of support) were not included in the officially counted votes (probably because they are contested) and that it won one of those by over 51,000 votes.

In addition, they point out that in 11 constituencies in the opposition’s key area of the Volta region, NPP poling agents were thrown out and did not sign the election returns. I’ve seen the violence done to one of the party election observers – he was beaten and stoned and may lose his eye.

Right now fear is running high in Accra. Makola Market, the main market, is closed because of fear of violence. I’m getting reports right now from people aligned with the NPP, so I’m only hearing about NDC “Machomen” riding around in empty streets.

The constituency that has yet to vote for the President, voted against the incumbent party at the Parliamentary level, thus kicking out the incumbent MP. So it looks good for the opposition in that area, but everything is really too close to call.

And rumors are spreading that the election commissioner is under pressure from the incumbent government to throw things their way.

None of this is good in terms of street level tensions and legitimacy for whichever candidate gets declared.

Update: Fortunately, the election concluded peacefully, as Nana Akufo-Addo of the New Patriotic Party graciously conceded defeat to John Atta Mills’ National Democratic Congress. A rare example of a peaceful democratic transition, then, from one African party to another, and further evidence that Ghana really is a beacon of hope for the region. Let’s hope leaders in other parts of the continent take note.

Courtesy of the NYT

There are many reasons why American foreign policy has been so teeth-grindingly awful during the Bush years, but the hiring policy for ambassadors probably didn’t help.

Thomas Schweich had three senior diplomatic jobs under Bush. Each time, he had to run the gamut of the politically-appointed ‘kids’ (sons and daughters of Bush supporters, campaign workers etc) who had taken over the personnel department. What they lacked in experience, they made up for in attitude, he says.

“For two of these jobs, my appointment was preceded by an effort by a 20-something in personnel to place an unqualified friend in the job,” he writes. “In the third instance, the State Department went out of its way to avoid the personnel office by appealing directly to a senior assistant to the president.”

Others had a similar experience:

Another top foreign service officer called me after his interview to be ambassador to a volatile African country. “The problem was,” he told me, “the kid interviewing me could not pronounce the name of the country I was being interviewed for. It made for an awkward interview until he just started saying ‘the country we are considering you for.’”