The Pakistani Spectator

Drawing up a scorecard of winners and losers from the financial crisis and the resulting global economic downturn is relatively easy if we concentrate on straightforward economic effects, and if we think of them in the short term.  Political ramifications, especially over the longer term, are more difficult to calculate.  Some losers by both measures are readily identifiable, though.  Oil exporting countries head the list: e.g. Russia, Iran, Iraq, the Gulf states, and Venezuela.  All are suffering a sharp drop in revenues as oil prices have fallen precipitously from $160 a barrel last summer to around $45 today.

Russia, the world’s second largest oil exporter, has relied on oil revenues to fuel a decade of growth and stability beginning with the recovery from the last crisis in 1998.  The resulting rise in living standards was the foundation of Vladimir Putin’s successful reconstitution of a strong Russian state. Popular at home and less dependent on the West for economic sustenance, he enjoyed the freedom to pursue a more assertive, self-interested foreign policy.  Changing economic fortunes crimp his style, although it is unlikely that Moscow will revert from has been its historical vocation of activism in managing its external relations.

Iran, too, has highly dependent on oil revenues.  Iranians have been cushioned from the full effects of the American led sanctions regime by the flow of petrodollars.  Understandably, there is now much talk in Washington that a further tightening of the screws could force the leadership in Teheran to make major concessions on its contentious nuclear program.  That is a dubious argument.  The mullahs, and Mr. Ahmedinejad, have proven themselves resilient players in a high stakes game  They will not forgo what they see as core national interests unless concessions are part of a comprehensive deal that accords them a prominent place in a new regional security system.  Their mechanisms of social control can contain any domestic pressures.

Iraq’s fate is something to worry about.  Whatever prospects exist for the evolution of a stable polity are jeopardized by the drying up of oil revenues.  Mr. Maliki is using his treasury to win allies, to buy off possible enemies, and to keep already poverty stricken Iraqis from complete despair.  He, or any successor whether democratically selected or an authoritarian figure, will find it impossible to consolidate their power unless they have oil money as the all purpose lubricant.  Whatever exaggerated hopes the Obama administration has for a secure Iraq serving as a bulwark for American interests in the region now look even more fanciful.  Iraq as an obvious loser from the economic crisis is also a strategic loss for the United States.

Saudi Arabia, Kuwait and the Gulf principalities are in far better shape.  Small populations and prudent policies of building up large financial reserves are making it possible for them to ride out the storm.  Economic pressure will not figure prominently in their strategic calculations.

Hugo Chavez’s Venezuela is too insignificant diplomatic player for its drop is export earnings to make much of a difference.

What of the United States- and China, the looming great power?

Assessing the effects of the financial crisis and economic downturn on China’s weight in world affairs relative to the United States should begin by laying some of the essential facts.  They can be listed simply.

• China’s rate of growth has slowed, yet is surpassing that of the US by an even greater margin today than before the crisis hit.  All forecasts are that this gap will be maintained for the foreseeable future given the dim outlook for the American economy.
• China holds $2 trillion of hard currency reserves, roughly 70% in dollars.  The United States depends on inflows of capital from China, Japan and the oil rich Gulf states to cover our yawning trade and budget deficits.
• China has enormous sovereign wealth resources that it is using to underwrite long term contracts with suppliers of natural resources around the world and to buy into critical technology based industries.
• Senior Chinese officials recently have stated publicly that they are concerned by its large, continuing investments in US financial paper given: low interest rates, the US’ parlous financial state, and China’s vulnerability to a drop in the dollar’s exchange rate.
• The same officials have proposed a gradual move to wean the world’s economy off the dollar and to replace it with a world currency modeled on the IMF managed Special Drawing Rights (SDRs)
• The privileges that the United States has enjoyed from the dollar’s status as an international reserve and transaction currency are going to be progressively reduced.  That means: domestic policy will have to more attentive to constraining international monetary conditions, i.e. higher interest rates, fiscal discipline, and a reduction in the money available to apply to foreign policy objectives – military and civilian.

IMPLICATIONS ECONOMY

1,  The United States will have to choose between observing the strictures placed on other  countries who find themselves in financial straits or run the risk of a further deterioration of the dollar’s value and growing difficulty in financing its twin deficits.

2.  The United States will lose influence in the IMF and, to a lesser extent, in the World Bank.  As a greater share of their capital is provided by China and other Asian countries, Washington will lose its veto in the IMF as its relative share of contribution based voting rights goes down.  Its indirect influence over decisions by both bodies with decline as the world’s dependence on the dollar and American financial oversight globally drops sharply.  Too, it will suffer a further decline from the discrediting of the American version of market fundamentalist capitalism.  Campaigns to pressure others to follow the American model and to open their economic to American financial interests are losing credibility.

3.  International financial management will have to become truly multilateral as the United States, with some of its European partners in train, is no longer in a position to call the shots.

4.  Working out the terms of that multilateral management, and making the requisite organizational adjustments, will be the prime test of whether the United States and China can work together to each other’s mutual benefit and in the interest of global economic stability.

5.  Mutual economic dependency is the overriding reality – whatever the exact balance.  China has it within its power to bring the American economy to its knees overnight by using its financial firepower on world markets.  However, by doing so it would do grievous damage to its own economy  It would be akin to Samson bringing down the temple on himself.  In other worlds, a condition of Mutual Assured Destruction exists with similar stabilizing consequences.

POLICY IMPLICATIONS

1. American strategy should aim at adapting to China’s growing politico-economic strength rather than containing it.  While competition for resources and markets will be a feature of the relationship, emphasis should be place on reaching agreement on the rules of the game – formal and informal.
2. The United States should anticipate a larger voice for China, and other substantial contributors to expanded IMF loan facilities, by: (1) engaging them more directly in Fund’s governance, in the necessary review of lending practices, and in the organization’s enhanced oversight functions; and (2) rethinking the doctrinal foundation of the present policies who effectiveness and fairness have been highlighted by the current crisis.
3. Be prepared to join in an orderly process for loosely managing a smaller role for the dollar in global economic transactions.
4. Offer sympathetic support for the building of East Asian regional monetary area so as to be in a position to ensure its compatibility with global institutions.
5. Above all, it is imperative to put the United States’ economic house in order.  That entails: imposing strict regulatory controls financial institutions and the innovative practice that are the source of the current crisis; qualify the premise that the opening of financial markets in other countries on American terms serves the nation’s national interest; take steps to reverse the hollowing out of the manufacturing sector; move toward a marked reduction of the trade deficit before global markets and foreign governments do so by forcing the adoption of austerity policies; curb bloated budget deficits and the attendant dependence on foreign purchase of Treasury debt.
6. Prepare Americans, psychologically as well as politically and economy, for the loss of supremacy and its privileges.  This is a condition for effective implementation of the above noted policy recommendations.

POLITICAL IMPLICATIONS

1. China’s ‘soft power’ is rising, America’s is declining.  That refers above all to economic influence. In turn, that enhances the attraction of China as a model for other –especially in Asia and the NIC and LDC countries generally.
2. China will be able to use diverse economic instruments to win favor around the world just as the United States has done for 60 years.
3. Financial constraints in the United States will make it more and more difficult to sustain current levels of military expenditure.  The burden of costly campaigns in places like Iraq and Afghanistan will become onerous.  This condition may induce the United states to reconsider the inordinate prominence that it gives to military force to achieve its objectives abroad.  The sort of fundamental strategic rethink that demands will be painful and strongly resisted.
4. The greatest, and in many ways the most telling effect will be on American self-esteem.  Americans believe them destined by Providence or History to lead the world into a more enlightened state.  Our exceptionality explains and requires that we be number one in all fields of endeavor that count.  It demands as well that the rest of the world recognize this exceptionality and the prerogatives attendant upon it.  As the United States slips economically, politically and in its worldwide image, the country will be hard pressed to reconcile those realities with it s exalted sense of self.

1. China matches in the United States in the depth of its belief in its own exceptionality.  Historically, China as Heaven’s Middle Kingdom was felt to stand at the apex of earthly attainments.  There is a basic difference between the two countries’ self image, however.  The United States’ sense of exceptionality and uniqueness is closely ties to its sense of mission as model and agent of world progress.  Others are presumed to emulate the United States in aspiring to its achievements.  The Chinese by contrast have no sense of mission.  After all, to their way of thinking, no other people is capable of matching them  This may be a good thing in that there is no inevitable clash between two proselytizing nations.