Innovation, Technology, and Knowledge Management
Series Editor Elias G. Carayannis, George Washington University, Washington D.C., USA
For further volumes: http://www.springer.com/series/8124
Elias G. Carayannis Denisa Popescu
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Ali Pirzadeh
Institutional Learning and Knowledge Transfer Across Epistemic Communities New Tools of Global Governance
Elias G. Carayannis School of Business George Washington University Washington, DC, USA
[email protected]
Ali Pirzadeh Independent Consultant Washington, DC, USA
[email protected]
Denisa Popescu World Bank Group Washington, DC, USA
[email protected]
ISBN 978-1-4614-1550-3 e-ISBN 978-1-4614-1551-0 DOI 10.1007/978-1-4614-1551-0 Springer New York Dordrecht Heidelberg London Library of Congress Control Number: 2011940431 © Springer Science+Business Media, LLC 2012 All rights reserved. This work may not be translated or copied in whole or in part without the written permission of the publisher (Springer Science+Business Media, LLC, 233 Spring Street, New York, NY 10013, USA), except for brief excerpts in connection with reviews or scholarly analysis. Use in connection with any form of information storage and retrieval, electronic adaptation, computer software, or by similar or dissimilar methodology now known or hereafter developed is forbidden. The use in this publication of trade names, trademarks, service marks, and similar terms, even if they are not identified as such, is not to be taken as an expression of opinion as to whether or not they are subject to proprietary rights. Printed on acid-free paper Springer is part of Springer Science+Business Media (www.springer.com)
Series Foreword
The Springer book series Innovation, Technology, and Knowledge Management was launched in March 2008 as a forum and intellectual, scholarly “podium” for global/ local, transdisciplinary, transsectoral, public–private, and leading/“bleeding”-edge ideas, theories, and perspectives on these topics. The book series is accompanied by the Springer Journal of the Knowledge Economy, which was launched in 2009 with the same editorial leadership. The series showcases provocative views that diverge from the current “conventional wisdom,” that are properly grounded in theory and practice, and that consider the concepts of robust competitiveness,1 sustainable entrepreneurship,2 and democratic capitalism,3 central to its philosophy and objectives. More specifically, the aim of this series is to highlight emerging research and practice at the dynamic intersection of these fields, where individuals, organizations, industries, regions, and nations are harnessing creativity and invention to achieve and sustain growth. Books that are part of the series explore the impact of innovation at the “macro” (economies, markets), “meso” (industries, firms), and “micro” levels (teams, individuals), 1
We define sustainable entrepreneurship as the creation of viable, profitable, and scalable firms. Such firms engender the formation of self-replicating and mutually enhancing innovation networks and knowledge clusters (innovation ecosystems), leading toward robust competitiveness (E.G. Carayannis, International Journal of Innovation and Regional Development 1(3), 235–254, 2009). 2 We understand robust competitiveness to be a state of economic being and becoming that avails systematic and defensible “unfair advantages” to the entities that are part of the economy. Such competitiveness is built on mutually complementary and reinforcing low-, medium-, and hightechnology and public and private sector entities (government agencies, private firms, universities, and nongovernmental organizations) (E.G. Carayannis, International Journal of Innovation and Regional Development 1(3), 235–254, 2009). 3 The concepts of robust competitiveness and sustainable entrepreneurship are pillars of a regime that we call “democratic capitalism” (as opposed to “popular or casino capitalism”), in which real opportunities for education and economic prosperity are available to all, especially – but not only – younger people. These are the direct derivative of a collection of top-down policies as well as bottom-up initiatives (including strong research and development policies and funding, but going beyond these to include the development of innovation networks and knowledge clusters across regions and sectors) (E.G. Carayannis and A. Kaloudis, Japan Economic Currents, p. 6–10 January 2009). v
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drawing from such related disciplines as finance, organizational psychology, research and development, science policy, information systems, and strategy, with the underlying theme that for innovation to be useful it must involve the sharing and application of knowledge. Some of the key anchoring concepts of the series are outlined in the figure below and the definitions that follow (all definitions are from E.G. Carayannis and D.F.J. Campbell, International Journal of Technology Management, 46, 3–4, 2009).
Conceptual profile of the series Innovation, Technology, and Knowledge Management • The “Mode 3” Systems Approach for Knowledge Creation, Diffusion, and Use: “Mode 3” is a multilateral, multinodal, multimodal, and multilevel systems approach to the conceptualization, design, and management of real and virtual, “knowledge-stock” and “knowledge-flow,” modalities that catalyze, accelerate, and support the creation, diffusion, sharing, absorption, and use of cospecialized knowledge assets. “Mode 3” is based on a system-theoretic perspective of socioeconomic, political, technological, and cultural trends and conditions that shape the coevolution of knowledge with the “knowledge-based and knowledge-driven, global/local economy and society.” • Quadruple Helix: Quadruple helix, in this context, means to add to the triple helix of government, university, and industry a “fourth helix” that we identify as the “media-based and culture-based public.” This fourth helix associates with “media,” “creative industries,” “culture,” “values,” “life styles,” “art,” and perhaps also the notion of the “creative class.” • Innovation Networks: Innovation networks are real and virtual infrastructures and infratechnologies that serve to nurture creativity, trigger invention, and catalyze innovation in a public and/or private domain context (for instance, government– university–industry public–private research and technology development coopetitive partnerships).
Series Foreword
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• Knowledge Clusters: Knowledge clusters are agglomerations of cospecialized, mutually complementary, and reinforcing knowledge assets in the form of “knowledge stocks” and “knowledge flows” that exhibit self-organizing, learning-driven, dynamically adaptive competences and trends in the context of an open systems perspective. • Twenty-First Century Innovation Ecosystem: A twenty-first century innovation ecosystem is a multilevel, multimodal, multinodal, and multiagent system of systems. The constituent systems consist of innovation metanetworks (networks of innovation networks and knowledge clusters) and knowledge metaclusters (clusters of innovation networks and knowledge clusters) as building blocks and organized in a self-referential or chaotic fractal knowledge and innovation architecture (Carayannis 2001), which in turn constitute agglomerations of human, social, intellectual, and financial capital stocks and flows as well as cultural and technological artifacts and modalities, continually coevolving, cospecializing, and cooperating. These innovation networks and knowledge clusters also form, reform, and dissolve within diverse institutional, political, technological, and socioeconomic domains, including government, university, industry, and nongovernmental organizations and involving information and communication technologies, biotechnologies, advanced materials, nanotechnologies, and next-Generation energy technologies. To whom is this book series directed? The book series addresses a diversity of audiences in different settings: 1. Academic communities: Academic communities worldwide represent a core group of readers. This follows from the theoretical/conceptual interest of the book series to influence academic discourses in the fields of knowledge, also carried by the claim of a certain saturation of academia with the current concepts and the postulate of a window of opportunity for new or at least additional concepts. Thus, it represents a key challenge for the series to exercise a certain impact on discourses in academia. In principle, all academic communities that are interested in knowledge (knowledge and innovation) could be tackled by the book series. The interdisciplinary (transdisciplinary) nature of the book series underscores that the scope of the book series is not limited a priori to a specific basket of disciplines. From a radical viewpoint, one could create the hypothesis that there is no discipline where knowledge is of no importance. 2. Decision makers – private/academic entrepreneurs and public (governmental, subgovernmental) actors: Two different groups of decision makers are being addressed simultaneously: (1) private entrepreneurs (firms, commercial firms, academic firms) and academic entrepreneurs (universities) interested in optimizing knowledge management and in developing heterogeneously composed knowledge-based research networks and (2) public (governmental, subgovernmental) actors that are interested in optimizing and further developing their policies and policy strategies that target knowledge and innovation. One purpose of public knowledge and innovation policy is to enhance the performance and competitiveness of advanced economies.
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3. Decision makers in general: Decision makers are systematically being supplied with crucial information, for how to optimize knowledge-referring and knowledge-enhancing decision-making. The nature of this “crucial information” is conceptual as well as empirical (case-study-based). Empirical information highlights practical examples and points toward practical solutions (perhaps remedies), conceptual information offers the advantage of further-driving and further-carrying tools of understanding. Different groups of addressed decision makers could be decision makers in private firms and multinational corporations, responsible for the knowledge portfolio of companies; knowledge and knowledge management consultants; globalization experts, focusing on the internationalization of research and development, science and technology, and innovation; experts in university/business research networks; and political scientists, economists, and business professionals. 4. Interested global readership: Finally, the Springer book series addresses a whole global readership, composed of members who are generally interested in knowledge and innovation. The global readership could partially coincide with the communities as described above (“academic communities” and “decision makers”), but could also refer to other constituencies and groups. Elias G. Carayannis Series Editor
Preface
The mission (and business) of development was launched as part of the opening salvos of the Cold War with the foundation of the United Nations (San Francisco, 1945) and creation of the World Bank and the IMF (Bretton Woods Agreement, NH, 1947), where development initiatives (including the Marshall Plan for the European reconstruction) served as complementary strategic devices to military, political, and diplomatic efforts for containment and pre-emption of the “domino effect” (the Dulles Doctrine). As we are completing this manuscript in the shadow of a gloomy US economic condition and Europe’s debilitating deja-vu in October 2011 and as one more European Union Leaders gathering comes to close with accompaniment of increasingly global protests, it seems that the public opinions and to some extent the nationstates are becoming less relevant and weakened in the prevailing global financial integration and the global economic system. This book aims to shed some light and promote the understanding of the challenges and opportunities of development policies and practices that are in essence knowledge formulation, transformation, transfer, absorption, and implementation devices in the context of an emerging new world order. Lessons learned will hopefully serve to inspire and enlighten future actions toward more efficacy in development interventions as well as to better align development with progress, innovation, and democracy as the world oscillates and vacillates between the Washington consensus and the Beijing consensus in search of a better tomorrow. Washington, DC, USA
Elias G. Carayannis Ali Pirzadeh Denisa Popescu
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Contents
1
Introduction and Definition of Terms ....................................................
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Globalization, Nation-States, and Global Governance ......................... Nation-States, Globalism, Globalization ................................................... Technological Advancements and Financial Institutions........................... Power and Financial Institutions ................................................................ The Notion of Power .............................................................................. How Financial Institutions evolve in the Prevailing environment ................................................................ Financial Institutions and Exercise of Power ......................................... Global Governance .................................................................................... Global Neighborhood............................................................................. Conceptual Foundation of Global Governance ...................................... Structure of Global Production: Post-Industrial Age ................................. Mode of Global Production ................................................................... Contributing Factors to Change in Structure of Global Production ..............................................................................
7 7 19 26 26
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“Good Governance,” Institutions, and Global Rules ............................ Concept of “Good Governance” ................................................................ Institutional Environment: Rules of the Game .......................................... Organizations and Institutional Perspectives ......................................... International Financial Standards and Regulations....................................
97 97 103 105 108
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Epistemic Communities, Knowledge Transfer, and Institutional Learning ...................................................................... Internationalization and Technocratization of Policy Making ................... Networks and Epistemic Communities ...................................................... Knowledge and Institutional Learning....................................................... Formal Knowledge and Institutional Learning as Related to Global Standards .................................................................................... Policy Convergence....................................................................................
33 45 67 68 74 81 85 92
123 123 130 135 142 147 xi
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Contents
Case Study: International Financial Architecture and Standards........................................................................................... New International Financial Architecture .................................................. Emprical Research Results of Knowledge Transfer and Standards Adoption: ROSC Programs ................................................ Conceptual Model of Knowledge Transfer Used in the Case Study ................................................................................... Empirical Research Results ................................................................... A Note on Case Study: Limitations, Challenges, and Opportunities .......................................................................................
151 151 155 155 162 167
Concluding Remarks ............................................................................... Decline of Nation-States ............................................................................ Epistemic Community ............................................................................... Conformity ................................................................................................. International Standards ..............................................................................
171 171 174 176 178
Appendix .........................................................................................................
183
Reference.........................................................................................................
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Index ................................................................................................................
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Chapter 1
Introduction and Definition of Terms
Discussion about the notion of globalization often leads to certain skepticism as to its meaning and implication. Yet one can argue that there has been intensification in the economic, political, and institutional relations among countries over the last decades that led to the formation of a Global Economic System (GES). This new trend was marked by increasing economic interdependence and the deepening of economic integration between countries across the world. The increase in foreign trade and economic openness, internationalization of a productive system, reduction in the economic role of the state, and leadership of multinational firms especially in the financial sector are among the main trends of the process of increasing economic integration.1 In this regard, globalization is a historical process that was promoted, more or less, by community of experts worldwide and various international organizations to the rest of the world. An important dimension of the globalization process, but certainly not one that has been discussed at length in the general populace’s popular discussion, is the gradual spread of values with regard to civil and political rights as well as certain economic and social “codes of conduct.” In fact, efforts have been put forward so that the basic objective of a GES, namely, to conjure a “level playing field” for the efficient operation of free market forces, can be obtained (ECLAC 2002: 26). In other words, there are certain values/ideas that are valued above others – and these have become the norm in the global system.
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The various forms of regionalization and integration of national economies, such as the European Union, the North American Free Trade Agreement, the Common Market of the South, or the Association of Southeast Asia Nations, can be understood as the institutionalization of the globalization process. E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0_1, © Springer Science+Business Media, LLC 2012
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Introduction and Definition of Terms
In this regard, the process is naturally evolving toward global standards and rules, to the point where countries’ institutional environments become similar to one another.2 Two points must be underlined to comprehend our use of “naturally” evolving process. First, participation in the global financial market is by no means compulsory, but rather based on clear economic motives – when a country intends to join the global system, its institutional and legal system and economic structures need to move toward the global norms that are established within the global system. Second, there are no preexisting mechanisms to either enforce or punish noncompliance applicants since these countries’ engagement in such one-way exchange is voluntarily – they initiate to engage in such transfer to gain credibility and acceptance by economic powerhouses of the world so they can claim that they play by the same rules. As a result, specific objectives (e.g., strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international cooperation, and international financial institutions) have become one of the priorities as indicated by the recent G-20’s gatherings. The ample confirmation of these objectives is the notion of global governance. It must be noted that global governance does not mean, nor imply, a world government. In fact, global governance would not be necessary were there a world government in place. While domestic governments retain legitimate monopolies on the use of force and the power to enforce legislation, global governance refers to the interaction (political, economic, social, etc.) that is required to solve problems that affect more than one state or region specifically in light of the lack of a world governing body. The tools used to tackle global problems may be rules (laws, norms, and codes of behavior) and/or institutional functions or practices that aim to manage collective affairs. In this respect, a system of governance has been established in which highly selective standards and regulations have become an important tool for members of international institutions and their expert epistemic communities to ensure the stability of the global system. This book focuses on programs of International Organizations, such as the World Bank (WB) and International Monetary Fund (IMF), which come to existence as a result of the GES. To face these concerns, international organizations have become increasingly outward looking as they seek to construct international regulatory mechanisms and global rules to effectively manage the growing diverse cross-border issues, which regularly surface on national agendas and ensure that all nation-states play by the same rules. In this context, transfer of specialized and procedural knowledge from various international organizations, such as WB and IMF, and their own epistemic communities is becoming a policy tool to “convince” participants in the international system to have similar ideas about what rules govern their mutual participation: everyone is expected to play by the same rules. One of the possible consequences of
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Here, “naturally” implies the same connation as when it is used to describe unemployment.
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Introduction and Definition of Terms
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a rise in standards setting and regulations is convergence of specific functions of national policy-making institutions toward international code of conducts, which eventually may lead to change in mechanisms and relationships between involved actors (regulate setter and regulated agencies). The primary focus is on transfer of specialized and procedural knowledge in development-related technical domains (e.g., accounting procedures, payment systems, corporate governance principles, etc.), promoting institutional learning at national and local levels. However, transferring such knowledge comes with challenges, and requires certain preexistent conditions to be in place for such transfer to become effective. We argue that nation-states must face difficulty to comply with the global governance rules and norms’ demands and requirements because of their weaker absorption/ implementation capacity, insufficient institutional readiness to face global system (in a sense that possible governments’ failure is related to their material, organizational, or epistemic resources, which are not sufficient to perform adequately particular functions), and incompatibility of national rules with international rules. For instance, existence of “absorptive capacity” within a recipient country (e.g., established national epistemic community) to understand and use effectively the knowledge transferred or substantial resources (e.g., appropriate national institutional environment) are needed to support and implement the right policies. As a result, nation-states’ inabilities mentioned above can be addressed through knowledge transfer mechanisms from international organizations. In this regard, a core strategy of international organizations is to build upon effective knowledge transfer flowing from global institutions to national institutions with the ultimate objective of creating national and local epistemic communities that would improve, in long term, the countries’ institutional and absorptive capacity and the focus they should have on international standards in the financial/economic sector. As a Russian representative at IMF stated, in regard to knowledge and policies aimed to ensure convergence toward global rules, “their implementation by certain countries requires substantial effort and/or outside technical assistance.”3 We argue in this regard that the process by which international rules and standards are promoted by global governance institutions can be conceptualized as oneway knowledge transfer process from international organizations and their global epistemic communities to nation-states. An important aspect of our argument is the role of epistemic communities within a GES that is built upon specialized knowledge and trained professional. In this regard, the role of epistemic communities in decision making and policy formulation (both at national and international levels) is increasing to the extent that a new class of technical experts is created within the global and national arena. More often, national epistemic communities include those that retain institutional knowledge and do not change often as a result of political changes (the so-called technocrats)
3
See http://www.imf.org/external/spring/2000/imfc/rus.htm.
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Introduction and Definition of Terms
and not the top-level policy makers. Thus, one can argue that top-level government officials are to some extent “excluded” from decision making, and this reinforces the nation-states’ demise. As a result of the move toward a GES, we argue that incumbent governments are required to abandon its incumbent government’s interest, and as a result a nation-state, as a sovereign entity, turns into coordinating entity to meet the global economic demands.4 The current global system can be seen as a multi-actor system, in which its main goal is to diffuse elite national political interest and sources of bilateral decision making (Rosenau 1997). Indeed, integration of the world economy through internationalization of production has shifted the balance of power away from nation-states and toward the global markets and global market agents. One criticism, which is repeatedly mentioned in relation to international organizations’ programs and successful transfer of specialized knowledge, is the fact that these programs do not take into their consideration the local condition and culture (local knowledge). In this book, we argue that such common criticism when applied to the transfer of international standards is misguided since the world as we knew has changed as a result of several phenomena that we are discussing above. More importantly, and in the context discussed in this book, e.g., accounting standards, the local condition, and culture are irrelevant. This is mostly due to the fact that accounting has often perceived as the language of business,5 and as such it only conveys bookkeeping information to the extent that Laudie refers to it as process of bidirectional and impersonal communication.6 Indeed, with regard to the communication issue, the Financial Accounting Standards Board’s Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises declared that” [t] the information [presented in financial statements] should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence.”7 The book is divided into six chapters beginning with the introductory chapter. This chapter has introduced the topic of the book, followed by an overview of the
4
According to Alford and Friedland, “The state is a more fundamental concept than government, because it is not merely the specific regime in power at any one moment—the governing coalition of political leaders—but also the basis for a regime’s authority, legality, and claim for popular support.” (see Robert R. Alford and Roger Friedland, Power of theory; Capitalism, the state, and Democracy, Cambridge University Press, 1985, pp. 1). 5 For instance, see S. Lawrence, “How Accountants Do It: The Social Creation of Objective Reality,” Asian Review of Accounting (December 1992), 1–15. For a review of the literature on the topic, see Ahmed Riahi-Belkaoui, The Linguistic Shaping of Accounting, Quorum Books, 1995. 6 D. Laudie, “The Accounting of Interpretations and the Interpretation of Accounting: The Communicative Function of The Language of Business,” Accounting Organizations and Society (June 1987), 579–604. 7 Financial Accounting Standards Board’s Statement of Financial Accounting Concepts No. 1: Objectives of Financial Reporting by Business Enterprises, Stanford. CT: Financial Accounting Standards Board, 1986, 16.
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core arguments developed in this book. In the second chapter, Pirzadeh begins with a description of the prevailing economic and political system at the global level as well as the significant events that led to creation of global governance as the emerging global institutional framework. It lays out our argument in terms of globalization versus globalism, impact of technology innovation as enabler of financial institutions; change in the structure of global production; decline in nation-states to control their economic affairs; and finally, the inclination of the global governance body to dismiss a need for legitimacy. In the third chapter, Pirzadeh and Popescu discuss the construct of “good governance” which is reflected in the global governance view of importance of institution and institutional building. A review of the political economy literature on institutional environment and the setting of global rules and norms provides the basis for content chosen as the object of the knowledge transfer process that is core to this investigation. In chapter four, Carayannis and Popescu provide an analysis of the core elements that underline our argument of using knowledge transfer and institutional learning as tools of global governance to achieve standardization and harmonization in the policy-making arena. The concept of epistemic communities and networks, and technocracy and expertise in policy-making design, core components to this investigation, are discussed. We present the theoretical framework for knowledge and institutional learning that is later applied in the case study. In the fifth chapter, Popescu, Pirzadeh, and Carayannis describe a case study on international financial regulations and standards to illustrate the importance of the concepts covered, including the empirical research results for selected case study of the financial international regulatory standards that were being promoted part of the Reports for Observance of Standards and Codes (ROSC) Program. The conclusions chapter closes this book with conclusions and final remarks, and draws implications for global and local practices.
Chapter 2
Globalization, Nation-States, and Global Governance
Nation-States, Globalism, Globalization In this chapter, we summarize the general direction of the book and present the premises on which our arguments developed in the following chapters are based on. In doing so, we try to overlook our political predilections that may tint our analysis or our citations, so we can present impartial and balance perspective of the current state of the world. While we cannot possibly claim to have found the full explanation to the questions or the issues discussed in this chapter, our arguments sketch a perspective or a line of inquiry in the study of globalization that may provide a different perspective. The most natural place to start our discussion is with the notions of “nation” and “nation-state.” For one thing, the nation is a modern idea that is highly charged politically, just like the revolutionaries of nineteenth century who yearned for “freedom,” the call for nationalism was the driving force of the process of decolonization in the twentieth century.1 And yet, defensive posters caused the various national movements of the end of twentieth century. They are built through inward reflexes, a phantom fear of the outside world, in which ironically they cannot escape. One can look at the world today and realize that the idea of nation often survive only by allying itself with forces that have undermined its very essence such as religion, ethnicity, ideology, and the tribe, instead of its geological history. It is, therefore, hardly surprising that nationalist impulses during this period should be viewed as
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Looking back at the past two centuries, it seems like no one had questioned the link between independence and liberty in a sense that independence would not always accompany liberty for various nations who sought them.
E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0_2, © Springer Science+Business Media, LLC 2012
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divisive, xenophobic, if you would, rather than conspiratorial or imperialistic intent.2 Moreover, in the landscape of the prevailing global system battered by various financial cries of the past several decades, one of the main traditional functions of nation-state, i.e., control over its national economic affairs, is increasingly being divorced from its national dimension and command to the extent that it seems to evoke the demise of nation-states. This is a significant development especially during the epoch in which the state of Union of Soviet Socialist Republics disintegrated into multiple states under the pressure of nationalism, Germany reestablished itself as a nation-state and in Middle East (Palestinian nation), South East Asia (Tamil Tiger nation) and Europe (former Yugoslavia), ethnic cleansing is either in process or has already occurred. Consequently, these concepts are not only relevant to the content of this book and bear significant in our analysis, but they continue to be defined and redefined, sometime contradictory, by the leading scholars and authors on the subject matters, and heir to the vast tradition of liberal historiography, social science and even English literature.3 A nation, according to Jean-Marie Guehenno, “defines itself first by what it is not: it is not a social group, it is not religious group, and it is not a racial group; in other word, what bind together the citizens of a nation is the product of a unique combination of historical factors, and can never be reduced to a single dimension, whether social, religious, or racial.”4 Guehenno further elaborates that the idea of nation “brings people together not for what they are but for the memory of what they have been.”5 In this respect, for him, nation has no other definition but “the locus of a common history, of common misfortunes, and of common triumphs.” For Hugh Seton-Watson, “…a nation exists when a significant number of people in a community consider themselves to form a nation, or behave as if they formed one.”6 Benedict Anderson, used the Watson’s definition and defined a nation as an imagined community in a sense that “members of even smallest nation will never know most of their fellow-members, meet them, or even hear them, yet in the minds of
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The reader should note that while various national movements in the third world were perceived as important allies for the Communist Internationalists, the fact is that the Communists did not support the “nationalism of the oppressed” as an end in itself. In this regard, Lenin captured the point when he stated, “If we demand freedom of secession for the Mongolians, Persians, Egyptians, and all other oppressed and unequal nations without exception, we do so not because we favor secession, but only because we stand for free, voluntary association and merging as distinct from forcible association. That is the only reason.” See V. Lenin, A Caricature of Marxism and Imperialist Economism, Moscow, 1974, p. 47. 3 “What is it? Says John Wyse. A nation? Says Bloom. A nation is the same people living in the same place. By God, then, say Ned, laughing, if that’s so I’m a nation for I’m living in the same place for the past 5 years. So of course everyone had the laugh at Bloom and say he, trying to muck out of it,” See James Joyce, Ulysses, Vintage Books, 1986, pp. 272. 4 Jean-Marie Guehenno, The End of Nation State, translated by Victoria Elliott, University of Minnesota Press, 2000, pp. 4. 5 Ibid. 6 Seton-Watson, Hugh, Nations and States, Westview Press, Inc., 1977, pp. 5.
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each lives the image of their communion.”7 In short, a nation, according to Anderson is “an imaginary political community – and imagined as both inherently limited and sovereign.”8 In defining state, Ernest Gellner argues that, at its core, is the specialization and concentration of order maintenance, “The state is that institution or set of institutions specifically concerned with the enforcement of order (whatever else they may also be concerned with).”9 As a corollary of these two definitions the third notion, nation-state can be formed with denotation that implies “a community that specializes and concentrates on maintaining order.” While these definitions have render sufficient contextual framework for the objectives of this book, to find a general definitional consensus for nation and nation-state that satisfy a wide range of audiences and expertise is proven daunting task. This is partly due to the fact that each of us perceives the world as we get accustom with it. Kafka’s fable “Before the Law” is, among other things, a reminder that each of us enters the world through a different door.10 More importantly, however, the difficulties of reaching definitional agreement are mostly attributable to the nature of this type of investigations, which are ideological-charged, and hence commonly fail to separate the facts from pseudo-facts.11 More importantly, and despite the fact that these notions have immensely influence one’s mindset, reasonable theoretical grounds about them are noticeably absent. This emptiness starched to the point that Hugh Seton-Watson declared: “Thus I am driven to the conclusion that no ‘scientific definition’ of the nation can be devised; and yet the phenomenon has existed and exists.”12 To some extent, whether we consider the political function of
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Benedict Anderson, Imagined Communities: Reflections on the Origin and Spread of Nationalism, Verso, 1991, pp. 6. 8 Ibid. 9 Ernest Gellner, Nations and Nationalism, Cornel University Press, 1983, pp. 4. 10 The summary of Before the Law plot goes as follow: “A man from the country seeks the law and wishes to gain entry to the law through a doorway. The doorkeeper tells the man that he cannot go through at the present time. The man asks if he can ever go through, and the doorkeeper says that is possible. The man waits by the door for years, bribing the doorkeeper with everything he has. The doorkeeper accepts the bribes, but tells the man that he accepts them ‘so that you do not think you have failed to do anything.’ The man waits at the door until he is about to die. Right before his death, he asks the doorkeeper why even though everyone seeks the law, no one else has come in all the years. The doorkeeper answers ‘No one else could ever be admitted here, since this gate was made only for you. I am now going to shut it.’” 11 According to Urban Dictionary, “A pseudofact is a piece of information that, despite being completely false, is far more interesting than the equivalent correct information. Because pseudofacts are more interesting, they are more likely to get repeated. This result in people who believe them because it’s what their friends and family has always told them. This belief is often strong enough to ward off solid evidence of the contrary.” 12 Seton-Watson, Hugh, 1977, pp. 5. It is noteworthy that Seton Watson cites with some irony the would-be “scientific” definition of a nation by Joseph Stalin: “All that Stalin could say was that a nation must have four characteristics: a common language, a common territory, a common economic life and a common mental make-up. Stalin mentioned neither religion nor historical tradition” (Seton-Watson, pp.3–4).
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a sovereign state, like defense, or the traditional function, like ensuring that the public has access to goods and services they consider essential, the concept of nation appears more and more like a straitjacket, poorly defined and inadequately adapted to the growing integration of the world. Significant part of the difficulty in defining nation or nation-state is perhaps related to the popular tendency to defined Nationalism with capital “N” and then to validate “it” as a legitimate ideology. However, unlike most other ideologies that end with “ism,” e.g., liberalism capitalism, communism, or even globalism, nationalism has never produced its own grand thinkers: no Hobbes, no Tocqueville, no Marx, and no Weber, etc.13 This “vacuum” easily renders certain pretext for intellectuals to either consider the subject through condescending lenses, or simply avoid and dismissed it as irrelevant in modern time. For instance, consider Marxism. In what way one can explains the absence of questions related to nationalisms except by stating that these questions have proven uncomfortable anomalies for Marxist theoreticians to the extent that they have been elided, instead of confronted.14 Moreover, how else to explain Marx’s frequent use of “national bourgeoisies” without a comprehensive attempt to justify theoretically the relevance of the adjective? To make the point clear, let’s consider one of Marx and Engels grant works, The Communist Manifesto, in which they suggest: “Though not in substance, yet in form, the struggle of the proletariat with the bourgeoisie is at first a national struggle. The proletariat of each country must, of course, first of all settle matters with its own bourgeoisie.”15 Yet, they never addressed why this segmentation of the bourgeoisie is theoretically significant.16 To simply claim, as Marxists usually do, that “the nationalism is a product of the bourgeoisie class and capitalism” is not only utterly insufficient but also disappointing. The concept of nationalism, however, appears as the catalytic process, unifying various definitions of nation into a single collected mass, or as Gellner claims, “Nationalism holds that they [nations and states] were destined for each other; that either without the other is incomplete, and constitutes a tragedy.”17 To put it less dramatic, nationalism resembling Eugen Weber’s account of peasants being turned into Frenchmen,18 or Massimo D’Azeglio who after the Unification of Italy cried “We have made Italy, now we must make Italians.” In Gellner’s view, nationalism is
13
Benedict Anderson, 1991, pp. 5. In related matter, Tom Nairn also observed: “The theory of nationalism represents Marxism’s great historical failure,” (See Tom Nairn, Break-up of Britain, Common Ground Publishing, 2003. pp. 317.). 15 Karl Marx And Friedrich Engels, The Communist Manifesto, Wildside Press, 2008, pp. 22. 16 In fairness to Marx and Engels, one can argue that such neglect is due to the fact that classical Marxism main emphasis is on history as the progressive augmentation of the forces of production or history as the progressive evolution of societies through class struggle, and hence the notion of nationalism dissolved in them. 17 Ernest Gellner, 1983, pp. 6. 18 Eugen Weber, 1 edition, Peasants into Frenchmen: The Modernization of Rural France, 1870–1914, Stanford University Press, 1976. 14
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not a sentiment expressed by preexisting nations; rather it creates nations where they did not previously exist. Nationalism, observed Gellner, “is not the awakening of nations to self-consciousness: it invents nations where they do not exist.”19 The shortcoming of this perception, claims Anderson, is that “Gellner is so anxious to show that nationalism masquerades under false pretenses that he assimilates ‘invention’ to ‘falsification’ and ‘falsity’, rather than to ‘imagining’ and ‘creation’.”20 Nevertheless, the importance of Gellner to the present study is related to his description of nationalist principle that can be asserted in the “universalistic” spirit. According to Gellner, “There could be, and on occasion there have been, nationalistin-the-abstract, unbiased in favor of any special nationality of their own, and generously preaching the doctrine for all alike: let all nations have their own political roofs, and let all of them also refrain from including non-nationals under it… As a doctrine it [universalistic spirit] can be effective to preserve cultural diversity or a pluralistic international system, and of the diminution of internal strains within states.”21 He further reinforces his argument by stating, “This argument [universality] is further and immeasurably strengthened by the fact that very many of the potential nations of this world live, or until recently have lived, not in compact territorial units but intermixed with each other in complex patterns.”22 The Gellner’s argument is particularly useful when applied at the global scale because it helps us to understand the place of the humans in the world, which is increasingly crucial to realization of the notion of universality and more importantly to the survival of the planet. Regardless of one’s ideological beliefs, the prevailing consensus indicates that human actions have jeopardized many of the life-systems of the planet. To curtail, and eventually eliminate, these adverse affects we have no choice but to see our world in light of a universal perspective (also known among experts as a planetary perspective). To reach this vision, we must embrace the notion of globalism, which requires enhancement of communications between nations to foster understanding, support sharing of needed resources on the basis of equity and sustainability, and call for mutual aid in times of need, all of which point to the notion of globalism.23 Moreover, one must navigates through the anthropocentric
19
Ernest Gellner, Thought and Change, University of Chicago, 1978, pp. 168. Emphasis added. Benedict Anderson, 1991, pp. 6. 21 Ernest Gellner, 1983, pp. 2. 22 Ibid. 23 See Mark Ritchie, Globalization versus Globalism, International Forum on Globalization. This article is online: http://www.ifg.org. Nevertheless, generally speaking, Globalism is perceived to embrace at least two different and opposing meanings. “One meaning is the attitude or policy of placing the interests of the entire world above those of individual nations. Another is viewing the entire world as a proper sphere for one nation to project political influence. Political scientist Joseph Nye, cofounder of the international relations theory of neoliberalism, argues that globalism refers to any description and explanation of a world which is characterized by networks of connections that span multi-continental distances; while globalization refers to the increase or decline in the degree of globalism” (See Frederic P Miller, Agnes F Vandome, John McBrewster, editors, Globalism, VDM Publishing House Ltd., 2010.). 20
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notion of creation that describes humanity as the central and most significant entity in the universe, and the nonanthropocentric vision that would leave other species the task of cleaning up human environmental destruction. In fact, the notion of globalism can be expressed as a noble idea, the belief that we share one planet and its survival depends on mutual respect among its inhabitants and careful treatment of the Earth environment. In a sense, we would think, globalism is steered by people. Of course, the globe is crowded turf, and hence no one would expect all contributors to speak alike. And yet, they do have in common a belief in unlimited horizon. Wai Chee Dimock has perhaps said it best: “As a set of temporal and spatial coordinates, the nation is not only too brief, too narrow, but also too predictable in its behavior, its sovereignty uppermost, its borders defended with force if necessary. It is a prefabricated box. Any literature crammed into it is bound to appear more standardized than it is: smaller, tamer, duller, conforming rather than surprising. The randomness of literary action – its unexpected readership, unexpected web of allegiance – can be traced only when that box is momentarily suspended, only when the nation-state is recognized as a necessary but insufficient analytic domain, ceding its primacy upon scale enlargement.”24 To be sure, the idea of globalism might dispute the local as well as the national, personal experiences as well as collective ones, “but in any guise it is a horizontal phenomenon, dynamic because never fully visible. That is what constitutes it [globalism] as an idea”25 Globalism can also be defined as a doctrine. And as such, it incorporates the Global Commons, which are areas and resources that do not fall under the sovereignty of any state: the high seas, Antarctica, the Ozone layer, outer space. While, self-interest behavior provides the dynamics for the operation of global markets, in areas of Global Common, it can lead to a tragedy. As a result, realization of globalism can only comes about as a result of maturity of mankind that values morality, righteousness and dependability not as weakness but rather strength. In short, globalism is a realization of a utopian dream; it is sublime, elevating and disturbing, revealing and confusing. And yet, if we rise high enough we can see it is an inspired ideal that, in an uninspired world, may prove more inspiring than Kant’s three definitive articles. However, Gellner’s argument of universality makes explicit a case for the kind of world that provides a suitable intellectual setting for the global mode to the extent that the notion of universalistic spirit can be seen as an interpretation, in which the world is perceived as homogenous structure, a globalized system, which pluralizes the world into the single economic framework.
24
Wai Chee Dimock, Through Other Continents: American Literature across Deep Time, Princeton University Press, 2006, pp. 3. 25 Marshall Brown, “Globalism or Globalization?” Modern Language Quarterly, June 2007, vol. 68, no-2, pp. 139.
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In many respects, the globalized system is similar to an empire that controls no distinct territories but its realm covers the entire globe; an empire with no emperor whose capital cannot be located.26 Once the borderless empire is established and the frontier disappears, whether in the case of a state, enterprise or corporation, procedures replace principles in a sense that top-to-bottom organizational management becomes a substitute for ideology. Consequently, the nature of power does change in a sense that power is no longer defined by mastery but rather through influence and network. Nowhere this observation is felt more than in the formulation and formation of policy decisions both at national or global levels. Decision-making process is fragmented, and traditional political debate, a debate about principles and ideological perspectives, a debate over how society is to be organized and function, faded away, or rather yield to interests and their army professionals. The new empire has no constitution but instead constructed e body called “governance” that is concerned with the establishment and operation of the “rules of the game” that serve to define economic practices, assign roles, and guide interaction.27 The new empire is free from any legacy, and is with no history to preserve and no ideology that may be contested. In this respect, the political inclination of the empire has no other purpose than the preservation of the rules set forth by its institutional setting – no account is required of a policy, only the assurance that a procedure has to be respected. To the great extent, respect for procedures is the only agreed operating standard of the new empire. Guehenno described the new empire when he observed, “We are entering into the age of open system, whether at the states or enterprises, and the criteria of success are diametrically different from those of institutional age and its closed systems. The value of an organization is no longer measured by the equilibrium that it attempts to establish between its different parts, or by the clarity of its frontiers, but in the number of openings, of points of articulation that it can organize with everything external to it.”28 The necessary condition to sustain this empire has been already in place – no external threats, no barbarians at the gate. The global imperial age neither stands, nor tolerates conflict; it needs similarity and, in its absence, promotes conformity through standardization. This tendency is mostly due to the fact that in the prevailing system, in which the world is well “connected” with transparent regulations and disclosed rules, conflict should be perceived as a social anomaly. Guehenno underlined this point more eloquently when he observed that in the global system, “conflict supposed an incomprehensible incompatibility of perceptions: if there are both weak and powerful, how dare the weak engage in battle, when their defeat in
26
As Guehenno stated, “Power is no longer settled in Washington, Moscow, London, Paris, etc. Rome will no longer be in Rome.” 27 Oran Young, International Governance: protecting the environment in a stateless society, Cornell University Press, 1994, pp. 15. 28 Jean-Marie Guehenno, 2000, pp. 49.
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inscribed in the social order?”29 Perhaps, this observation can explain the reason why global governance is commonly perceived to be suited to prevent conflict rather than to resolve it.30 In this empire, behavior(s) of individual(s) or organization(s) often viewed, as if, it is originated as, and mainly remain, a microeconomic process. Supported by evolutionary psychologists and neo-liberal economic values, the pillars of such process are built on hypothetical evolutionary impulses, which suggest mankind share common drives like aggression, self-interest and utilitarianism.31 At the individual level, instances like this are abundant. However, the one that comes to mind, especially in light of the crisis of past few years, is the fact that in the aftermath of a financial crisis that generated hundreds of billions in losses and millions of individuals lost the entire life-saving, their jobs and their houses, no high-profile participants, including bankers, related to the crisis has been prosecuted.32 While, the main presumed reason for such neglect is the alleged complexities of pursuing legal cases in a time of panic, the underlying cause is the evolutionary impulses. At the organizational level, endorsement for these inclinations came from within. For instance, Charles Taylor, Director of the Pew Financial Reform Project, in his speech entitled “looking through Darwin’s Glasses” puts forward the case for using evolution theory to
29
Ibid., pp. 70. However, as we know very well, conflicts do occur in the global system, and they require prevention through various means. As the report by Atlantic Council on Global Governance stated, “Prevention, for example, often can require direct political intervention or even the threat or use of military force as a last resort. Efforts to prevent conflict have often been slowed by reluctance and resistance to intervene directly, potentially overriding another country’s sovereignty.” (see Global Governance 2025; At a Critical Juncture, Atlantic Council, September 2010, pp. v). 30 See Mathias Koenig-Archibugi, “Mapping Global Governance” and James N. Rosenau, “Governance in a New Global Order” in David Held and Anthony McGrew, edited, Governing Globalization: Power, Authority and Global Governance, Polity Press, 2002. 31 The reader should note that these pillars are challenged by research in evolutionary biology, neuropsychology and child development, which questioned some of the conventional long held theories about human nature. Through various experiments, using the MRI brain-scanning machine, scientists have discovered that human beings, and perhaps some animals, are connected, what is called “soft wired,” with what is known as “mirror neurons,” which enable all humans to experience another’s plight as if we are experiencing it ourselves. Selfhood goes together with empathic development (increase selfhood increase empathic development). In the psychological world, this is called empathy. In other words, empathy is as plausible as competition, self-interest, etc. The interested reader can read more on this topic in a fascinating book by Jeremy Rifkin (see Jeremy Rifkin, The Empathic Civilization; The Race to Global Consciousness in a World in Crisis, Jeremy P. Tarcher/Penguin, 2009). 32 See Gretchen Morgenson and Louise Story, “In Financial Crisis, No Prosecutions of Top Figures,” New York Times, April 14, 2011. It can be accessed at http://www.nytimes.com/2011/04/14/ business/14prosecute.html?_r=1.
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think of global financial institutional behavior.33 Taylor stretches his explanation to the point that Darwin’s natural selection is replaced by selection based on profitability. Evolution, he claimed, “breeds complexity, specialization and predator-prey relationship.”34 The main purpose of these hypothetical commonalities is to present the world as communities (individuals) that compete between and within themselves to accumulate, consume and fulfill their self-interest.35 In some sense, globalization should be perceived as a culture, promoted by ideology, before it is defined as an ideology or a process. Despite some resonant similarities between globalism and globalization, these notions convey different connotations. The most significant distinction among these differences is related to the nature as well as the origins of these notions. Globalism only can come about as a result of maturity of our civilization maturity and realization that humanity shared a common destiny. Consequently, globalism is formed by consensus and can be thought of as an international solidarity that strives on commonalities. In contrast, the prevailing globalization, a single global economic mechanism, is a forced feed process, which has been promoted rather than evolved. Consequences, such process incites popular discontents around the globe, as Robert Cox observed, “Globalization is generating a global resistance movement.”36 The movement, which begun in 1994 in Chiapas, Mexico, and mainly continues today.37
33
Charles Taylor, “Macro-Prudential Regulation and the New Road to Financial Stability: Looking Through Darwin’s Glasses,” Chicago Federal Reserve Bank/IMF conference: “Macro-prudential Regulatory Policies: The New Road to Financial Stability”; September 23–24, 2010. 34 Taylor description renders useful ammunition, particularly for “experts” journalists, to explain the recent economic policy. For instance, James mackintosh of Financial Times claimed, “From an evolutionary view, we might say government have abolished death in the lifecycle of banks” (see James Mackintosh, “Sex and Death in Financial Evolution,” FT, March 24, 2011.) 35 It should be noted that the issue of interpretation is important concern, and hence we offer a different view of these concepts so the reader is expose to diversified views on these subjects. For instance, Steger draws attention to the differences between empirical observations and interpretive framings and suggesting the different between globalization and globalism can be explained as: “globalism constitutes a coherent discursive regime that shapes the social understandings of authority, but it is not a monolithic ideology. A complex phenomenon, it comes in many variations on the main theme of market liberalization… [Its] preferred method is to employ its dominant codes and hegemonic meanings as battering rams to crush the remaining obstacles in the path of global capital” (p. 13). Thus for Steger, globalism refers to a discursive matrix that has certain ideological effects. See Manfred, B. Steger, Globalism : the new market ideology. Lanham, Md., Rowman and Littlefield Publishers, 2002. 36 Robert Cox and Michael G. Schechter, 1 edition, The Political Economy of a Plural World: Critical reflections on Power, Morals and Civilization, Routledge, 2002, pp. 136. 37 For a comprehensive analysis of these unrests see Anup, Shah, Public Protests Around The World, Global Issues, 2003. For an analysis of Chiapas unrest see Richard Stahler-Sholk, “Globalization and Social Movement Resistance: The Zapatista Rebellion in Chiapas, Mexico,” New Political Science, Vol 23, Issue 4, December 2001, pages 493–516.
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In our view, significant portion of the globalization constitutes neither behavioral wisdom, nor cultural development, but instead finds its origin in the changing patterns of “… transborder operations of firms undertaken to organize their development, production, sourcing, marketing and financing activity.”38 The essence of globalization is the integration of production across national boundaries, or as Richard Lipsey has observed, a globalized economy is one that “…increasingly integrates both the financial and the production sectors of economies of many individual countries.”39 Thomas Hatzichronoglou follows the similar sentiment and claims, “The economy’s entry into its globalisation phase has radically altered the nature of competition. Now, numerous new actors from every market in the world are simultaneously in competition on every market.”40 Heightened competition at home and abroad accentuated the interdependence that obviously strives on diversities rather than commonalities. In effect, the International Monetary Fund defines globalization as the “growing economic interdependence of countries worldwide through increasing volume and variety of crossborder transactions in goods and services, free international capital flows, and more rapid and widespread diffusion of technology.”41 International organizations,42 particularly Bretton Woods institutions, through highly value-laden policies, e.g., liberalization and deregulation, systematically reinforce this trend. 43 This observation may seem to contradict the popular view that express by popular commentator like Thomas Friedman when he claims “the most basic truth about globalization is this: No one is in charge,” or upper echelon managements of financial institutions, like Rober Hormats, the vice chairman of Goldman Sachs International when he claimed, “The great beauty of globalization is that no one is in control. The great beauty of globalization is that it is not controlled by any individual, any government, any institution.” While these statements have some merit in a strict sense, which denied the existence of orchestrated entity created by tacit collusion among “imperial evil forces,” it is quite sensible to think that the prevailing global economic system must be sustained and managed to secure its future. 38
OECD, Globalization of Industry: Overview and Sector Report, 1996, p. 15. Richard G. Lipsey “Global change and economic policy,” in Nico Stehr and Richard V. Ericson, eds, The Culture and Power of Knowledge, Walter DeGruyter, 1992, pp. 285. 40 T. Hatzichronoglou, “Globalisation and Competitiveness: Relevant Indicators,” OECD Science, Technology and Industry Working Papers, 1996, pp. 3. 41 IMF, “World Economic Outlook,” May, 1997 42 The reader should note that in this book we used various adjectives such as Bretton Woods, coordinating agencies, lending agencies, etc., to described international organizations. The main reason for doing so is related to the context i.e., global governance in which we analysis the conduct of these agencies. We feel that such variety in description is a necessary condition to explain these agencies role in the context of global economic system. 43 Value-laden policies implies that they are implemented not by their merit but rather by policymakers ideology. For instance, a survey of the literature on capital account liberalization by Eichengreen concludes that there is no empirical substantiation of the conventional theoretical tenets about the growth benefits of capital account liberalization. See Barry J. Eichengreen, “Capital Account Liberalization: What Do Cross-Country Studies Tell Us?” World Bank Economic Review, Vol. 15 (October), pp. 341–65. 39
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In this respect, and unlike globalism, globalization is ahistorical process in which promoted and sustained, more or less, by various international organizations, e.g., IMF, the World Bank, WTO, etc., and manage by the world-governance system, which is a multilateral system.44 This process is also more or less endorsed by the industrialized states (OECD nations) under the leadership of the USA. It is not surprising that for the past 3 decades, all US presidents have been heralding the benefits of merging the American economy with the rest of the globe. George Bush Sr., Bill Clinton, George W. Bush, and Barack Obama have all steadfastly supported the emerging one world economy. These presidents have each used different terms to describe this process such as “globalization,” “an integrated world,” “the global economy” and even “a New World Order,” but they have all seem to imply the same thing; a single world economy so that the single institution setting project its’ influence. All of these presidents have sought to integrate the USA even more deeply into the developing one world economic system. For instance, only 6 months into 44
In the context global governance, article 151 of Forum for a new World Governance underlined why the global governance is need, “the executive, legislative, and judicial structures inherited from the past do not provide an adequate response to the complexity of contemporary society” See (http://www.world-governance.org/spip.php?article151.) Moreover, the article claimed to the world-governance system, “we must go beyond the conceptual and ideological foundations of the current system. One of the necessary innovations is to introduce a regional level of governance, between national and world institutions. We need to prevent, for example, the construction of Europe from being undermined by sterile arguments among states. Europe represents a historic effort to build a supranational entity on the foundations of economic convergence and community law. New negotiations and decision-making processes must be anchored at a regional level, something that the future – and inevitable – reform of the UN Security Council needs to take into account. The Security Council ought to be a world committee in which all the regions of the planet are represented. Its chair would be held on a rotation basis by a country of one of the regions, which would also represent it in international negotiations.” See (http://www.world-governance. org/spip.php?article151.). The article 152, identified five principles on which to build governance. They are as follows: (1) Legitimacy in the exercise of power. Exercise of power must be linked to a clearly expressed mandate from the people as to how they are to be governed. Persons in positions of authority must be deemed worthy of the confidence placed in them. Limits on private freedom must also be reduced to a minimum and clearly perceived as necessary for the commons. Organization of society must be based on ethical principles that are recognized and respected; (2) Conformity with the democratic ideal and with the principles of citizenship. All individuals must feel that they are part of a shared destiny, which excludes, for example, tyranny by the majority. Rights, power, and responsibility must be evenly balanced. No one can exercise power without being subject to checks and balances; (3) Competence and effectiveness. The way that public and private institutions are set up, their organizational structures, and the people working within them must all be reviewed to ensure that they remain pertinent, and that they have the skills and the capacity required to assume responsibility for responding to the needs of society in all of its diversity; (4) Cooperation and partnership. It is essential that everyone work together for the commons and that governance organize relationships and cooperation among the various types of player, whether public or private, the various levels of governance, and the various administrations in accordance with procedures established by common agreement; and finally (5) Linking the local and the global, and the different levels of governance. Societies must be able to organize themselves in such a way that the autonomy of the smallest communities is compatible with social cohesion at all levels, up to and including the global level. See http://www.world-governance.org/ spip.php?article152.
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Clinton Administration economic acronyms such as G7, NAFTA, APEC, and GATT become major part of his policy declarations. As Clinton saw it, the USA was “like a big corporation competing in the global marketplace.”45 Barack Obama also showed very clearly how he feels about this emerging notion of one world economy when he made the following statement during his speech in Mumbai, India, 2010: “This will keep America on its toes. America is going to have to compete. There is going to be a tug-of-war within the US between those who see globalization as a threat and those who accept we live in a open integrated world, which has challenges and opportunities.”46 In retrospect, the task we chose for the present study is narrow in its vision and limited in its ambition. However, we have tried simply to present various observations and use common sense to correct errors of fact, conception, and interpretation, which would assist us to avoid inconsistency and redundancy in the following chapters. There are no assumptions in our arguments, except in those cases that making assumption is an intrinsic part of conceptual argument and framework. Our objective is to show how the new global order contributes to the new economic arrangements and organizations. Our view is based on three distinct pillars (1) financial institutions, through rapid technological advancements, not only are strengthening their operations and diversify their services but also expand their domain of activities, and hence provide a necessary condition to sustain global capital flows that are vital to existence of the global economic system; (2) creation of global institutional setting, e.g., global governance, in addition to coordinating agencies e.g., the World Bank, IMF, UN, etc., renders the necessary institutional infrastructure for managing adverse affects of the global economic system; and (3) the prevailing global economic interdependence has caused major change in the structure of global production, which has led to decline in the authority of nation-states over their national economy – in terms of deciding; what should be produced in the economy; how within the existing factors of production (land, labor, capital, and technology) should be produced; and for whom the output should be produced.
45
Economist Paul Krugman, in a 1994 Foreign Affairs essay, decried this quotation. He further alluded that the world’s leading nations are not, to any important degree, in economic competition with each other. Nor can their major economic woes be attributed to “losing” on world markets. This is particularly true in the case of the USA. He criticized “dangerous obsession” with “national competitiveness” and pointed out that the tendency to think that “the United States and Japan are competitors in the same sense that Coca-Cola compete with Pepsi,” is “flatly, completely and demonstrably wrong.” See Paul Krugman, “Competitiveness: A Dangerous Obsession,” Foreign Affairs, March/April, 1994. 46 http://www.whitehouse.gov/the-press-office/2010/11/07/remarks-president-and-first-lady-townhall-with-students-mumbai-india.
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Technological Advancements and Financial Institutions In 1945, a paper by Caroline Isard and Walter Isard points out that the most pervasive changes in the economy came from innovations in transport and communication.47 More than 30 years later, in 1987, Office of Technology Assessment conducted a pioneer report about the impact of technological change in the US economy. In the introduction, the report made stunning observation, “During the next 2 decades, new technologies, rapid increases in foreign trade, and the tastes and values of a new generation of Americans are likely to reshape virtually every product, every service, and every job in the U.S. These forces will shake the foundations of the most secure American businesses.”48 Furthermore, the report painted a dismal picture of the future by stating, “Change can lead to wrenching dislocation and pain for workers with obsolete skills, for management unable to recognize opportunity, and for communities where traditional businesses have failed.” It has now been 23 years since that report, and by all accounts, evidences seem to strengthen the report’s judgments not only in the U. S but also around the global. Indeed, technological changes and innovations are commonly perceived as one of the major factors driving the global economy. Our position on technology and subsequently its impact on globalization do not quite match with the conventional stand, which subscribes to techno-determinism. For instance, if you say that the Internet has changed business or politics, you are saying that technology itself has determining effect, and you are a techno-determinist. However, we view technology in a different light and described it as a mere tool, which can be used as an oar to propel a boat or to enable a space shuttle. In this respect, our concern is not whether the Internet taken by internal forces creates certain effects on us, but weather technology has determinative effects. We are convinced that the determinative power of technology is not intrinsic. It comes from its uses by various entities like institutions, individuals, etc., which eventually explains the current state of global economic system in light of power exercised by the global financial institutions.49 To start, we must apply great care in using technology as a noun and then make general inferences as if the noun is confined to its absolute connotation. In our view, it is not. For one thing, we subscribed to Harvey Brooks’ definition of technology, in which technology “is the use of scientific knowledge to specify ways of doing
47
Caroline Isard and Walter Isard, “Economic Implication of Aircraft,” Quarterly Journal of Economics, vol. 59, 1945, pp. 145–169. 48 Technology and the American Economic Transition: Choices for Future, Office of Technology Assessment, 1988, pp. 3. 49 However, this does not imply that we outright reject the role of technology in global economic system, but rather places the emphasis elsewhere.
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things in a reproducible manner.”50 Moreover, we must clarify the type of technology under consideration. For instance, Ernst Friedrich “Fritz” Schumacher in his book “Small is beautiful” introduced the term “intermediate technology” (or appropriate technology), and defines it as tools that are much cheaper than technologies developed in developed world and can be used in the developing countries more effectively in a decentralized way and without much training form outside.51 Moreover, it is a gross mistake to infer impacts of technological innovations and developments in a uniform matter. Technological changes come in varying degrees and so do their affects on environments in which they occur. For purpose of clarity we underlined four types of improvements: incremental innovations; radical innovations52; changes in technology systems; and technological revolutions. Respectively, the common sense indicates to consider how different technological changes would have led to different outcomes.53 Accordingly, in the following, we tried to be specific in the various examples given, so the reader related them to the real world. We argue in this book that technological developments per se should not be considered as vehicles of change because they are just means or tools used to achieve a certain goal and/or improve or change existing processes.54 Technological advancements
50
Harvey Brooks, “Technology and Ecological Crisis,” lecture given at Amherst, May 9, 1971, p. 13, from unpublished text, italic added. For better understanding of professor Brooks’ see Technology, Processes of Assessment and Choice, Report of the National Academy of Science, published by the Committee of Science and Astronauticiem, U.S., House of Representatives, July 1969, and Science Growth and Society, OECD, (Paris, 1971). 51 See E. F. Schumacher, Small Is Beautiful: Economics as if People Mattered, HarperCollins Publishers, 2010. For dentition of the term see pp. 190–92. 52 Henderson and Clark (1990) described incremental innovation as relatively minor changes to existing designs that exploit the potential of the established design, and often reinforce the dominance of established firms, as opposed to radical innovation, such as the introduction of a totally new type of machinery. 53 Industrial revolutions were possible only because of technological revolution such as the steam engine, steel, and electricity (see Andrew Atkeson and Patrick J. Kehoe, “Modeling the transition to a new economy: lessons from two technological revolutions,” American Economic Review, vol. 97, no. 1, March 2007, pp. 64–88). 54 We certainly can add to this list the social aspect of technological development. Indeed, We also must pay great attention to social consequences of technological development in the prevailing world. Today, there are those who invent/own knowledge and define the procedure, and those who carry them out, which increasingly implies those who supervise their execution by machine. The consequence of this division is profound, as Guehenno observed, “The individuals in the contemporary enterprises are far too atomized to cultivate bond of solidarity, far too rootless to find in the notion of social class an answer to their need to belong. Integrated into the enterprise whose regulations they master, but vulnerable nevertheless, solidarity, remote from any tangible product, they owe it to themselves to be ‘conformist’: but this conformity does not afford them an identity.” (See Jean-Marie Guehenno, 2000, pp. 44).
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do not occur in vacuum.55 Indeed, throughout the history, they spark responses from economic, political and social environments. For instance, the past technological development such as telecommunication, automatic control machinery, and supersonic transportation each has been directly affected by a complex set of interactions among technological, economical, political, social, and legal consideration.56 More to the point, our argument is based on the notion that “necessity is the mother of invention.” This implies that solutions to problems (the invention bit) are born out of the propensity to meet prevailing challenges (opportunities), or the exiting need (the necessity), to achieve certain objectives. Once the need is identified, the tools will be adapted according to the characteristics of the people and institutions involved, and their economic objectives.57 Financial institutions usage of technology is not only to meet the prevailing global economic conditions, but also assist them to attain their main objectives, profit maximization, is ample illustration this process. Capital markets (markets for securities – debt or equity) around the world have been linked for some time now. The October 1987 crash, which began in Hong Kong, and then spread to West through the international time zones to Europe and then to the USA, renders ample evidence that capital markets incline to move in parallel in response to economic and financial events, and react sharply to the stress in other markets. Moreover, several developments change the nature of international trade, and hence the globalized economy. Among many we only name the few here: (1) rapid economic interdependence underlined the growing complexity of crossborder transactions; (2) technological advancements in transportation58 such as the development of what the trade calls LASH (lighter-aboard-ship) systems and RORO (roll- on, roll-off) vessel, significantly improved the pace of international trade; (3) advances in telecommunications and information processing lowered transaction cost and risk of managing trade at a distance; (4) the emergence of the Internet has reduced information asymmetry, and hence giving individual investors unprecedented access to the global marketplace. Inevitably, these evolutions have led to the
55
In contrast, there are those who believed that “Industrial history shows that the development of new technology can have a major impact on any industry and has often done so. This is most especially the case when technology affects the very core of the business – in the case of banking: information, processing and delivery. In this respect, banking is no different from other industries. It is largely technology, and what follows from it, that will transform the banking and financial services industries.” See Malcolm Edey, editor, The Future of Financial System, Proceedings of a Conference held at the H.C. Coombs Centre for Financial Studies, Kirribilli on 8/9 July 1996, pp. 141. 56 For instance see Mel, Horwitch, Clipped Wings: A Study of the Supersonic Transport, MIT press, 1982; Graham. W. Astley and Charles Fombrun, “technological innovation and industrial structure: The case of telecommunication.” In Robert lamb (ed.), Advances in Strategic Management, JAI Press, 1983; and David Nobel, Forced of Production: A social History of Automation, Knopf, 1984. 57 The process by which technological benefits are realized is essential in understanding and assessing technological developments since only through such process tailoring occurs to achieve the specific objective. 58 Transportation is often referred as an enabling factor that is not necessarily the cause of international trade, but a mean over which globalization could not have occurred without.
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need for more and unrestricted capital, which include widening financial services and instruments as well as restructuring, especially in banking industry.59 These changes are mostly due to the fact that like a capitalistic system, the global economic system is built on circular flow of capital to the extent that without it, there is no globalization.60 As financial institutions identified the prevailed conditions, they expanded their activities across borders, improved their payment systems and raise their ability to provide cash management or working capital services.61 They also abandoned traditional financial instruments and creating the new financial instruments, e.g., derivatives, which no one really understands and no one, with few exceptions such as Guy Hands, is ready to admit the void.62 While financial innovations are blamed for
59
According to Loretta J. Mester of Federal Reserve Bank of Philadelphia, the banking industry has been undergoing significant restructuring since the mid 1980s. For instance, the number of commercial banks has fallen while average bank asset size has increased. This has led to concentrated financial service industry, in which a handful of very large institutions can exert monopoly power (see Loretta J. Mester, “Economies of Scale and Scope,” in Anthony Saunders, Financial Institutions Management: A Modern Perspective, Irwin, 1994, p. 230). Allen N. Berger followed Mester observation and found the similar conclusion from 1984 to 2002 (see Allen N. Berger, “The Economic Effects of Technological Progress: Evidence from the Banking Industry,” Journal of Money, Credit and Banking, vol. 35, no. 2 (Apr., 2003), pp. 141–176). 60 It should be noted that there is a difference, which often neglected, between a free market economy and capitalism. A free market economy is a system that mainly concerned with exchange of goods and services while capitalism leans more on wealth creation for themselves. A free market economy operates by “demand and supply” analogy and at the optimal level is leading to free competition without interference. However, in capitalism, capital owners incline to interfere, e.g., the terms of trade, to obtain larger share of wealth. In this respect, exchanges in various markets are a key component of capitalism although they do not fully define what capitalism is. Read more: Difference Between Capitalism and Free market | Difference Between | Capitalism versus Free market http:// www. differencebetween.net/business/difference-between-capitalism-and-freemarket/#ixzz1DNvaMtip. 61 Among major services provided are (1) wholesale lockbox – a centralized collection services for corporate payments to reduce the delay in check clearing or the float (the time between when a check is received and when the funds are credited to the account); (2) electronic funds transfer – includes overnight payments via Clearing House Interbank Payment System (CHIP) or Fedwire transfer network, automated payment of payrolls or dividends via automated clearing house (ACHs), and automated transmission of payment messages by Society for Worldwide Inter-bank Financial Telecommunication (SWIFT) (an international electronic message service owned and operated by US and European banks that instructs bank to make particular payment); (3) Electronic initiation of letter of credit – allows customers in a network to access bank computers to initiate letters of credit; and (4) treasury management software – allows efficient management of multiple currency portfolios for trading and investment purposes (for more information see Anthony Saunders, 1994, pp. 217). 62 Traditional financial instruments are like repurchase agreements (receivables), bonds, and capital stock. Derivative instruments constitute formal agreements to transfer risk from one party to another without transferring the underlying basic instrument. The reader should also noted that financial derivative is not the only hedging products that currently exist, and in fact it only represents a fraction of the massive innovative financial instruments that are making their way into the financial scene. A useful listing of additional innovative financial products can be found in John E. Stewart, “The Challenges of Hedge Accounting,” Journal of Accountancy, November 1989.
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recent financial crisis and seem to be synonymous with credit-default swaps and collateralization debt obligations and derivative securities, the former IMF chief economist Rajan remind us that these “innovations also gave us the money-market account, the credit card, interest-rate swaps, indexed fund and exchange-traded funds” 63 all of which have been proved very profitable for financial institutions. For instance, in 2007, only the derivative markets valued at $531 trillion.64 Moreover, technology has allowed the creation of a globally integrated market for distinct, unbundled financial attributes. 65 The high-speed technology such as algorithmic trading (or also known as automated trading) is used by many large hedge funds, pension funds, and mutual funds allowing them to divide many large scale trades into small chunks and therefore minimize risk and exposure in the market place. Artificial intelligence enables financial institutions to replaced man with a machine, which assists these institutions to observed billions rather than hundred market transactions.66 Ray Kurzweil,
63
Raghuram G. Raja, Fault Lines: How Hidden Fractures Still Threaten the World Economy, Princeton University Press, 2010, pp.159. 64 New York Times, October 8, 2008. 65 Any financial instrument can be thought of as a bundle of financial attributes, such as amount, term, currency, repricing interval, base rate, credit risk, tax benefits, etc. The new technologies, caps, floors, options, futures, and so forth are used to unbundle and repackage these attributes. Traditionally, a financial instrument was priced by comparing it to other instruments of the same name and the same structure trading in the same market. Today, it is common to price an instrument by comparing it to pieces or packages of other types of instruments in many different markets, which in combination produce the same financial result, that is, the same bundle of financial attributes. For example, a US dollar floating-rate loans from a US bank is not simply compared to other floating-rate loans offered by other US banks. It is also compared to a fixed-rate Eurodollar bond issue coupled with an interest rate swap and to a floating-rate sterling loans from a UK bank coupled with a currency swap. All produce the same bundle of attributes: funding in a given currency for a given term that floats off a given base rate at the given repricing interval (see Charles S. Sanford, Jr and George J. Vojta, “Deregulation, Technology, and the Safety and Soundness of the Financial System” in Martin Feldstein, The United States in the World Economy (National Bureau of Economic Research Conference Report), University of Chicago, 1989, pp. 268). 66 Ironically, as Goldin and Vogel point out, “Technological change via the acceleration of computer processing has greatly contributed to system fragility because microprocessors facilitate logistical chains, increase connectivity and facilitate the innovation of complex financial instruments, the underlying mathematical theories of which can be flawed, hard to understand and even more difficult to regulate (see Colander, D., Goldberg, M., Haas, A., Juselius, K., Kirman, A., Lux, T. and Sloth, B., ‘The Financial Crisis and the Systemic Failure of the Economics Profession’, Critical Review, 2009, 21 (2–3), pp. 249–267). Daníelsson argues that while statistical risk models are applicable to small frequent events, such as internal risk management, these models do not and cannot account for systemically important events (see J. Daníelsson, ‘Blame the Models’, Journal of Financial Stability, 2008, 4, pp. 321–328). In retrospect, it is not surprising that both the traders and regulators had a poor understanding of the systemic risks of new financial instruments. This is because ‘when interconnections are dense, it may be difficult to trace the impact of any change even after the fact, let alone predict it ahead of time, making the system complex and hard to control’ (see R. Jervis, System Effects: Complexity in Political and Social Life, New Jersey: Princeton University Press. 1997, p. 17).” (see Ian Goldin and Tiffany Vogel, “Global Governance and Systemic Risk in the 21st Century: Lessons from the Financial Crisis,” Global Policy, January 2010, vol. 1, iiuse 1, pp. 11.). The cross-references were added.
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an inventor and new hedge fund manager, is describing the future of stock-picking, and it isn’t human. “Artificial intelligence is becoming so deeply integrated into our economic ecostructure that some day computers will exceed human intelligence,”67 Kurzweil tells a room of investors who oversee enormous pools of capital. “Machines can observe billions of market transactions to see patterns we could never see.”68 Louis Morgan, managing director of HG Trading, a three-person hedge fund in Wisconsin, also observes, “5 years ago it would have taken $500,000 and 12 people to do what today takes a few computers and co-worker. I’m executing 1,500–2,000 trades a day and monitoring 1,500 pairs of stocks. My software can automatically execute a trade within 20 ms – five times faster than it would take for my finger to hit the buy button.”69 These developments confirmed by many observers of the globalized economic system. For instance, Reinicke observed, “technological innovation itself is a rich source of new products and services, especially the financial services that create international business opportunities. Computer-driven financial innovation such as 24-h trading, program trading, online trading, and electronic settlement have provided the hardware and software that now make it possible to move huge sums of money around the globe in interval often measured in seconds.”70 In short, adaptation of technology by financial institutions “helped to globalize financial market and drove up trading volumes.”71 The adapted technological tools, as we argued above, should also reflect the characteristics and the economic objectives of financial institutions. To confirm this, one needs only to listen to voices of the insider. A well-known quant (quantitative analyst) Paul Wilmott72 informed New York Times readers “Hedge funds won’t necessarily care whether the increased volatility causes stocks to rise or fall, as long as
67
Charles Duhigg, “Artificial intelligence applied heavily to picking stocks” – Business – The New York Times, November 23, 2006. 68 Ibid. 69 Ibid. 70 Wolfgang H. Reinicke, Global Public Policy: Governing Without Government? Brookings Institution Press, 1998, pp. 16. 71 “Moving markets Shifts in trading patterns are making technology ever more important,” The Economist, Feb 2, 2006. 72 According to Newsweek magazine, “Paul Wilmott is a 49-year-old Oxford-trained mathematician and arguably the most influential quant today, the brightest star in their insular, nerdy universe. The Financial Times calls him a ‘cult derivatives lecturer.’ Nassim Taleb, the mathematician and author of the bestseller The Black Swan, calls him the smartest quant in the world. ‘He’s the only one who truly understands what’s going on … the only quant who uses his own head and has any sense of ethics,’ says Taleb. Wilmott stands atop a veritable quant empire. His wonk-madesimple textbooks sell for hundreds of dollars. A subscription to his bimonthly magazine, Wilmott, costs $695 a year. His Web site, Wilmott.com, is the nerve center of the quant community, with 65,000 registered users and a chat forum that buzzes over such topics as geodesic stochastic manifolds and swaption vol arbitrage.” See http://www.newsweek.com/2009/05/28/revenge-of-thenerd.html.
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they can get in and out quickly with a profit.”73 Indeed, these institutions made immense profits. A report released in August 2009 by the TABB Group, a financial services industry research firm, estimated that the 300 securities firms and hedge funds that specialize in this type of trading took in roughly $21 billion in profits in 2008, the year that financial meltdown hits the global market.74 All things considered, one can conclude that specific technological tools and innovation are adopted because they greatly contributed to the profit maximization of financial institutions. In addition, significant portion of adapted technological advancements have, directly or indirectly, contribute to sustainability of the global system in a sense that they help global coordination agencies like IMF and the World Bank to monitor the economic system and managed possible crisis as they may unfold as well as facilitate collaborations among these agencies. For instance, information technologies, particularly in data architecture domains, have greatly aided the gathering and distribution of various sorts of data e.g., financial, political and economic data. For instance, a successful implementation of the macro-prudential approach,75 which was endorsed at the G20 Summit in London, “requires a huge amount of up-to-date – if not real time – data from a variety of sources. This data will need to be analyzed for indicators of treats to the system and shred in a digestible form with senior international policy makers.”76 Indeed, the Declaration on Strengthening the Financial System, published with the London Summit Communique, calls for the launch by the IMF and FSB of an “Early Warning Exercise” at their spring 2009 meetings.77 Moreover, investment in well-suited technological tools has potential, “…for increasing both the FIs [financial institutions] net interest margin, or the difference between interest income and interest expense, and other income.”78 For instance, as a result of technological adaptation, interest income can increase if the financial institution sells a broader array of financial services, which may include crossselling of financial products by computer matching customers and telemarketing of financial services products and bank products.79
73
Opalesque (4 August 2009). “Opalesque Exclusive: High frequency trading under the microscope.” 74 Ibid. 75 In its mots general form, “macro-prudential” approach recognizes the importance of generalequilibrium effects, and seeks to safeguard the financial system as a whole. By contrast, a microprudential approach is one in which regulation is partial-equilibrium in its conception, and aimed at preventing the costly failure of individual financial institutions. 76 Angus Hislop and Peter Gruetter, “Using Technology to Accelerate G20 Plans for Strengthening Global Financial Supervision,” Cisco Internet Business Solutions Group (IBSG) white paper, 2009, pp. 2. 77 See the London Annex at: http://www.pittsburghsummit.gov/resources/125091.htm. 78 Anthony Saunders, 1994, pp. 215. 79 For examples see Ibid, pp. 215–217.
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Technological tools also facilitate information sharing among financial institutions. In terms closer information sharing, G20 Group acknowledged, “Bilateral Memoranda of Understanding are an important means for information sharing between banking supervisors. We ask the Basel Committee on Banking Supervision (BCBS) to consider up-dating its 2001 template for information exchange (“Essential Elements of a Statement of Cooperation between Banking Supervisors”) in the light of current best practices and to consider further improvements that would enhance bilateral information exchange and supervisory collaboration world-wide.”80 G20 Working Group also recognizes that “for effective early warning, data collection must be strengthened,” and recommends that the IMF and FSB provide proposals to this effect before the next meeting of G20 finance ministers in September.81 Finally, to strengthen collaboration effort, “A range of technologies is being used by international companies to enhance collaboration. These extend from closed social networks and discussion forums to voice, video, and data-sharing technologies. One particular new technology developed to address the challenge of enhancing collaboration is telepresence – a high-definition-video, sensitive-audio system that matches the experience of physical, face-to-face meetings. There is a range of configurations that meet the needs of small to very large groups across multiple locations. While it is possible to envision virtual meetings of whole boards – as is already being practiced in the private sector – the more likely early use is as a substitute for many of the smaller committee and working group meetings of senior officials of supervisory agencies.”82 In retrospect, technological advancements per se should not be considered as an agent of change but rather the emphasis should be on institutions that utilize these tools to achieve their economic objectives. This takes us to the second part of our argument, in which we suggest that the current state of globalized economic system is mostly due to the power exercised by financial institutions. However, before we go further, it is imperative to clarify one important issue, that is, to define the notion of power.
Power and Financial Institutions The Notion of Power To understand an idea, a mere definition is certainly misleading. Instead one must take into consideration the domain in which the notion is investigated, but more importantly contrasting perspectives under which the idea is labeled and explained.
80
G20 Working Group on Reinforcing International Cooperation and Promoting Integrity in Financial Markets (WG2), Final Report, 27 March 2009, pp. 4. 81 Ibid. pp. 27/8. 82 Angus Hislop and Peter Gruetter, 2009, pp. 5.
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The main reason for such a care is the fact that the meanings of a term should not be taken as absolute since they vary depending on their user’s approach and perception to the subject. This is necessarily so in any field where theories are contradictory, e.g., social science disciplines. The contradiction of theories creates differences in the meaning of terms across theories. In this respect, the notion of power is not an exception. With this in mind, we start to examine the idea of power by tracing it back to the Social Science disciplines, and in particular economics, which is the most relevant field to the context of the present study. In 1972, Abba Lerner claimed, “Those who benefit from the activity gain the approval of those who object by giving them something to get them to agree. What I want particularly to stress is that the solution is essentially the transformation of the conflict from a political problem to an economic transaction. An economic transaction is a solved political problem. Economics has gained the title of queen of the social sciences by choosing solved political problems as its domain.”83 Indeed, with some exceptions, the standard approach to the notion of power among conventional economists was best summed up by Paul Samuelson “Remember that in a perfectly competitive market, it really does not matter who hires whom; so have labor hire capital.”84 In this respect, it is not surprising that “the term [power] does appear among the 1,300 or so index entries of the leading graduate microeconomics text.”85 In this respect, the first point we would like to underlined is the fact that by not considering the notion of power relevant to economic explanation, economists failed to capture it’s essence, that is, power as an effective means to gain economic advantage in private exchange. As such, we argue in this book, the notion of power bears significant weight in constructing as well as shaping the future of global economic system. It is a common knowledge that the notion of power has close link to politically charged words such as “coercion” and “freedom,” “democracy,” which generally evokes controversy and debates among philosophers and political theorists.86 83
Abba P. Lerner, “The Economics and Politics of Consumer Sovereignty,” The American Economic Review, Vol. 62, No. 1/2 (Mar. 1, 1972), pp. 259. Emphasis is added. 84 Paul Samuelson, Samuelson, P. 1957. “Wages and interest: a modern dissection of Marxian economics,” American Economic Review vol. 47, no. 6, Dec., 1957, pp. 894. Samuelson in the footnote elaborates further, “The argument holds even if capitalists do all the hiring, provided only that workers go where they get highest w and competing capitalists do what gives highest profits.” (See Ibid). In respond, John Kenneth Galbraith chided economists for not examined more thoroughly the relationship between the factors of production, where power is associated with some factors and not with others. For instance, he asked, “why did ownership of land once convey plenary power over the dominant form of productive enterprise and, therewith, in the community at large?” (See John Kenneth Galbraith, The New Industrial State, 4th edition, Houghton, Mifflin Company, 1985, pp. 49). 85 Samuel Bowles, Samuel and Gintis Herbert, “power.” The New Palgrave Dictionary of Economics. Second Edition. Eds. Steven N. Durlauf and Lawrence E. Blume. Palgrave Macmillan, 2008. 86 For instance, we refer the reader to: P. Bachrach, and M. Baratz, “The two faces of power,” American Political Science Review, vol. 56, 1962, pp. 947–52; B. Barry, ed., Power and Political Theory: Some European Perspectives, John Wiley, 1976; Steven, Lukes, 2nd edition Power: A Radical View, Palgrave Macmillan, 200; and Steven Lukes, Power (Readings in Social and Political Theory, No. 4), NYU Press, 1986. These are among many books on this topic.
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Nonetheless, even among political theorists, no consensus has emerged so far in term of general theory of power. However, on the epistemic front, several views were expressed, in which we briefly underlined as the point of reference. Some, most notably Hans Morgenthau among them, views power in the content and the manner of its use, both of which are determined by the political and cultural environment. Power, claimed Morgenthau, “may comprise anything that establishes and maintains the power of man over man…from physical violence to the most subtle psychological ties by which one mind controls another. Power covers the domination of man by man.”87 Morgenthau’s description of power, therefore, can be seen as relational, that is, power in relation to others (man, states, etc.). In contrast, Kenneth Waltz views power in the international system and suggest that it can be understood as the capacity of a state, most notably military capability, to affect the behavior of other states (while resisting unwelcome influence from those states).88 Waltz’s description is mostly due to the traditional thinking in international relations, with deliberate behavior, and inevitably with states. States have monopolized power because they have military capability (resources). As McCormick observed, “Powerful states have integrated militaries that answer to integrated command structures and pursue national security policies, and have integrated economies governed by a single set of national policies.”89 The critics of Waltz’s view commonly point out that capability, no matter how effective, is not always translated into power. For instance, Stanley Hoffman described the US as a “Gulliver” tied by an international system, and hence in many instances she wears straitjacket.90 More importantly, in today global economic system, the ownership of the means of production has become more significant than ownership of the means of destruction. The prevailing influence in the post-industrial world is measured not by guns and smart booms, but instead by the role of corporations in the global exchanges system, the strength and influence of currencies and financial institutions, and the control of budget deficits and trade balances. As Rosecrance puts it in 1986, where state once had no choice but to pursue military power, they now have a choice: they may remain political-military states, or they may have instead pursue economic power and become trading states.91
87
Hans J. Morgenthau, Politics Among Nations: The Struggle for Power and Peace, Fifth Edition, Revised, Alfred A. Knopf, 1978, pp. 11. The reader should note that this book was first published in 1948. 88 Kenneth Waltz, Theory of International politics, McGraw Hill. 1979, Chap. 1. 89 John McCormick, The European Superpower, Palgrave Macmillan, 2006, pp. 15. 90 Stanley Hoffman, Gulliver’s Troubles, or the Setting of American Foreign Policy, McGraw Hill, 1968. 91 Richard Rosecrance, The Rise of the Trading State: Commerce and Conquest in the Modern World, Basic Books, First Edition, 1986.
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Nevertheless, Waltz’s significant contribution, in the content of this book, is two folded. First, he warned us against confusing the use of power with its usefulness.92 The military power has proven useful on occasions to shape the preference of others, but its’ usefulness to consolidate domination, indefinitely, over another is not sustainable in a sense that even a military occupation of a country will eventually must end. Second, he also draws attention to different between national and international politics, which compels one to consider his view is utterly bounded to the post WWII era and onward. According to him, “National politics is the realm of authority, of administration, and of law. International politics is the realm of power, of struggle, and of accommodation.”93 Others, like Klaus Knorr, followed more or less the Morgenthau lead.94 However, Knorr had to acknowledge that relational power alone is unable to explain the future possession of it.95 The relevancy of Knorr’s view in this book related to the fact that he underlined the important issue and noted the difference between influence that was coercive (actor B is affected by fear of sanctions or threats or restrictions by actor A) and influence that was noncoercive (B’s choices are “enriched rather than limited” by A). In a coercive situation, B loses or expects to lose while A gains; in a noncoercive situation, A and B both expect to gain.96 Joseph Nye’s distinction between “soft” and “hard” power bears striking similarity with Knorr’s notion of coercive and noncoercive power.97 According to Nye, hard power is essentially based on military and economic might, to “pursue” others to change their position. It can rest on a combination of inducements and threats.98 Similar to the noncoercive power, the idea of soft power, Nye argues, “is more than just persuasion or the ability to move people by argument, though that is an important part of it. It is also the ability to attract, and attraction often leads to acquiescence. Simply put, in behavioral terms soft power is attractive power.”99
92
Kenneth Waltz, 1979, pp. 191. Ibid, pp. 113. 94 Kluas Knorr in Power and Wealth: The Political Economy of International Power conferring power of states in international relations – reviewing the general bases of influence, e.g., wealth, skill, etc., among state actors and considered the manner in which military and economic power may be generated and used (see Kluas Knorr, Power and Wealth: The Political Economy of International Power, Basic Book, 1970). 95 Susan Strange, The retreat of the State: The Diffusion of Power in the World Economy, Cambridge University Press, 1996, pp. 18. 96 John McCormick, 2006, pp. 14. 97 Joseph S. Nye, Soft Power: The Means To Success In World Politics, Public Affairs, 2005. It should be noted, however, as Susan Strange points out, “the distinction is never precisely defined nor developed into a general theory of power in the international political economy.” (See Susan Strange, the Retreat of the Sate, 1996, pp. 19). 98 However, Nye also acknowledge that sometimes persuasion based on less tangible inducements, such as shaping the preferences of others through values that others aspire to adopt. 99 Joseph S. Nye, 2005, pp. 6. 93
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If hard power rests on command behavior, or the ability to change what others do by coercion or inducement, then soft power can be described as a co-optive power, or the ability to change what others want through either the appeal of its ideals attraction, i.e., cultural values, or manipulation of agenda.100 In a more or less similar domain, Northedge attempted to shed some light on the different connotation of the notion of power by separating “force” from “power.”101 More traditional international relation thinkers perceived power in term of hegemonic tendency in the system, which perhaps is due to growing awareness, or apprehension if you would, that the system is susceptible to “crisis” that apparently perceived as an innate attribute of that system. This view is built on hegemonic stability theory, which developed by Charles Kindleberger who demonstrated that the stock crash of 1929 and ensuing international chaos were due to the absent of a world power capable to assume the role of global hegemon.102 Among the subscriber of this school, some are convinced that the international system is constructed around dominant poles to the extent that international stability necessitates a recognized power that is capable of taking political and military responsibility at the global level.103 In this sense, the world works best when it is dominant by a state, hegemonic state,104 or as Gilpin described the hegemon’s role as “the cement that holds the system together.”105 Robert Dahl’s explanation of power can be perceived as a response to the traditional thinkers. Dahl thought capabilities or resources, at the local government level, are poor way of judging relative power. In his view, it is more “power over” than “power from” that matter. For instance, power derived from a military relationship, e.g., a defense agreement, is different from power derived by ideological relationship, and both are different from power over by economic relationships such as relationships between “buyer and seller, lender and borrower, producer and processor, processor and consumer, investor and entrepreneur, employer and employee,
100
Ibid, pp. 7. For instance, Northedge in his essay, The Use of Force in International Relation distinguished “force” from “power” in a sense that in political science domain power usually means “the capability of a person or group to make his or its will felt in the decision-making process of another person or group… A state may be said to have power in the international system when another state recognizes that it cannot be ignored when issue have to be determine.” (See F. S. Northedge, ed, The Use of Force in International Relations, London, 1974, pp. 12). 102 See Charles Kindleberger. The World in Depression: 1929–1939, London, the Penguin Press, 1973; “International Public Goods without International Government,” The American Economic Review, Vol. 76, No. 1 (Mar., 1986), pp. 8–9; and “Dominance and Leadership in the International economy,” International Studies Quarterly, vol. 25, no. 2, June 1981, pp. 242–254. 103 See Robert. Gilpin,The Political Economy of International Relations, Princeton University Press, 1987. See also Mario. Telo, International Relations: A European Perspective, Ashgate Publishing, 2009, pp. 57–58. 104 To be a Hegemon, a state must have three attributes: (1) The Capability to enforce the rules of the system; (2) The Will to do so; and (3) A Commitment to a system, which is perceived as mutually beneficial to the major states. 105 Robert Giplin, The Political Economy of International relations, Princeton University Press, 1987, pp. 76. 101
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and so forth.”106 Therefore, the exaggerated interest of scholars in hegemonic power is not only overly narrow, but their tendency to concentrate attention on capabilities based within a geographical area lead them to either a wrong direction or a wrong conclusion.107 For one thing, the Hegemonic Stability Theory emerged not for the explanation of international regimes, but as a justification for the condition of international economy. Kingleberger’s analysis of the Great Depression of 1929–1939 clearly confirmed this observation as he argued that “for the world economy to be stabilized, there has to be a stabilizer, one stabilizer.”108 The theory also labeled invalid by Snidal when he claims, “If the theory could be taken at the face value, it would be among the most powerful and general in all international relations. Yet its widespread use seems more closely associated with an equally sloppiness in ‘applying’ the theory than with any general or fundamental validity.”109 In retrospect, and regardless of absent of general theory of power, we would like to underline the point that it is certainly possible to recognize power when it is applied and witness it execution when it is exercised. In fact, those who have been a subject to such exercise will recognize power readily than those who have it and exercised it. As Foucault stated, “Power exists only when it is put into action.”110 Or as Susan Strange observed, “this is why power is so often defined, either at the local or international level, in terms of ‘resources’ or ‘capability’.”111 We end this section by few remarks and a summation of the relevant points. First, we are convinced that the role of state in defining the concept of power is not only overly exaggerated but it is also outdated. History offers many examples of nonstate actors exercising power over others, the most obvious being organized religion. The encounter of Islam with human civilization, and the West in particular, dates back to 1,300 years when European areas like Spain, Portugal, Sicily, and the southern France came under Muslim jurisdictions and “experienced a thriving cultural revival that become a major influence in the transmission of civilization that sparks the European Renaissance.”112 Christianity was the primary driving force in European politics and culture for the best part of 1,500 years.113 And quite recently, who can deny the power of al-Qaeda over the rest of the world – with its drug-running financial resources and shady identity it has single handedly inflicted heavy fiscal burden on government, change policies, and the routine of daily life of millions.
106
Susan Strange, “What Is Economic Power, and Who Has It?” International Journal, Vol. 30, no. 2, Spring, 1975, pp. 216. She further explains, “In each case, the process of deciding the balance, and therefore the outcome, is essentially a bargaining process.” (Ibid, pp. 217). 107 Susan Strange, 1996, pp. 25. 108 Charles Kindleberger, The World in Depression 1929–1939, The Penguin Press, 1973, p.305. 109 Duncan Snidal, “The limits of hegemonic stability theory,” International Organization, vol. 39, no-4, Autum 1985, pp. 579. 110 Michel Foucault, Beyond Structuralism and Hermeneutics, 2nd edition. Ed. Hubert L. Dreyfus and Paul Rabinow, U of Chicago Press, 1982. 111 Susan Strange, 1996, pp. 18. 112 John L. Esposito, The Oxford History of Islam, 2000, pp. 602. 113 For discussion, see J. M. Roberts, The Penguin History of the World, 1990, pp. 255–67, 459–71.
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Second, the outdated emphasis on states is mostly due to the fact that for the past several decades the world around us has change. We are living in the world in which the single uniform economic system is now operating at full scale. The building blocks of this system would not be states, but at best, portion of state functions such as courts, legislatures, networks, etc.114 In short, globalization has the dual effect of displacing politics and of diffusing authority of state, and hence diminishing state’s capacity to monopolized power, or in Weber’s view violence. In this light, we should review our perception of the way the today world works, that is as Cox puts it, “through a series of connected structures of production relations,”115 and thereby abandon the emphasis on nation-states and their unitary view in favor of a focus on complex and integrated global economic network. Respectively, we chose the notion of power that reflects this objective. Therefore, power is defined as the ability of an entity (or collections of entities) to affect outcomes that their interests take precedence over the interests of others. On this issue, Waltz points out “The power of the strong may deter the weak from asserting their claim, not because the weak recognized a kind of rightfulness of rule on the part of strong, but simply because it is not sensible to tangle with them. Conversely, the weak may enjoy considerable freedom of action if they are so far removed in their capability from the strong that the later are not so much bothered by their action or much concerned by marginal increases in their capability.”116 In light of Waltz’s observation, the notion of power relationship bears considerable weight in the global economic system, and more importantly, among actors who take on vital role in operation of the global system and able to exercise power over others. Power relationship, according to Foucault, “can only be articulated on the basis of two elements which are each indispensable if it is really to be a power relationship: that ‘the other’ (the one over whom power is exercised) be thoroughly recognized and maintained to the very end as a person who acts; and that, faced with a relationship of power, a whole field of responses, reactions, results, and possible inventions may open up.”117 Although violence may be a part of some power relationships, according to Foucault “In itself the exercise of power is not violence”; it is “always a way of acting upon an acting subject or acting subjects by virtue of their acting or being capable of action.”118 In short, exercise of power can be viewed as a set of actions upon other actions. In this respect, the exercise of power in the form of an effective means to gain economic advantage is not the sole privilege of ruling elites or governance bodies but “emanates from a loosely woven web of interconnected actors and institutions whose interests sustain existing conditions while allowing certain forms of discontent and resistance to emerge.”119 The ample example of such discontent is the outcries over the recent financial crisis around the world. 114
For more detailed analysis see Anne-Marie Slaughter, A New World Order, Princeton University Press, 2005. 115 Robert Cox, Production, Power and World Order, Columbia University Press, 1987, pp. 5. 116 Kenneth Waltz, 1979, pp. 113. 117 Michel Foucault, 1982. 118 Michel Foucault, 1982, pp. 220. 119 Subhabrata Bobby Banerjee, Corporate social responsibility: the good, the bad and the ugly, Edward Elgar, 2008, pp. 141.
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The notion of power under consideration in this book is not related to capabilities, but rather associated to the prevailing power relationships in the global economic system. In this respect, when we talk about the power of financial sector we mean to imply that global finance has the upper hand (in exercising power) over all others actors in the global system.
How Financial Institutions evolve in the Prevailing environment We start this section by simply presenting several events in a chorological order and expert opinions that in our opinion are ample indication of the prevailing environment under which the financial institutions were helped to rise above others, including policy makers as well as the institution of government. More importantly, in the following pages, the highlighted developments suggest that during the past several decades these institutions constructed the pathological inclination that was capable to maintain enduring royalty only with shareholders and callous unconcern for others; incapable to define or experience quilt by self-promotion of deceitfulness; authenticate conning others for profit; and inability to conform to social norms with respect to lawful conducts and common ethic.120 In presenting these events and opinions, we mainly focused on the US economy and its financial institutions for three distinct but interrelated reasons. First, the US economy is largest in the world to the extent that it’s nominal GDP is equal to the next three largest economies combined, namely, China, Japan, and Germany combined.121 The value of goods and services produced in the USA is 23% of the value of entire global production.122 Respectively, the US economy inherently has immense power over the rest of the world.123
120
To reaffirm this observation it is sufficient to remind the reader that the Goldman Sachs CEO, who was scheduled to testify in front of the Senate Permanent Subcommittee on Investigations about the SEC lawsuit charging the firm with securities fraud, once proclaimed that investment bankers are in the business of doing “God’s work.” For detail see http://www.timesonline.co.uk/ tol/news/world/us_and_americas/article6907681.ece?token=null&offset=36&page=4. Moreover, similar sentiments were expressed in Joel Bakan, The Corporation: The Pathological Pursuit of Profit and Power, Free Press, 2005. 121 International Monetary Fund, World Economic Outlook Database, April 2011. 122 However, another telling statistics is food accounts for a significant share of total consumer expenditure in many parts of the world except the USA, as the 2007 World Economic Outlook observed “the weight of food in the consumption basket averages more than 60% in sub-Saharan Africa, whereas it is about 30% in China, and only 10% in the United States.” See pp. 13. 123 For instance, in various global markets, e.g., oil, the US economy has monopsony power over the oil producing economies because “its consumption is a substantial fraction of total world production” (For detail study of this topic see Ian W.H. Parry and Joel Darmstadter, “The Costs of U.S. Oil Dependency,” Resources for the Future, Discussion Paper 03–59, December 2003, pp. 12–14); or, as Magnuson astutely explains monopsony power is the common used strategy by large US-based corporations to pressure their suppliers into slashing their prices (see Joel Magnuson, Mindful Economics: How the US Economy Works, Why it Matters, and How it Could be Different, Seven Stories Press, 2008).
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Second, the USA, more than any other nations in the world, is the home-based to the large financial institutions (including banks). For instance, banks that are either among the most profitable with holding assets well above trillion US dollars, such as J.P. Morgan ($2,02 trillion), or among the world largest wealth managements like Bank of America that “serves clients all over the world and has a relationship with 99% of the U.S. Fortune 500 companies.”124 Moreover, according to Alpha magazine, eight out of the ten largest and most profitable hedge fund firms in the world are based in the USA125 The importance of the global financial institutions, which often overlooked, is that “They are strategically positioned to directly and indirectly lever more than most other businesses, expand the aggregate money and credit supplies, create debt and speculatively affect stock, commodity and real estate prices.”126 The domination of US financial sector was also noted by the Think Tank circle and International organization even before the 2008 episode.127 Finally, the more we examine various financial crises, particularly the 2008 episode, the more we discover how interconnected the US financial market and institutions are with the rest of the world. The cliché of a “small world” resonates. As Davidson observes, “A family defaults on its mortgage in Florida and its house repossessed, and this contributes to the write-down of a bank in Europe. The US Federal Reserve cuts interest rate and send out a message to central banks around the world.”128 Perhaps, it is not a far fetch to assert that the 2008 financial crisis signals the primacy of US financial institutions. Taking these reasons into consideration, it was easy to conclude that the USA played the significant part in triggering the global crisis. In addition, the role of financial sector in the USA and elsewhere is noteworthy, as Ferguson has observed, “In 1947 the total value added by the financial sector to US gross domestic product was 2.3 per person; by 2005 its contribution had resin to 7.7% of GDP. In other word, approximately $1 of every $13 paid to employees in the United States now goes to people working in finance. Finance is even more important in Britain, where it accounted for 9.4% of GDP in 2006.”129 Under this circumstance, one should not be surprised to see the Communist
124
See http://www.doughroller.net/banking/largest-banks-in-the-world/. See http://www.alphamagazinerankings.com/HF100/rankings1.asp. 126 Assaf Razin and Steven Rosefielde, “Currency and Financial Crises of the 1990s and 2000s,” NBER Working Paper no. 16754, February 2011, pp. 2. 127 For instance see Ehrmann, Michael, Marcel Fratzscher, and Roberto Rigobon, “Stocks, Bonds, Money Markets, and Exchange Rates: Measuring International Financial Transmission,” NBER Working Paper No. 11166, 2005. In addition, IMF in its 2007 annual report, World Economic Outlook, also noted, “with the continued dominant role of the United States in global financial markets, cross-border spillovers from financial shocks in the United States remain a particular concern.” (see IMF, World Economic Outlook: Globalization and Inequality, 2007, pp. 183. See also Bayoumi, Tamim, and Andrew Swiston, 2007, “The Ties That Bind: Measuring International Bond Spillovers Using the Inflation-Indexed Bond Yields,” IMF Working Paper 07/128). 128 Alexander Davidson, How the global markets really work: the definitive guide to understanding the dynamic of the international money markets, Kogan Page, 2009, pp. 2. 129 Niall Ferguson, The Ascent of Money: A Financial History of the World, Penguin Press, 2008, pp. 5. 125
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China become one of the main creditors of the Capitalist America to the extent that China passed Japan to become the US government’s largest foreign creditor (the America’s debt financier).130 The next step is to demonstrate chronologically the major developments that shaped the prevailing US financial power and consequently contributed significantly to globalization of financial sector, and hence the dominant role of the global financial institution. In October 15, 1982, less than 2 years into his presidency, President Regan introduced one of his administration’s major pieces of deregulation of America’s financial institutions, known as the Garn-St Germain Depository Institutions Act.131 The bill changed the half of century American practice of home financing and allowed Savings and Loans financial institutions, known as thrifts, to compete in the complex and highly volatile financial marketplace. As a result, a new breed of aggressive Savings and Loans emerged, whose main business was making mortgage loans within their community and attracted large pools of deposits by offering higher returns, and then used this cash to move into new lines of business, including junk bonds and real estate developments. The result was the rise in housing construction, and consequently significant increases in value of the real estate in the country. Two years later, the simulated real estate boom came to an end and losses of speculative investments started to pile up to the extent that by 1988 were estimated at $60 billion. Soon after, Congress created a Government-owned asset management company known as Resolution Trust Corporation (RTC) to take over the assets of insolvent financial institutions.132 The adventure of Savings and Loans ended up costing taxpayers about $124 billion.133 It is worthy to note, and in direct contrast to the 2008 episode, the major lenders in the Saving and Loan affair were under investigation prior to the collapse. The Saving and Loan affair sparked dynamic debates among experts and academicians in terms of vulnerability of thrift institutions and the incentive to gamble and risk taken which had led these institution to engage in fraudulent accounting. In 1993, two economists at University of California in Berkeley suggested that, “an
130
This development, unlike the popular view, is also presents dangerous case for China since China is now holding US dollar for than any other nation, and hence to certain extent its well being is dependent on how well dollar is value in the world market. 131 For detail information of the act see: http://realestate.bryanellis.com/52/garn-st-germain-depository-institutions-act-of-1982/. 132 According to the New York Times, “Resolution Trust closed or reorganized 747 institutions holding assets of nearly $400 billion. It did so by seizing the assets of troubled savings and loans and then reselling them to bargain-seeking investors. At the peak in early 1990 there were 350 failed savings and loan institutions under the agency’s control.” (see “Saving and Loans Associations,” The New York Times, Tuesday, May 10, 2011). 133 It is noteworthy to mention here that when someone says “the cost to taxpayers is $… amount,” one should immodestly ask what does it imply; what will happen to this money, where the money goes, who received it and why? These are the questions that are often neglected but bear significant weight in understanding the situation. For an informative discussion, see http://start-businessloans.com/blog/personal-credit/24/.
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economic underground can come to life if firms have an incentive to go broke for profit at society’s expense (to loot) instead of to go for broke (to gamble on success). Bankruptcy for profit will occur if poor accounting, lax regulation, or low penalties for abuse give owners an incentive to pay themselves more than their firms are worth and then default on their debt obligations.”134 Nevertheless, regulatory changes of 1980s continued well into 1990s, first with the Interstate Banking and Branching Efficiency Act of 1994 and later the 1999 Financial Service Modernization Act. According to Saunders, however, these changes, which included, “lifting the regulatory barriers to lend or to entry or on products offered, exposed financial institutions to risk or sudden collapses and unexpected changes in financial market.”135 Despite the thrifts financial collapse and warnings by professionals in the financial discipline the popular trend continues, as if All Quiet on the Western Front. Participants of the popular culture also strengthened the euphoria of easy money. In 1998, Jeremy J. Siegel, the author of best-selling book advice the public that, “Stocks should be constitute the overwhelming proportion of all long-term financial portfolios.”136 And to make sure everyone understand the notion of long term he further elaborated that “portfolio composition is crucially dependent on the holding period of the investor, and holding periods are often far longer that most investor realized.” And yet, even within such tamed and contented climate red flags were raisin by foes and die-hard supporters of financial deregulation, signaling the apprehension of what may occur. In 2000, Economist claimed that it “has long argued that the American economy is suffering from a financial bubble.”137 During the same year, the Yale economist Robert Shiller also warned the vulnerability of economy to financial speculations.138 Soon thereafter, the stock market crashed, also known as the dot-com bubble crash, which caused the loss of $5 trillion in the market value of various companies.139 According to Wall Street insider, Bull Investor, the main causes of crash was corruption and fraudulent practices – a lot of companies inflated their profits by means of
134
George A. Akerlof, Paul M. Romer, “Looting: The Economic Underworld of Bankruptcy for Profit,” Brookings Papers on Economic Activity, Vol. 1993, No. 2 (1993), pp. 2. 135 Anthony Saunders, Financial Markets and Institutions: A Modern Perspective, 2nd edition, McGraw-Hill, 2003, pp, 543. 136 Jeremy J. Siegel, 2nd edition, Stocks for the Long Run, McGraw-Hill, 1998, pp. 361. 137 Economist, “A hard landing? The risk of a hard landing in America is real,” Economist, Dec 7th 2000. 138 Robert Shiller, Irrational Exuberance, Princeton, University Press, 2000. Shiller also points out, “In 2000, at the peak of the market, it become popular to refer the Greenspan put. Many thought that Greenspan was so supportive of the shock market that his presence as Fed chair was as good as having a put option on the stock market to protect us from stock market declines. The rationale behind this talk of the Greenspan put was that Greenspan had used his power to prevent a stock market debacle” (ibid, pp. 40). 139 http://articles.latimes.com/2006/jul/16/business/fi-overheat16.
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fraud and accounting loopholes and hid their debt.140 The fraudulent accounting practices were so popular that Forbes published, the Corporate Scandal Sheet, stating, “With the avalanche of corporate accounting scandals that have rocked the markets recently, it’s getting hard to keep track of them all – but our Corporate Scandal Sheet does the job.”141 The stock market crash followed by recession, as Samuelson famously noted, “The stock market has predicted nine of the last five recession.”142 The recession forced the Fed to cut interest rate to offset the collapse of investment, as the conventional wisdom prescribed. The Fed curtailed short-term interest rate from 6.5 in January 2001 to unprecedented level in the post-1971 era of floating exchange rate of 1% by June 2003. As a direct result of Fed action, credits become widely available, housing construction picked up and real states started upward trend again as more people found they could afford the lower mortgage payment. Indeed, Rajan argument “let them eat credit” could well summarize the mantra of the political establishment in the go-go years before the crisis. In April of 2004, the five member of the Securities and Exchange Commission (S.E.C) met to consider the proposal put forward by the five powerful investment banks, asking the Commission to change “the net capital rule.” The five banks, led by Goldman Sachs, which was headed by Henry M. Paulson Jr, who 2 years later left Goldman Sachs to become Treasury secretary. According to New York Times, “They wanted an exemption for their brokerage units from an old regulation that limited the amount of debt they could take on. The exemption would unshackle billions of dollars held in reserves as a cushion against losses on their investment. Those funds could then flow up to the parent company, enabling it to invest in the fast growing but opaque world of mortgage-backed securities; credit derivatives, a form of insurance for bond holders; and other exotic instruments.”143 The proposal was approved and the decision was complete and published in the Federal Register a few months later.144 The 2004 decision, more than anything else, reflected the view that taming Wall Street pedagogical pursue of overindulgence was a thing of the
140
For instance, on June of 2002, WorldCom, the Nation’s second largest long distance telecommunications company and 42nd among Fortune 500 companies, was found practicing illegal accounting practices by overstated earnings in 2001 and the first quarter of 2002 by more than $3.8 billion. A month later, and $11 billion collapse forced WorldCom filed for corporate bankruptcy, the largest bankruptcy in US history at the time. http://www.bullinvestors.com/stock-market-history. It should be noted that WorldCom’s external auditor during and before the fraud-case was Ather Anderson, the same firm was also audited Enron and convicted of accounting fraud. 141 http://www.forbes.com/2002/07/25/accountingtracker.html. 142 Paul Samuelson, “Science and Stocks” Newsweek, September 19, 1966. 143 The New York Times, Agency’s 04 Rule Let Banks Pile Up New Debt, New York Times, (October 2, 2008). The article can be access at: http://www.nytimes.com/2008/10/03/ business/03sec.html?em=&pagewanted=2. 144 Ironically, the decision was intend to ease regulation that the EU was about to impose on the foreign operation of US investment banks.
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past and both Washington regulatory interests and Wall Street interests have converged. How else one can explains the conduct of the Commission that was created to “catch thief.”145 Few months later, on September 2004, a top FBI official claimed that fraud is running rampant in the nation’s mortgage industry, with nearly three times as many reports of suspicious activity so far this year compared with 2001. “It has the potential to be an epidemic,” said Chris Swecker, FBI assistant director for criminal investigations. A year later, another warning was delivered at a celebration honoring Alan Greenspan, who was about to retire as chairman of the US Federal Reserve. Raghuram Rajan, an insider of the global financial system, presented a paper called “Has Financial Development Made the World Riskier?” in which he argued that because banks were holding a portion of the credit securities they created on their books, if those securities ran into trouble, the banking system itself would be at risk. Banks would lose confidence in one another, he said: “The interbank market could freeze up, and one could well have a full-blown financial crisis.”146 More importantly, he also suggested that change in financial sector have change financiers’ incentive, which in turn have alter the essence of risk taken undertaken by the system to the extent that there is rich rewards for making money, but no penalized for losses. Such skewed incentive encouraged financial institutions to engage in complex products with potentially big payoffs, which could, and in fact has, fail spectacularly. Rajan’s observations hinted at an unwelcome but a plausible outcome, and hence evoke responds that were hastily made. For example, former Chief economist at Obama administration, which also carries number of titles such as former US Treasury Secretary and former Harvard President, Lawrence Summers told the audience that he found “the basic, slightly lead-eyed premise of [Mr. Rajan’s] paper to be misguided.”147 Before concluding this section, few issues must be clarified. First, an important issue that rarely investigated, with few exceptions, in all these developments and analyses is the fact that banks, by the nature of their lending and borrowing practices, bear significant vulnerability in terms of cash shortages, since banks tend to borrow short and lend long. Traditionally, banks’ borrowing is based on deposits, and hence can be redeemed on relatively short notice. However, the loans they make are mostly based on long-term basis like mortgages, and hence can be difficult to convert into cash on the short notice. For instance, if for some reason, all depositors
145
The phrase refers to President Roosevelt comment – “When President Franklin D. Roosevelt was asked in 1934 why he appointed Joseph P. Kennedy, a spectacularly successful stock speculator, as the agency’s first chairman, Roosevelt replied: ‘Set a thief to catch a thief.’ (See The New York Times, Agency’s 04 Rule Let Banks Pile Up New Debt, New York Times, October 2, 2008).” 146 Raghuram G. Rajan, “Has Financial Development Made the World Riskier?” NBER Working Paper No. 11728, November 2005, pp. 346. 147 Paul Krugman, “How Did Economists Get It So Wrong?” New York Times, September 2, 2009.
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simultaneously try to withdraw their funds at once (technically called bank run, trouble ensue in a sense that the bank might simply not be able to pay off all its depositors). The Lehman bankruptcy case in 2008 is an ample example of such episode.148 Second, the above developments and policies provided an environment that can facilitate institutionalization of an industry like the financial industry, which function through a feedback loop that ultimately would leads toward its instability and demise.149 On the one hand, the industry operates under weak set of rules against fraudulence conducts, which incline to invite dreadful practices, e.g., Alt-A loan150
148
Lehman borrowed significant amounts to fund its investing in the years prior to its bankruptcy on September 15, 2008. A significant portion of this investing was in real-estate-related assets such as subprime and other lower-rated mortgages, making it vulnerable to a abrupt shock or downturn in that market (The reader should note here the time dimension of assets and liabilities. A 30-year mortgage, for a bank, is a long-term asset. They will get a mortgage payment every month for 30 years and, most importantly, they can’t call in the loan before then; that is to say they can’t demand that the homeowner pay it back. On the other side, banks have liabilities with different maturities, i.e., deposits (savings accounts) can be withdrawn at any time, so their maturity is essentially instant). The situation was also exacerbated by the 2004 decision, which changed the net capital rule, powerful investment banks like Lehman were exempt to the same regulations applied to depository banks to restrict their risk-taking. 149 In a general term, Institutionalization involves the processes by which social processes, obligations, or actualities come to take on a rulelike status in social thought and action. For example, a No Smoking sign is an institution with legal status and implication as well as an attempt to regulate behavior. However, we applied the term here to imply a process which alters an industry’s code of conduct, mission, policies, vision, and strategic plans into guidelines applicable to the daily activities of its employees, from the top to the bottom as well as the interaction with the external environment. It aims at transferring fundamental values and objectives into new industrial’s culture and structure. 150 Alt-A loans are primarily credit-score driven, since the candidates for these loans tend to lack proof of income from traditional employment. The Alt-A loan reduces the gathering of documentation associated with fully documented loans, such as providing income verification and documentation of assets. On the contrary, borrowers do pay a slightly higher interest rate than fully documented loans. In short, the common verification process was gutted for sake of making more loans. We know that this process will produce enormous fraud, under economic theory, criminology theory, and 2000 years of life experience. One of the main mortgages that fall into the Alt-A category of mortgage lending is Liar Loans. According to INVESTOPEDIA, “These loan programs are designed for borrowers who have a hard time producing income and asset verifying documents, such as prior tax returns, or who have untraditional sources of income, such as tips, or a personal business. These loans are called liar loans because the SISA or NINA features open the door for abuse when borrowers or their mortgage brokers or loan officers overstate income and/or assets in order to qualify the borrower for a larger mortgage.” The 2008 episode was filed with these types of loans. For instance, IndyMac specialized in making liars’ loans. In 2006 alone, it sold $80 billion dollars of liars’ loans to other companies. In 2009, the Federal Deposit Insurance Corporation announced that it had completed the sale of IndyMac and sustained a $10.7 billion loss.
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and abusive accounting.151 On the other hand, these attributes are most likely lead to “superior opportunities for growth because they produce the kind of (fictitious) profits and net worth”152 that render even stronger incentive for investors and creditors to engage in even more unethical activities and hence perpetuates the vicious cycle. Finally, the events and developments of the last 3 decades have drawn our attention to the issues that are not only significant to the content of this book, but also bear great important for the globalized world and global governance; the issue of transparency, accountability and the rule of law. And yet, a sketchy review of popular media as well as academic analyses on recent financial misdeeds including the 2008 financial episode would reveal the fact the issues of transparency, accountability and the rule of law are either excluded, neglected or at best mentioned in a blurrily manner. Such absence is particular alarming since these concepts constitute the backbone of democratic societies, but appear to have suffered more from the financial crisis than conducts of authoritarian regimes and renegade states. Ironic as it may seems, the 1980s start with “Trust, but verify” slogan, which was a signature phrase adopted and made by former US president Ronald Reagan. However, the narrative of “trust, but verify” entails transparency, which conspicuously was not present for the last several decades, particularly during the 2008 episode. The absence of transparency can be illustrated by the need to know facts about how bad the conditions of the banks are? For instance, we need to know how much toxic assets are out there; how much the rescue banks’ assets are worth; and how much they should be sold for. Furthermore, how many banks are insolvent, such that we had rescued them in such hasty and controversial manner? It is a contradiction in term when you asked for $2 trillion taxpayer dollars to deal financial meltdown, as Secretary Geithner did publicly, meanwhile allowing all the big banks to report that they’re not only solvent, but fully capitalized. Both statements can’t be true. It can’t be that the banks need $2 trillion, because they faced massive lost, and that they’re solvent. These are practical issues which one needs to know to make educated decision about possible causes and impact of the crises with such magnitude. The more public the information is made, the faster this whole crisis will be
151
This observation has been substantiated by various sources, particularly by insiders like Guy Hands, a global financiers, who placed part of the blame for the current liquidity crisis on governments, saying that while borrowing by both individuals and institutions soared, loans were allowed to slowly become too generous in their terms, “Governments have had a vested interest in making everything appear rosy, and thus have encourage ever increasing borrowing as the alternative would have been a slowdown in growth.” (See Mathieu Robbins, “Guy Hands’ Xmas gift compares market now to 1929,” Reuters, Monday December 17, 2007. Available at: http://www.reuters.com/article/2007/12/17/us-hands-idUSL1751976620071217). 152 William Kurt Black, The Best Way to Rob a Bank Is to Own One: How Corporate Executives and Politicians Looted the S&L Industry, University of Texas Press, 2005, pp. 7.
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solved, and then everyone can move on to fixing the damage being done to the real economy.153 The important question is this: would greater transparency have helped stave off the 2008 financial crisis? There is more and more evidence that it might have, and more and more voices calling for a new approach moving forward. For instance, Transparency International, the world’s most-respected anticorruption NGO, called upon the leaders of the Group of 20 (G-20) industrialized nations, “to ensure that transparency, integrity and public accountability become the foundation of the vital reforms needed to rebuild the world’s financial system.”154 The sentiment also appeared in the declarations by the G20 Summits held in Washington in 2008, in London and Pittsburgh in 2009, and in Toronto and Seoul in 2010. The links between financial crisis and the need for more transparency is also related to the nature of modern financial transaction and the way people perceived what money is. On the former, an ample example is Derivatives. Derivatives are financial instruments whose value is derived from something else – the weather, or interest rates, or the likelihood that a borrower will default on a loan. They’re largely traded over-the-counter, which basically means that one banker picks up the phone and calls another banker, and they make a deal. In this respect, nobody really knows what derivative contracts are out there, or how much risk any bank is taking on. That is how a big bank collapses. On the latter, a bit of elaboration is needed. The 2008 episode clearly underlined the importance of money as social phenomenon and relationship, the concept that was introduced brilliantly by Tobin and later by Hahn.155 They explain money, like language, as a means of communication, which owes its value to its general acceptance by individuals. In terminological domain of economics, we can say that money is socially accepted because it is endowed with a positive purchasing power, or as Hahn claims, “a positive exchange value.” In this respect, money is merely a relationship of trust between certain parties that enables trade. If one trusts this piece of paper is worth a certain amount, one would engages in an exchange with another (the opposite is also true). Indeed, significant portion of the problem we are facing
153
The is an argument against dissemination of information, which suggests that such information drives depositors to run for an exit in a sense that they incline to withdraw their deposits from the banks all at once, a phenomenon known as “bank run.” However, the counter argument in this case is the government can take over banks, the approach selected in many European economies, instead of bailing them out. In this respect, facts can be published and the public can judge for themselves how bad the financial situation is. 154 See http://www.transparency.org/news_room/latest_news/press_releases/2008/2008_10_30_ amm_financial_crisis. 155 See James Tobin, “Discussion of Overlapping Generations Models” in J. H. Kareken and H. Wallace (eds) Model of Monetary Economics, Federal Reserve Bank of Minneapolis, 1980; and Frank Hahn, first edition, Money and Inflation, Basil Blackwell, 1982.
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today is due to a lack of clear and trustworthy information, or simply put the absence of transparency. Significant portion of population is quite sure what anything is worth, which in turns makes any sort of trade difficult. Money only works when there’s a trusting relationship, and such trust can only build when there is a reasonable flow of information to the parties involved, such that they’re confident that what they have (or what they’re trading for) has value.156 In fact, the subprime crisis was begun where people realized they had no idea what everything was worth and it escalated from there. The lack of accountability and respect for rule of law among policy makers and public officials is also striking features of various financial episodes, particularly in the latest episode. This is an astonishing development, given the extent as well as the magnitude in which the 2008 affairs affected significant portion of the population. With few exceptions, no governmental officials, including policy-makers or member of Congress or Senate, take responsibility of the past erroneous decisions or wrong doing, which shattered life of millions, and cost the country unprecedented financial burden.157 This is mostly due to the fact that a meticulousness of policy formulation is replaced either by a sheer elitist mind-set, or/and a silly case of selfserving amnesia. An ample example of former appeared in an interview between Mr. Summer and the New York Times, in which he defends his record by saying, “Did we 10 years ago foresee everything that happened with respect to derivatives? Absolutely not. Would I have acted differently with the benefit of everything that I’ve seen over the last 10 years? Of course.”158 Little the veteran policy makers and prominent economists realized that the rationale he used to defend his record, that is, if we only knew, is the exact rationale that would convict him. How else a policymakers meet the minimum requirement of his/her job and served the people who elected him/her, but to know the impact of a policy he/she designed? How else one separates a policy advocate from policy-makers, but to distinguishing advocacy that bears no responsibility from
156
As Mike Masnick quite elegantly observed, “The problem over the last few months (or, for some, years) is this realization that the information they [individuals] had was bad, and they could not trust it, and thus, the “relationship” that made thing valuable disappeared. Without this trust, plenty of things that do have value are being severely undervalued, because there’s no (or very little) credible information, and that’s leading to panic, because no one is sure what anything might actually be worth.” See http://www.techdirt.com/articles/20081130/2031042973.shtml. 157 As an exception, one can name Scott Polakoff, interim director of the Office of Thrift Supervision (OTS) begun his testimony in US Senate in 2009 by stating, “It’s time for the OTS to raise their hand and say they have some responsibility and accountability here. We were deemed an acceptable regulator for both U.S. and domestic and international operations.” It was acceptance of mistake, in which Polakoff was clearly saying, “Blame us.” (see Chana Joffe-Walt, “Regulating AIG: Who Fell Asleep On the Job?” NPR, June 5, 2009, at http://www.npr.org/templates/story/story. php?storyId=104979546). 158 New York Times Magazine, May 15, 2011, pp.14.
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policymaking that necessarily entails responsibility.159 Mr. Summer’s persistent refusal to take responsibility for policies he, and others in the inner circle, advocates and fought for 20 years truly makes one wonder about the notion of ethic and code of conduct within the institutions of government. Secretary Geithner’s testimony provides an excellent conformation of the latter case. On March 26, 2009, Mr. Secretary claimed that in his previous job, as president of the Federal Reserve Bank of New York, “never been a regulator, for better or worse. And I think you’re right to say that we have to be very skeptical that regulation can solve all of these problems.” Needless to say, if Mr. Secretary has bothered to look at the New York Federal Reserved stated objective, he would see that “As part of our [NY Fed] core mission, we supervise and regulate financial institutions in the Second District. Our primary objective is to maintain a safe and competitive U.S. and global banking system.”160 The set of circumstances under which the rule of law was not pursued (violated) suggest even more clear infringement of the principles of a democratic society as well as democratic governance. The policy makers, those responsible to up held the law violated the rule of law. For instance, the former Secretary Paulson’s conduct, in addition to entire governmental body including Congress and Senate, during the first phases of 2008 financial episode is ample illustration of clear violation of US Federal law called the Prompt Corrective Action Law (PCA)161 when they refused to obey its mandates and placed the insolvent banks into receivership,162 as the PCA required.163 The implication of such clear violation is severe, not only for the USA
159
Moreover, the claim that one could not possible “foresee everything” is really a poor justification for enormous bad decisions that have been made through many years of complacency that eventually led to self-defeating prophecy. For one thing, financial calamities did not appear out of thin air and any student of economics should, at least, be aware of the 300 year history of financial crisis. In addition, many experts and nonexperts warned against incoming collapse that often disregarded as misguided view or irrelevant. For instance, and as we mentioned earlier, Nobel prize-winner economists George Akerlof and Paul M. Romer predicted in 1993, the financial giants would used CDS until the system crashed, knowing that the taxpayers would bail them out when the crash happened. 160 See Newyorkfed.org. 161 The PCA “mandating progressive penalties against banks that exhibit progressively deteriorating capital ratios. At the lower extreme, a critically undercapitalized Federal Deposit Insurance Corporation (FDIC)-regulated institution (i.e., one with a ratio of total capital/assets below 2%) is required to be taken into receivership by the FDIC in order to minimize long-term losses to the FDIC. The motivation behind the law is to provide incentives for banks to address problems while they are still small enough to be manageable.” To learn about the History of the law, see http:// www.pcanet.org/general/history.htm. 162 According to INVESTOPEDIA, The responsibility of the receiver is to recoup as much of the unpaid loans as possible. Being in receivership is not an enviable situation for a company. Oftentimes, receivers find that the best way to pay back loans is to liquidate the company’s assets, which effectively puts the company out of business. According to Saunders and Cornet, “receivership is mandatory even before the book value ratio falls to 0%.” (see Anthony Saunders and Marcia Cornet, Financial Institutions Management: A Risk Management Approach, McGraw-Hill/Irwin; 7 edition, 2010, pp. 522). 163 See William K. Black, “Why Is Geithner Continuing Paulson’s Policy of Violating The Law?” HUFFPOST Business, February 23, 2009. It can be accessed at http://www.huffingtonpost.com/ william-k-black/why-is-geithner-continuin_b_169234.html.
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but also for the entire global system. As William Black observed, “In the Savings and Loan debacle, we developed excellent ways for dealing with the frauds, and for dealing with the failed institutions. And for 15 years after the Savings and Loan crisis, didn’t matter which party was in power, the U.S. Treasury Secretary would fly over to Tokyo and tell the Japanese, ‘You ought to do things the way we did in the Savings and Loan crisis, because it worked really well. Instead you’re covering up the bank losses, because you know, you say you need confidence. And so, we have to lie to the people to create confidence. And it doesn’t work. You will cause your recession to continue and continue.’ And the Japanese call it the lost decade. That was the result. So, now we get in trouble, and what do we do? We adopt the Japanese approach of lying about the assets. And you know what? It’s working just as well as it did in Japan.”164 All things considered, as long as the issues of transparency, accountability and respect for the rule of law are not taken into account, popular analyses continually to point in different directions and sometime underline less relevant factors such as behavioral deviant like a mere “greed,” lack of liquidity by investment financial institutions, absent of regulatory framework, or even individual bankers, CEOs, as the root cause of the financial meltdown may confusing the effect with the cause. Indeed, the prevalence of these type of analyses are raising so fast that one may thinks that their analytical objective bear no relevancy to the main causes, and hence they rather made to draw attention away from the main cause.165 For instance, the standard line on what went wrong with insolvent financial institutions fell into some sort of “regulatory gap.” From members of Congress to Federal Reserve Chairman Ben Bernanke, the narrative was clear: Hundreds of regulators around the globe missed the calamity in the making because none of them was watching over the whole country. But such narrative failed to stand against facts, especially when one considers the facts about regulatory agencies and financial institutions. For one thing, banks choose their regulators – they go shopping and pick regulators that are more sympathetic to their business modules and overall objectives. Moreover, regulators want to get picked, because banks pay them for the service of regulation.166 Similarly, financial institutions employ rating agencies, instead of outside party, to assess their products and services as well as their overall stability and robustness. It must be obvious that while “regulatory gap” existed, the cause of the crisis is the power of financial institutions to operate at well – with almost no strain attached and no credible supervision.
164
See Bill Moyers Journal: William Black Interview at: http://www.pbs.org/moyers/journal/ 04032009/transcript1.html. 165 We were inspired by the following, “The President is very much a figurehead – he wields no real power whatsoever. He is apparently chosen by the government, but the qualities he is required to display are not those of leadership but those of finely judged outrage. For this reason the President is always a controversial choice, always an infuriating but fascinating character. His job is not to wield power but to draw attention away from it.” (See The Hitchhiker’s Guide to the Galaxy, 2005.) 166 Chana Joffe – Walt, “Regulating AIG: Who Fell Asleep on The Job,” NPR, June 5, 2009 at: http://www.npr.org/templates/story/story.php?storyId=104979546.
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Financial Institutions and Exercise of Power To explain how financial institutions exercise power over others, one must clarify how they obtain power and then how they sustain such power over time. In doing so, to ascertain all factors involved is certainly beyond the scope of this book, and hence we only underline factors that are related to the topic of the book. Respectively, we have used various studies and experts opinions on the subject matters as well as plenty of common sense and a bit of economics. To understand how financial institutions obtain the power we must first explain the traditional function of financial institutions, particularly banks, as a monetary intermediation.167 From purely monetary point of view, “banks provide the economy with the numerical instrument necessary to carry out its various transactions. Nominal money is, first of all, a unit of account, whose function is to make real output homogeneous by providing it with purely numerical expression.”168 In this respect, banks monetize current output by issuing the numerical units. Since numerical instrument, nominal money, have no intrinsic value, bank can freely issue any amount of nominal money required by the economy. However, as banks (and financial institutions) moved their activity outside their traditional role and involve in various schemes, e.g., off-balance sheet,169 they gained ability to create “capital,” “assets,” and “wealth”170 to the extent that numerical
167
According to Cencini, “Monetary intermediation consists in supplying the economy with numerical instrument (the ticket) by means of which goods can be (economically) counted.” See Alvaro Cencini, Monetary Theory: National and International, Routledge, 1995, pp. 21. In nutshell, banks “play the role both of supplying the economy with the numerical vehicle required for the measurement and the circulation of current output, and of fostering its (economic) consumption through the loan of the deposited income.” (Ibid). 168 Ibid. 169 Off balance sheet (OBS) activities “include issuing various types of guarantees (such as letter of credit), which often have a strong insurance underwriting element, and making future commitments to lend. Both services generate additional fee income for banks. Off-balance sheet activities also involve engaging in derivative transaction – future, forward, options and swaps. Under current accounting standards, such activities are not shown on the current balance sheet. Rather, an item or activity is an off-balance sheet asset if, when a contingent event occurs, the items or activity move onto the asset side of the balance sheet or an income item is realized on the income statement. Conversely, an item or activity is an off-balance sheet liability if, when a contingent event occurs, the item or activity moves onto the liability side of the balance sheet or an expense item is realized on the income statement.” (See Anthony Saunders, Marcia Cornett, 7th edition, Financial Institutions Management: A Risk Management Approach, McGraw-Hill/Irwin, 2010, pp. 32). For more information on off-balance sheet activities see Anthony Saunders, Joshua Ronen and Ashwinpaul C. Sondhi, editing, Off-Balance Sheet Activities, Quorum Books, 1990. 170 Here what we mean by wealth is not what economists like Henry George defined in his book Progress and Poverty, which claimed wealth is produced by labor, but rather what most understand of wealth and quite recently acknowledge by economists like Raghuram G. Rajan, who observed, “the industry’s entire system of values uses money as the measure of all things.” (See Raghuram G. Rajan, 2010, pp. 153).
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instrument (nominal money) mysteries turns into real store of value. This metamorphosis monetization not only refutes the process that identified the bank money (the numerical instrument) with an asset-liability,171 but it is also changes the nature of banking and their practices.172 As Saunders and Cornett observed, there has been a sudden drop of business loans (as a proportion of the balance sheet) since 1990. “This drop has been mirrored by an offsetting rise in holding s of securities and mortgages. These trends reflect a number of long-term and temporary influences. One important long-term influence has been the growth of the commercial paper market, which has become an alternative funding source for major corporations. Another has been the securitization of mortgages – pooling and packaging of mortgage loans for sale in the form of bonds.”173 Curry, Fung, and Harper also confirmed these trends and observed, “The diminishing role of traditional banking is reflected in the increased migration of financial activity off-balance sheet. Loan securitization is an example.”174 Off-balance sheet basically means that money issued (disbursed credits) by banks is not acknowledgement of debt, as it should be.175 Rajan observed, “Securitization allowed bank to get the risky loans off its books.”176 Keeping debt off the balance sheet may sees beneficial to a institution’s position in the financial market, but it also expose financial institution as well as participants in financial markets to highrisky attributes, which can easily spread throughout the economy. Off balance activities also blurred the issue of transfers of financial assets, and consequently entail disclosure requirements that including transparency and accountability amendments.177 Moreover, under the present structure of financial institutions,
171
For a detailed analysis of this subject see Alvaro Cencini, 1994, pp. 11–15. Traditionally, banks “are entrusted with the double function of issuing the vehicular (nominal) money required for the circulation of output, and of lending the income (real money) generated by production and entered by them as a bank deposit.” (see Alvaro Cencini 1994, pp. 3). 173 Anthony Saunders, Marcia Cornett, 2010, pp. 29. 174 Elisa A. Curry, Justin G. Fung and Ian R. Harper, “Multinational banking: historical, empirical and case perspectives” in A.W. Mullineux and Victor Murinde, edited, Handbook of International Banking, Edward Elgar Publishing limited, 2003, pp. 52. 175 Based on accounting principle, money flows back to its point of origin at the very instance it is issued – banks acknowledgement of debt is lent to firms, who transfer it to workers, who earn it as a claim to a bank deposit. Thus, in the process of monetary integration money is simultaneously created, associated with current output and destroyed, in a circular movement that leaves a book-keeping defining the value of currently produced goods and services (See Alvaro Cencini, 1995, pp. 21). 176 Raghuram Rajan, 2010, pp. 2. 177 In fact, Financial Accounting Standard Board (FASB) adopted Financial Accounting Standard No. 166: Accounting for Transfers of Financial Assets in June 2010 to end widespread off-balancesheet treatment of securitized assets, most notably failing loans that were changing hands beyond the view of investors. At the same time, it adopted FAS 167: Amendments to FASB Interpretation No. 46R to give new direction on when a company should consolidate a special purpose entity, or add it to the parent company’s balance sheet. (see http://www.complianceweek.com/fasb-codifiesnew-rules-on-off-balance-sheet-vehicles/article/189488/). 172
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“credit or default exposure is a major risk faced by modern bank managers. Because commercial banks are highly leverage, and therefore hold little equity compared to total assets, even a relatively small amount of loan default can wipe out the equity of a bank leaving it insolvent.”178 Taken into consideration various financial crises of the past decades, either at national or global level, the critics can claim that this observation is accurate description what often had happened. Further reaffirmation of this claim comes from Reinhart and Rogoff, in which they described the 2007–2008 implosion of the US financial system, “came about precisely because many financial firms outside the traditional and regulated banking sector finance their illiquid investment.”179 And yet, the ingenuity of financial institution in providing speculation opportunities is second to none. The inventiveness of financial institutions is their ability to identify, or create, various instruments to broaden participation in various financial markets, and hence increase speculative actions. For instance, call option, or simply call, is one way to leverage one’s investment. Leveraging is any technique that increases the potential yield as well as risk of an investment. These devices facilitate the augmentation of market domains as well as ensure broad participation in the markets. The larger participation in larger markets literally transfers to greater power for financial institutions. However, before we close this section we would like to emphasize on the fact that changing the nature of currency bears much profound consequences. On this note, we only allude to Keynes who observed, “Lenin was certainly right. There is no subtler, no surer means of overturning the existing basis of society than to debauch the currency. The process engages all the hidden forces of economic law on the side of destruction, and does it in a manner which not one man in million is able to diagnose.”180 The next question is this: how financial institutions obtained their power? First, these institutions gained power through usage of technological innovations, which we underlined above. However, another important area where technology has impacted customer services is in banks’ ability to provide cash management or working capital services.181 According to Office of Technology Assessment Report, “Information processing and communication technologies are being used to enhance existing services, to implement new ones, and to make them available in new ways. Money market mutual funds, operated by investment companies and securities broker/dealers, permit shareholders to redeem shares by writing the equivalent of a check. Banks, depending heavily on information processing and communication technologies, are beginning to offer securities through discount brokerage subsidiaries. Banks, credit
178
Anthony Saunders, Marcia Cornett, 2010, pp. 30. Ibid, pp. 145. 180 John Maynard Keynes, The Economic consequences of the peace, Harcourt, Brace and Howe, 1920, pp. 236. 181 For a detailed and comprehensive analysis of this subject see Anthony Saunders, Financial Institutions management: A Modern Perspective, Irwin, 1994, ch.10. 179
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unions, and savings and loan associations join networks of automated teller machines that enable account holders to obtain cash 24 h a day from machines that are available nationwide.”182 Second, according to Saunders and Cornett, the current accounting standard help banks to earn additional income and avoid regulatory costs or “taxes” since reserves requirements and deposit insurance premiums are not levied on off-balance-sheet activities. “Thus, banks have both earnings and regulatory ‘tax-avoidance’ incentive to undertake activities off their balance sheet.”183 Third, through favorable policy e.g., Financial Services Modernization Act of 1999, commercial banks, investment banks, securities firms and insurance companies were able to consolidate, and hence to realigned themselves into what is commonly referred to as financial conglomerates – “groups of financial institutions and firms that offer a wide range of services.” These institutions are characteristically giant and complex organizations operating across the globe. Citigroup, HSBC and the ING-group are just some of the well-known active conglomerates worldwide. Indeed, such consolidation, which commonly taken place among firms engaged in the provision of wholesale financial services, has been the driving force behind the globalization process.184 Fourth, financial institutions influence on policy-makers and policy designs through various means, most importantly, lobbying. The most common manner in which such influence occur is described by Roubini and Mihan, “Many of them [government employees] then move back to the private sector and use their government connections to lobby in favor of looser regulation and more lax supervision of financial firms.”185 Roubini and Mihan further elaborate, “They [government employees] insulate the financial system from regulatory meddling and starve agencies of the taxpayer necessary to implement regulation. In exchange, financial firms funnel massive amounts of money towards candidates – $311 million in 2008 alone.” Perhaps that is why the reforms introduced by President Obama in early 2009 have banned government employees from lobbying activities for 2 years. Along the same line of thinking, Saunders and Walter observed, “bank and other financial institutions are in an excellent position to convert them [financial institutions] into political power… They are often exceedingly well connected politically, and their lobbying power motivated by protectionist drives can be awesome.”186 The chair of the Congressional Oversight Panel for TARP, Elizabeth Warren, explained that banks and their lobbyists are hammering Congress and fighting against the interests of American families by blocking financial reform.187 Recently, Sheila Krumholz,
182
Office of Technology Assessment, 1988, pp. 3. Anthony Saunders, Marcia Cornett, 2010, pp. 32. 184 See Group of Ten, Report on Consolidation in the Financial Sector, Bank for International Settlements, Switzerland, 2001. 185 Nouriel Roubini and Stephen Mihm, Crisis Economics; A Crash Course in the Future of Finance, Penguin Group, 2010. 186 Anthony Saunders, Ingo Walter, Universal Banking in the United States: What could we gain? What could we lose? Oxford University Press, 1993, pp. 21. 187 See http://www.huffingtonpost.com/2010/02/20/elizabeth-warren-its-bank_n_469939.html. 183
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Executive Director of Center for Responsive Politics, said, “Even though some financial, insurance and real estate interests pulled back last year [2009] they still managed to spend more than $450 million as a sector to lobby policymakers. That can buy a lot of influence, and it’s a fraction of what the financial sector is reaping in return through the government’s bailout program.”188 Simon and Kwak also observed, “As of October 2009, 1,537 lobbyists representing financial institution,” which outnumber consumer groups, unions, and other supporters of stronger regulation twenty-five to one.189 To this figure, Kevin Conner also add, “243 lobbyists for six big banks and their trade associations used to work in the federal government – 202 in Congress, the rest in the White House, Treasury, or at a relevant federal government agency. That’s equivalent to 40 revolving-door lobbyists per bank.190
188
See http://www.opensecrets.org/news/2009/01/washington-lobbying-grew-to-32.html. Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Knopf Doubleday Publishing, 2010, pp. 192. 190 According to WIKIPEDIA, “The revolving door is the movement of personnel between roles as legislators and regulators and the industries affected by the legislation and regulation and on within lobbying companies. In some cases the roles are performed in sequence but in certain circumstances may be performed at the same time. Political analysts claim that an unhealthy relationship can develop between the private sector and government, based on the granting of reciprocated privileges to the detriment of the nation and can lead to regulatory capture.” As a blatant revealing door activity, one can mention Meredith Attwell Baker, an Obama appointee for Federal Communication Commissioner, who approved the merger of Comcast and NBC Universal, and then left her position a few weeks before the end of her term to become a chief lobbyist for Comcast. Ironically, On 21 January 2009, the day after he took office, US President Barack Obama signed two executive orders and three presidential memoranda (see http://www.whitehouse.gov/ issues/ethics) to help ensure his administration would be a more open, transparent, and accountable government. These documents attempt to rein in the influence of lobbyists, bring increased accountability to federal spending, and limit influence of special interests; they include a lobbyist gift ban and a “revolving door” ban. In May 2009, a Recovery Act Lobbying Rules set new limits on special interest influence (see Jesse Lee (29 May 2009). “Update on Recovery Act Lobbying Rules: New Limits on Special Interest Influence”). Accordingly, while Federal law says Baker can’t lobby the FCC for 2 years. But lobbying Congress is OK – and that’s what she’ll do. Arguments against these type of activities are abundant, “People should be outraged about this kind of blatant revolving-door activity, where one day you’re supposed to be a public servant, and the next day you simply go to work advocating for these big companies,” says Craig Aaron, president of the media advocacy group Free Press. However, the counter arguments are usually are made by insiders like Thomas Susman, head lobbyist for the American Bar Association and a longtime student of ethics-in-government issues, who claims in an interview with NPR, “I don’t like the results of saying you can’t do it,” he says. “And so, therefore, I suspect I’m willing to live with public perception, you know, of cronyism, and the occasional situation where it actually proves detrimental to the public good.” (See http://www.npr.org/2011/05/12/136250400/for-government-employees-revolving-door-continues?sc=emaf). It should be noted that a law in the penal code of France governing public officials who move between the public and private sectors requires a 3-year wait between working in the government and taking a job in the private sector, while in Japan, the institutionalized practice of placing government bureaucrats into senior positions of industries they once regulated, known as Amakudari, has increasingly been recognized for its corrupting influence on government. In April 2007, a law to phase out Amakudari will prohibit ministries from attempting to place bureaucrats in industry in 2009. However, the law also removed a 2-year ban that prevented retiring officials from taking jobs with companies they had official dealings with during the 5 years prior to retirement. 189
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This includes 33 chiefs of staff, 54 staffers to the House Financial Services Committee and Senate Banking Committee (or a current member of that committee) and 28 legislative directors. Senate Banking Committee chair Christopher Dodd (D-CT) leads all current members of Congress, with five former staffers now working as big bank lobbyists. Banking Committee ranking member Richard Shelby (R-AL) and members Chuck Schumer (D-NY) and Tim Johnson (D-SD) each have four. Many of the revolving-door lobbyists were key architects of financial deregulatory legislation during their time as congressional staffers, including the Financial Services Modernization (Gramm-Leach-Bliley) Act of 1999 and the Commodity Futures Modernization Act.”191 As the result of the financial power politics various policies as well as institutional changes ensued. As Rajan suggests, “Deregulation has removed artificial barriers preventing entry, or competition between products, institutions, market, and jurisdiction.”192 He also points to “The process of institutional change has created new entities within the financial sector such as private equity firms and hedge funds, as well as new political, legal, and regulatory arrangements.” These changes also are widely spread in the globalized economic system, particularly among G20 countries. Today, policy formulations in Washington, London, or any other capitals of developed economy, are formulated by particular interests and led by thousands of lobbyists. This army does not simply reflect a swollen bureaucracy, but also represents the fundamental confusion that has intervened in the decision-making process of the modern liberal economies. This confusion, first and most, caused by disappearing between private and common interests in a sense that we have no common interest, but rather a collection of fragmented private interests that guides our societal desires and goals. Second, the important of information confirmed the aphorism of “information is power,” for power lies in the global system in the mastery of information. As part of global meritocracy, professionals and lobbyists mobilized all the information necessary for the interest they represent and to present the point of view that they employed to defend.193 Today, there are abundant instances that confirmed this observation. For example, the US Monitor Group, a consulting firm founded by a Harvard Business School, had been paid by the Libyan government millions of dollars a year to support the public image of Libya and had used very
191
See Kevin Connor, Big Bank Takeover: How Too-Big-To-Fail’s Army of Lobbyists Has Captured Washington, Institute for America’s Future, 2010, pp. 1–2. 192 Raghuram G. Rajan, “Has financial development made the world riskier?” Proceeding, August 2005, pp. 313. 193 We would like to underline an important point here. The power of information in today world is mainly related to abounded of information and easy access to various sources of information. These, in turn, make us more prone to appearances, an expression, of one’s formulated view of the world. In the information age, one with almost no effort can in flight or desire, approve or disapprove, accept or refute, blame or praise, what is not exist but appear to him/her because it meant for his/her perception. In this world, as Hannah Arendt observed, “Being and Appearing coincide.”
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prominent individuals and professors to do this.194 The problem is, these individuals didn’t disclose their payments by the Libyan government because they knew such revelation simply discredit their works to polish the image of Mr. colonel. Another telling case is related to Frederic Mishkin. A Columbia University economist and former Fed Governor from 2006 to 2008, Mishkin was hired by the Iceland Chamber of Commerce to examine the Iceland financial institutions, including banking system, in which he and his co-author concluded: “Financial fragility is currently not a problem, and the likelihood of a financial meltdown is low.” Soon after, Iceland financial meltdown occurred. Indeed, during the financial crisis, only one Western country experienced a true collapse of its banking system: Iceland. Things got so bad that the country actually ran out of foreign currency. Even today, years later, foreign money is still scarce, and the government controls how much anyone can get. While, a wrong conclusion is almost normality in research of this sort, in the Mishkin case, the point is “he was hired to be wrong.” It must be obvious that the practice of “information for sale” striped a policymaking process from ideas and ideologies and confined such process into what stock exchange is to shareholders. Just as stock exchange, in which price is increasingly dependent on the opinion of “institutional” investor, who based their judgment on information related to a professional analysis of company balance sheet, so are policy-makers increasingly dependent and seek analytical information, to formulate and legitimize their decisions.195 Finally, these institutions retain power due to increase size of their market share. Indeed, the size of financial sector (including banking and insurance) as a percentage of GDP is more than double by 2007 (relative to 1970s).196 According to European Central Bank, “The prospects for the financial sector are good. Its growth
194
The individuals who were engaged in the Monitor project included Francis Fukuyama, author of The End of History; Richard Perle, a prominent neocon who advised President George W Bush in the buildup to the Iraq invasion; and American academics such as Benjamin Barber, Joseph Nye and Robert Putnam (see Ed Pilkington, “US firm Monitor Group admits mistake over $3 m Gaddafi deal,” The Guardian, (Friday 4, March 2011). The article can be accessed at http://www.guardian. co.uk/world/2011/mar/04/monitor-group-us-libya-gaddafi). 195 While, the lobbying process is correctly considered as an extension of the right to be heard and an exercise in democracy, it can also presents fatal error in comprehending what policy should be selected, how policy should be designed to address issue (or issues) in hand. As for knowing what should be done, this mode of exercise of democracy encourages simplistic oppositions. “On any given problem, there is a dominant position in relation to which one defines oneself by taking a stand for or against. Nuances and qualifications, the not exactly and the more or less correct are discredited, because they have no didactic weight. This reveals the handiwork of the lobbyist and the professionalization of information. The enrichment that lobbying affords complicates the process before fact, and simplifies it after the fact.” (see Guehenno, 2000, pp. 28). It is noteworthy that the main criticism often leveled at the global system is lack of consideration for common interest. In lobbyist circles, the public remains unrepresented, and hence its interests disregarded in design and formulation of policy, both at national and global level. 196 Thomas Philippon, “Why Has the U.S. Financial Sector Grown So Much? The Role of Corporate Finance,” NBER Working Paper 13405, National Bureau of Economic research, Cambridge, Mass, September 2007.
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rates are expected to be above GDP growth. That means the financial sector will become even more relevant for economic performance: its share in global GDP could grow from 6 to 10% in 2020. Moreover, as early as 2010 the global financial stock is expected to exceed the $200 trillion mark, compared with around $118 trillion at present.”197 Kolko claimed, “of the world’s top 200 corporation, 82 are classified as service companies. They are primarily banks and trading companies. 41% of them headquartered in Japan and 33% in the United States.”198 According to Reinhart and Rogoff, “The top employees of the five largest investment banks divided a bonus pool of over $36 billion in 2007.”199 Most financial services workers in the USA, about 50,000 people that are concentrated in New York, New Jersey, and Connecticut, make more than $200,000, said Alan Johnson, president and founder of compensation consultant Johnson Associates Inc. in New York.200 Saunders and Cornnett found that the value of total assets of ten largest financial service firms exceeds $8 trillion in 2000.201 According to Global Finance this value reached near $21 trillion in 2010.202 Indeed, to describe and explain these astronomical figures we have a new word in the global financial repertoire, known as Financialization.203 These developments provided ample means for financial institutions to strengthen their economic position as well as their grip over the global economic system. However, they also made the world less safer and altering the nature of common transaction in the financial sectors around the globe and allowing broader participation and much deeper financial markets, both of which added to more widely spread of risk throughout the globalized economic system. And yet, political circles around the globe as well as international organization continued their support for the prevailed financial system. In 2004, US Federal Reserve Chairman Alan Greenspan argued, “Not only have individual financial institutions becomes less vulnerable to
197
Speech by Gertrude Tumpel-Gugerell, Member of the Executive Board of the ECB, Liechtenstein, 28 October 2005. The entire speech is available at: http://www.ecb.int/press/key/date/2005/html/ sp051028_1.en.html. 198 Joyce Kolko, Restructuring the World Economy, Pantheon Books, 1988, pp. 96. 199 Carmen M. Reinhart and Kenneth S. Rogoff, This Time is Different: Eight Centuries of Financial Folly, Princeton University Press, 2009, pp. 210. 200 See http://www.bloomberg.com/apps/news?pid=20601109&sid=aB3HPM8qfcVc&pos=10&o m_rid=CfA9cS&om_mid=_BLq1LFB8GnQH8n&. 201 Saunders and Cornnett, pp. 557, Table 21.1. 202 http://www.gfmag.com/tools/best-banks/10619-worlds-50-biggest-banks.html#axzz1EBgPATOf. 203 Financialization may be defined as: “the increasing dominance of the finance industry in the sum total of economic activity, of financial controllers in the management of corporations, of financial assets among total assets, of marketised securities and particularly equities among financial assets, of the stock market as a market for corporate control in determining corporate strategies, and of fluctuations in the stock market as a determinant of business cycles” (see Collected Writings of Ronald Dore, copublished by Japan Library and Edition Synapse, 2002, pp. 182–3).
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shocks from underlying risk factors, but also the financial system as a whole has become more resilient.”204 In 2007, the IMF annual report, World Economic Outlook, claimed, “The balance of risks to the baseline growth outlook is clearly on the downside. While the underlying fundamentals supporting growth are sound and the strong momentum in increasingly important emerging market economies is intact, downside risks emanating from the financial markets and domestic demand in the United States and Western Europe have increased.”205 However, soon after the IMF report that reveals the bright future ahead, the whole world came to abrupt realization that the emperor has no clothes. It is certainly unconvincing to argue that both views are the result of unshaken faith in a market economic system philosophy or technical error by the Fund staffs. For years, the regulators of the global money supply ignored the advice of many including their top experts like former chief economist for the Bank for International Settlements (BIS) William White, probably because it would require them to do something unorthodox, namely embark on a fundamental change in direction. It is also hard to subscribe to views that leave the reader with more questions than answers. For instance, the “this time is different” syndrome rational put forward to Reinhart and Rogoff while provided an extremely rich quantitative analysis with immense pool of data, argues that any well-informed person, including policy makers and politicians, should have seen the 2008 crisis. The essence of the book is that while financial crises come in different varieties, they are not born of mysterious events, but frequently occurring events that can be spotted and even controlled if politicians and regulators look carefully at the signs (or know what to look for). This conclusion begs further questions like; why policy-makers and politicians didn’t consider the signs that lead to crises especially since according to the authors financial crises have been around for few centuries. It seems that people almost pride themselves on not paying attention to current events. Another question is; if policy makers and politicians don’t know what to look for, why are they holding such positions of power. The syndrome rational does not offer an answer. However, one plausible answer is that there is so much inbreeding within the global political circle and policy-making elites in a sense that they all have the same information sources, and hence they all use the same data sets, consider the same opinions and briefed by the same people, which eventually lead them to the same conclusion.206
204
See http://www.federalreserve.gov/boarddocs/speeches/2004/20041005/default.htm. For more information on Greenspan see http://www.nytimes.com/2008/10/09/business/economy/ 09greenspan.html?pagewanted=all. 205 World Economic Outlook: Globalization and Inequality, IMF, October 2007, pp. xv. 206 Based on this observation, then a joke perhaps can explain the failure to detect various financial crisis. A drunk on his way home from a bar one night realizes that he has dropped his keys. He gets down on his hands and knees and starts groping around beneath a lamppost. A policeman asks what he’s doing. “I lost my keys in the park,” says the drunk. “Then why are you looking for them under the lamppost?” asks the puzzled cop. “Because,” says the drunk, “that’s where the light is.”
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“There is endless extrapolation on extrapolation on extrapolation, and for years that is what has been rewarded” said Ms. Reinhart in an interview.207 This book, however, offers a different view. We argue that the prevailing predicament faced by the global economic system is a result of several factors, all of which contributed to the present condition. First, the prevailing global financial system truly created peculiar conditions, in which not only increase instability of the system as a whole but also provide a magical power to financial institutions. Here, we are not talking about instability of financial system, which is measurable by the conventional approach, e.g., stress test, or perceived as financial imbalances and asset price booms that persist for some time in a financially liberalized regime (with low inflation and interest rates), before reversing abruptly in a manner that generates not only a risk of banking problems but also marked economic weakness.208 Our view of instability of a system is based on common sense that implies quality or state of being erratic and bears attributes like lack of control or steadiness, indecisiveness in intent or purpose, etc. In this sense, we viewed the global financial system instable. Perhaps an example may clarify out notion. In December of 1996, Alan Greenspan, was invited to speak at the American Enterprise Institute gathering hold in the Washington Hilton Hotel. His speech entitled “The Challenge of Central Banking in a Democratic Society,” in which he posed
207
See www.nytimes.com/2010/07/04/business/economy/04econ.html. There is a rich literature on financial instability both from theoretical discussion and practical studies. In the following we used some excerpts from an 2005 article by Davis, E. Philip (from Brunel University and National Institute of Economic and Social Research) called “Financial instability – research, assessment and policy issues” Franklin Allen’s “Modelling Financial Instability” focuses mainly on asset price bubbles and their genesis in terms of credit expansion in the presence of agency problems of financial intermediation. A close link of such episodes to financial deregulation is highlighted. When bubbles burst, they can generate instability via banking panics, the business cycle or both together. In terms of empirical studies, Asli Demirguc-Kunt (World Bank) and Enrica Detragiache (IMF), wrote an article called “Cross-country empirical studies of systemic bank distress; a survey,” in which they present updated results of their original 1998 work on empirical determination of banking crises using a multivariate logit model and show broad consistency of their results, despite a much wider range of crises in the sample. The authors note that the “signals” methods has been widely used in early warning systems, while probability models have been the basis of a widening of understanding of the causes of crises to include aspects such as financial liberalization, bank ownership and deposit insurance. Finally, Claudio Borio from Bank of International Settlement (BIS) makes a transition from empirical work to analysis and assessment in “Monetary and financial stability: so close and yet so far?” He starts from the paradox that despite the achievement of monetary stability in the past 20 years financial stability has increased. Instability has typically been linked to financial imbalances and asset price booms that persist for some time in a financially liberalized regime with low inflation and interest rates, before reversing abruptly in a manner that generates not only a risk of banking problems but also marked economic weakness. In this context, he shows that a signals/indicator approach based on gaps between credit and asset prices and their longer-term trends can indeed provide an early warning of financial instability in a majority of cases, as well as having predictive power over inflation and the output gap. Claudio maintains that simultaneous achievement of monetary and financial stability will require a more macro-prudential focus of regulatory policy, as well as willingness of monetary policy makers to lean against developing imbalances. 208
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a rhetorical question: “But how do we know when irrational exuberance has unduly escalated asset values, which then become subject to unexpected and prolonged contractions as they have in Japan over the past decade?”209 He added that “We as central bankers need not be concerned if a collapsing financial asset bubble does not threaten to impair the real economy, its production, jobs and price stability.” Short after, according to Shiller, stock markets around the globe went into anxiety mood. In Japan, which was open as he gave this speech, “the Nikkei index dropped 3.2%; in Hong Kong, the Hang Seng dropped 2.9%; and in Germany, the DAX dropped 4%. In London, the FT-SE 100 was down 4% at one point during the day, and in the United Sates, the next morning. The Dow Jones Industrial Average was down 2.3% near the beginning of trading.”210 It has been said that the striking reaction of the markets all over the world was in respond to Greenspan’s question, which he casually posed in the middle of a black-tie dinner gathering. An argument can be formed to explain these reactions, which points to tendency that markets act in accordance with Greenspan’s sentiment because he is one of the major global policy-makers who hinted at “collapsing financial asset bubble.” If this observation is valid, then obedience to the opinions of policy makers means to uphold the authority of those who make decisions about what the market should be, and how it should operates. To uphold this authority also is to aid in maintaining aspect of the distribution of power to make decision for free market system. In this respect, however, the free enterprise system seizes to exist! However, assuming that the global economic system is based on the free enterprise economic model, we linked these erratic reactions to public perception of financial markets around the globe. Any institution that reacts simultaneously to a rhetorical statement or a hypothetical question clearly suffers from lack of balance that either caused by widely hold expectation that the system is extremely vulnerable, and hence inclined to fail, or the mindset of participants is unsure of the present success. Either case reminded us of the idiom, “easy come and easy go,” which implies that money or other material gains that come without much effort tend to vanish as easily. Second, the prevailing global trend created condition in which financial institutions are able to create wealth as easily as emission of paper money. For instance, derivative instruments are so called because they drive their value as a financial instrument from something outside the instrument itself.211 These instruments have
209
Italic is not in the original text. Robert J. Shiller, 2 edition, Irrational Exuberance, Crown Business, 2006, pp. 1. 211 For example, “a call option to purchase an exchange-trade stock would qualify as a derivative instrument. The value of the call option can only be determined by the market price of the related stock. For example, a call option allows the holder to purchase 1,000 shares of stock as $50 per share, but no determination can be made as to the value of the call option until the stock price is determine.” (see O. Ray, CPA, PhD Whittington and Patrick R., CPA, PhD Delaney, Wiley CPA Exam Review 2008: Financial Accounting and Reporting, Wiley, John and Sons, 2007, pp. 693). If the market value of the stock is determined around, let say, $58 per share, the holder of stocks make $8 per share out of thin air. Of course, the opposite is also valid, however, the point is that possibility of profit out of nothing is truly brilliant and economically destructive. 210
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no intrinsic values unless they are hedged to something of value. In short, they call derivatives because their values are drive from something else. Financial institutions are also allowed to conceal various transactions from their balance sheet, and hence defy one of the main principles of bookkeeping. However, the excitement of creating wealth out of tin air overwhelmed these institutions to the extent that they “tumble out of a window in a moment of irrational exuberance.”212 Third, despite mounting evidence that global financial system is exposed to extreme uncertain speculations213 and things were going wrong, all major financial institutions clung to the notion that “things would be just fine.”214 This is partly due to the fact that their interests lied in that outcome. As Rajan observed, “The problem was not that no one warned about the danger; it was that those who benefited from an over heated economy – which included a lot of people – had little incentive to listen.”215 More importantly, however, as a result of past several decades of financial crises in various countries financial institutions gained valuable lesson, that is, a financial meltdown almost invariably leads to sharp declines in tax revenues, and hence real government debt rises. To remedy this situation the natural impulse of government,
212
Amanda Cross, A Trap for Fools, Trafalgar Square, 1993, pp. 137. Generally, the name given to financial uncertainty is risk. Moreover, “Economists differentiate gambling and speculation on the ground that gambling involves the deliberate creation of new risk for the sake of diversion while speculation involves the assumption of the inevitable risks of the capitalist process. In other word, when a gambler places a bet on a horse he is creating a risk, while the speculator who buys a share is simply involved in the transfer of an existing risk.” (See Edward Chancellor, Devil Take the Hindmost: A History of Financial Speculations, Plume, 2000, pp. xii–xiii). 214 In addition to historical cases, there are many scholars, academicians and economists who confirmed this conclusion. First among them is Raghuram Rajan of the University of Chicago, whose book “Fault Lines” argues that rising inequality led governments to facilitate credit growth, contributing to the crisis. Robert Shiller of Yale University has long warned of the dangers of irrational exuberance, and urges colleagues to consider “animal spirits” in assessing economic fluctuations. Kenneth Rogoff’s work on debt bubbles with Carmen Reinhart placed the crisis in an 800-year continuum of borrowing and collapse: his papers have earned the most academic citations of the table-toppers in our poll. Edward Chaceller book on history of financial speculation is thought provoking and educational. Barry Eichengreen has written excellent works on the history of the gold standard and the danger of fixed-exchange-rate regimes. Nouriel Roubini earned the nickname “Dr Doom” for warning of an impending global crash. Finally Mark Gertler and Ben Bernanke presented a theoretical model detailing how imperfection in the financial market (due to asymmetric information between lenders and borrower can result in an exaggeration of economic downturns (see Ben Bernanke and Mark Gertler, 2000. “Monetary Policy and Asset Price Volatility,” NBER Working Papers no. 7559). In their model, a decrease in wealth (as a result of adverse productivity shock) forced firms to scale back their investment plan. Firms are forced to scale back on investment because, as their retained earnings fall, they must finance a large share of their investment via more expensive external financing rather than by means of relatively inexpensive internal financing. “Recession cause a loss in collateral that is then amplified through the financial system.” (see Reinhart and Rogoff, 2009, pp. 146)). 215 Raghuram G. Rajan, 2010, pp. 1. 213
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when face a financial crisis, is to bailout trouble institutions. Indeed, the bailing out approach has been a common practiced policy in face of financial crises since the banking crisis of 1977 in Spain.216 Therefore, financial institutions around the globe were give concrete assurance that no matter how they structure their asset portfolios and/or how risky their conducts may be, they and their interests will be protected. Without a doubt, governmental pledge not only encourages financial institutions to engage in more speculative behavior but also renders an excellent incentive for these institutions to evade consequences and responsibilities for their actions. Economists described this situation as moral hazard.217 Perhaps, that is why after each crisis, the financial markets invariably shrug off past follies and losses to confront the future with bright optimism and fresh credulity to the extent that rational markets descent into dementia. Finally, submissiveness of politicians as well as policy-makers, especially among G20 economies, towards financial institutions illustrated what it means when a government as an institution failed. John B. Taylor, former US undersecretary of treasury for foreign affairs, hinted that the crisis was partly due to the government permissiveness and ad hoc support for credit providers.218 For one thing, the laws governing markets are framed and enforced by states, and hence states failure to framed and enforced laws that tamed deviant behaviors, e.g., speculations, in markets is usually due to politicians endorsement of the status quo – taken action is particularly difficult if there is no intend to change the status quo.219 In this regard, Chancellor observed, “On numerous occasions we find politicians stimulating speculation mania for their own gain.”220 Alfred Marshall reaffirmed this sentiment when he wrote, “Public opinion and private morality have driven home the maxim that if
216
Reinhart and Rogoff, 2009, table 10.9, pp. 164. Economist Mark Zandi of Moody’s Analytics described moral hazard as a root cause of the subprime mortgage crisis. He wrote: “… the risks inherent in mortgage lending became so widely dispersed that no one was forced to worry about the quality of any single loan. As shaky mortgages were combined, diluting any problems into a larger pool, the incentive for responsibility was undermined. At every point in the financial system, there was a belief that someone – someone else – would catch mistakes and preserve the integrity of the process. The mortgage lender counted on the wall Street investment bankers, who counted on the regulator or the rating analyst, who assumed global investor were doing their own due diligence. As the process went badly awry, everybody assumed someone else was in control. No one was.” (see Mark Zandi, Financial Shock. FT Press, 2009, pp. 2–3). He also wrote: “Finance companies weren’t subject to the same regulatory oversight as banks. Taxpayers weren’t on the hook if they went belly up [pre-crisis], only their shareholders and other creditors were. Finance companies thus had little to discourage them from growing as aggressively as possible, even if that meant lowering or winking at traditional lending standards.” (See 218 John B. Taylor, Getting Off Track: How Government Actions and Intervention Caused, Prolong, and Worsened the Financial Crisis, Hoover Institute Press, 2009. 219 As an example of such status quo one can underlined the widespread and sustained surge of capital flows, in which ING-Barings called it the financial silk road (see The Financial Silk Road: A Fifth Wave of Global Money: Cross Border Equity Flows, ING-Barings, New York, 1995, vol. 1). 220 Edward Chancellor, 2000, pp. xiv. 217
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a statesman bases stock exchange speculation on his policy, he will soon base his policy on his speculation.”221 This take us to another but related predicament in which policy-makers commonly mixed the private sector’s objectives with the government’s objectives, and hence all too often policies were formulated and designed without taking the private-government distinction into account. Of course, taken into consideration such distinction does not implies that policy-makers favor one group over the other but rather it intends to clarify the policy objective underlined what issue needs to be address first.222 The affects that these factors have on financial institution have magnified their inclinations and behaviors to the extent that Greenspan’s notion of irrational exuberance is perfectly plausible outcome given the circumstances. According to Shiller, irrational exuberance “is the psychological basis of a speculative bubble.”223 If we start from here, then one can easily observed that financial institutions’ operation and conduct, especially in the prevailing environment, are so divorce from the prescribed textbook scenario that described financial markets are efficient in a sense that share prices reflect intrinsic values, and that speculators are simply rational agent intent on optimizing their wealth. In the world of efficient market, as Chancellor explained, “there are no animal spirit, no crowd instinct, no emotions of greed or fear, no trend-following speculators, and no ‘irrational’ speculative bubbles.”224
221
Cited by Edward Chancellor, 2000, pp. xiv. Robert Reich, the former secretary of labor under President Clinton first term, underlined this point elegantly when he stated, “What is truly remarkable is what Congress and the administration have shown no interest in doing. Large number of American have lost their homes to bank foreclosure or are in danger of doing so. Yet American bankruptcy law does not allow homeowners to declare bankruptcy and have their mortgages reorganized. If it did, homeowners would have more bargaining power to renegotiate with banks. But neither Congress nor the administration has pushed to change the bankruptcy laws. Wall Street opposes such change and was instrumental in narrowing the scope of personal bankruptcy in the first place.” (see Robert Reich, “Why Obama must take on Wall Street,” Financial Times, January 12, 2010). In respond, one may claimed that banks hold the heart bit of the economy (“too big to fail” rational) and therefore to help people, we need to help bank. However, such argument is weak on several fronts. First, banks should not hold such significant position since their function is clearly defined in economic theory as monetary intermediaries. Second, assuming banks are too big to be failed, the bailout policy is misguided and does not address the more important issues. For instance, in addressing the recent controversies of improper foreclosures during a speech last November, Fed governor Sarah Bloom Raskin said procedural flaws like robo-signing and other efforts that cut corners are “part of a deeper, systemic problem.” She added that she was “gravely concerned.” The complex challenges faced by the loan servicing industry right now are emblematic of the problems that emerge in any industry when incentives are fundamentally misaligned, and when the race for short-term profit overwhelms sustainable, long-term goals and practices,” Raskin said. “I believe that serious and sustained reform is needed to address the larger problems in mortgage servicing.” (see http://www.huffingtonpost.com/2011/02/16/occ-settlement-foreclosure-investigation_n_824357.html). Finally, As Axel A. Weber, an European Central Bank (E.C.B) policy maker and the head of Germany’s Bundesbank, observed, “if financial institution appears too big to fail, they are two big to exist.” 223 Robert J. Shiller, 2 edition, Irrational Exuberance, Crown Business, 2006, pp. 2. 224 Ibid., pp. xiii. 222
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Conversely, it has been known for sometimes know that financial market operates on the basis of crowd psychology rather than textbook rationality.225 This observation does not refute the notion of efficiency, however, it applies the concept in the different domain, namely speculator behavior. As Pepper and Oliver explained, “Speculators are remarkably efficient at detecting the game in town’ making money. When monetary forces are powerful, ‘following the trend’ (buying when the market is rising or selling when the market is falling) is profitable. People join in, and the heard instinct prevails. A crown forms, and patterns in chart follow.”226 The significant of crowd psychology is related to the fact that people in a crowd act differently from the way they would act if they were alone. The behavior of a crowd is different from the sum of the behavior of individuals if they are acting in isolation, as described by textbook scenario.227
225
According to Edward Glaeser, “Over the past two decades, predictions that came from the convenient assumptions of powerfully rational cognition and simple preferences have been challenged by an increasingly large number of facts. The unifying thread of much of behavioral economics is situationalism – the idea that decisions are made based on very local influences, not long-run wellbeing (Ross and Nisbett, 1991). Prospect theory (Kahneman and Tversky, 1979) tells us that people put enormous weight even when those reference points are quite arbitrary and ephemeral. Mental accounting (Thaler, 1985) tells us that people often make decisions ignoring events and consequences outside of a particular narrow domain. Hyperbolic discounters place an exceptional weight on the present and cue theory emphasizes ephemeral situational forces. People display negative altruism in ultimatum games based on a modest, situational cue.” (see Edward L. Glaeser, “Psychology and the Market,” NBER Working Paper 10203, 2003, pp. 2). Situationalism also includes two other theories, namely, property theory and loss aversion. As Genesove and Mayer observed, “Prospect theory argues, in part, that individuals make financial decisions relative to some reference point, suggesting that otherwise identical persons might act differently based on the price they paid for an asset. To explain loss aversion, also known as the disposition effect, prospect theory suggests that an individual’s value function is concave in gains but convex in losses, and much more sensitive to losses than to equivalent-sized gains.” (see David Genesove and Christopher Mayer, “Loss Aversion and Seller Behavior: Evidence From The Housing Market,” NBER Working paper 8143, 2001.). Interestingly, in the same paper, Genesove and Mayer argued that “loss aversion helps explain seller behavior in the residential real estate market. When house prices fall after a boom, as in Boston, many units have a market value below what the current owner paid for them. Owners who are averse to losses will have an incentive to attenuate that loss by deciding upon a reservation price that exceeds the level they would set in the absence of a loss, and so set a higher asking price, spend a longer time on the market and receive a higher transaction price upon a sale” (see Ibid.). 226 Gordon Pepper and Michael Oliver, The Liquidity Theory of Asset Prices, John Wiley and Sons, 2006, pp. 6. 227 Conventional economic analysis based on individuals acting in isolation, away from all possible interferences that may occurs in a human community and life, and hence individuals acting rationally – the utility function is optimized given perceived opportunities. Following this perception, the textbook necdote perceived that total market behavior is no more than the sum of decision by rational individuals. In this respect, “the market behaves as a coherent whole. It develops a life of its own.” (See Gordon Pepper and Michael Oliver, 2006, pp. 82).
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Indeed, in the world operates according to crowd behavior, like financial world, expectations are form as a result of a crowd mindset.228 In this kind of world, according to Burton Malkiel, “there is a sucker born every minute – and he exist to buy your investment at a higher price than you paid for. Any price will do as long as others may be willing to pay more. There is no reason, only mass psychology… It is perfectly all right to pay three times what something is worth as long as later on you can find some innocent to pay five times what it’s worth.”229 The Malkeil simple but clear explanation provides excellent description of the impact of crowd psychology as well as a sufficient account as to why rising prices can lead to expectation of further rises and vies versa, falling prices lead to expectation of further falls. Keynes also described the optimal strategy to select stocks for future earning prospect by emphasizing on crow psychology – the smart speculator/investor never chose stocks based on personal preferences but rather fancy those that are likely to be value by others.230
228
For skeptical readers we suggest a friendly chat with those individuals involved in past ponzi schemes, and in particular the Bernie Madoff ponzi scheme, like Senator Frank Lautenberg, owners of the NY Mets and the Philadelphia Eagles, real-estate magnate Mortimer Zuckerman and the foundation of Nobel laureate Elie Wiese, and Steven Spielberg’s charities. More importantly, according to Financial Times, HSBC, one of the ten largest global bank “has emerged as one the largest victims of Bernard Madoff’s alleged fraud with potential exposure of about $1bn to the investment manager’s collapsed venture…HSBC’s exposure stemmed from loans it provided to institutional clients, mainly hedge funds of funds, that wanted to invest with Mr Madoff. HSBC’s direct exposure is believed to be about $1bn in loans provided to clients who invested some $500 m of their own funds in Mr Madoff’s venture. Under the typical terms of these deals, if the US authorities recover any funds from Mr Madoff, HSBC will be paid first, with its clients suffering the first tranche of losses.” 229 Burton G. Malkiel, A Random Walk Down Wall Street, W. W. Norton, 1996, pp. 32. 230 According to Malkeil, “Keynes described the playing of the stock market in terms readily understandable for his fellow Englishmen; It is analogous to entering a newspaper beauty-judging contest in which you have to select the six prettiest faces out of a hundred photographs, with the prize going to the person whose selections most nearly conform to those of the group as a whole. The smart player recognizes that personal criteria of beuty are irrelevant in determining the contest winner. A better strategy is to select those faces the other players are likely to fancy. This logic tends to snowball. After all, the other participants are likely to play the game with at least as keen a perception. Thus, the optimal strategy is not to pick those faces the player thinks are prettiest, or those the other players are likely to fancy, but rather to predict what the average opinion is likely to be about what the average opinion will be” Ibid, pp, 31. Italic is not in original text. The reader should note that in the domain of pure theoretical economics such as the game theory paradigm the outcome can be different. For instance, in so called Expectation equilibrium, which introduced first by 1994 Nobel Prize winner John C. Harsanyi suggests, “When everyone’s playing his or her best move conditional on expectations of everyone else’s best move, then no-one’s going to want to move. This idea builds on the forgoing idea of thinking forward and reasoning backward, but now makes it conditional – not on the assumption of perfect rationality on the part of all players – but on one’s perceptions of what the other player is likely to do. One way to think about this is by considering what a famous nineteenth century German General, Baron Von Cluasewitz, called the “Fog of Battle.” To read more on this topic see Philippe Jehiel, “Analogy-based expectation equilibrium,” Journal of Economic Theory, vol. 123, 2005, pp. 81–104.
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The crowd behavior influence on financial markets has been observed since the first financial crisis occurred in 1593, known as the tulip-bulb craze.231 The wild speculation of 1593 triggered by nonfatal virus (called mosaic) infected tulip bulbs. The infected tulips petals had developed contrasting colored strips in which valued by people, and hence become subject to speculation attack – the more valuable (expensive) the bulbs become, the more people viewed them as subject of speculation. As a result, bulbs prices reached astronomical level to the extent that “The riches of Europe would be concentrated on the shore of the Zuyder Zee, and poverty banished from the favoured clime of Holland. Nobles, citizens, farmers, mechanics, seamen, footmen, maid-servants, even chimney sweeps and old clothes-women dabbled in tulips. People of all grades convert their property into cash, and invest it in flowers.”232 However, like all financial exuberance proceeds it, the market crashed in 1637, bankrupting many and the era came to be known as “Tulipmania” or “Tulipomania.” Perhaps, to sum up the issue of speculation, we can learn from one of the greatest American writer, Mark Twain, who advised us, “October. This is one of the peculiar dangerous months to speculate in stocks in. The other are July, January, September, April, November, May, March, June, December, and February. – pudd’nhead Wilson calendar.”233
231
In reviewing the literature on the topic, we have found the rich tradition that goes back as far as 1841. Charles Mackay the author of Extraordinary Popular Delusion and Madness of Crowd (first published in 1841) perhaps provide the first account of crowd psychology when he wrote, “Money, again, has often been a cause of the delusion of multitudes. Sober nations have all at once become desperate gamblers, and risked almost their existence upon the turn of a piece of paper… Men, it has been well said, think in herds; it will be seen that they go mad in heard, while they only recover their senses slowly, and one by one.” (See Charles Mackay, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, FQ Books, 2010, pp. 9). In the Psychology of the Stock Market, written by G.C. Selden and published first in 1912, but could have been published yesterday, Selden begins by observing that “Human impulses lead to speculative disasters.” (see G. C. Selden, Psychology of the Stock Market, Fraser Publishing Co, 1995, pp. 1). In The Money Game, Adam Smith takes a note of Harvard Economists Thomas Schelling, who described the stock market as the greatest gambling enterprise in the United Stated, and respond, “in no sense is the stock market a great gambling enterprise like a lottery. But it is an exercise is mass psychology, in trying to guess better than the crown how the crowd will behave.” (See Adam Smith, 8th edition, The Money Game, Vintage, 1976, pp. 18). These books are far more valuable books today precisely because it was written so long ago. In our opinion, these books would allow the reader to trace the contours of what was taken place in the nineteenth century, first decade of the twentieth century, and see that the same factors still dominate in the twenty-first, it becomes far more readily apparent what is truly vital (in terms of understanding financial institutions) versus what is not. Perhaps this is the main reason why books like these tend to last, while the vast majority of high-powered academic theories get scrapped. 232 Charles Mackay, Memoirs of Extraordinary Popular Delusions and the Madness of Crowds, FQ Books, 2010, pp. 65. This book first published in 1841. 233 Mark Twain, Pudd’nhead Wilson, Chatto and Windus, Piccadilly, London, 1894, pp. 130.
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The important of financial institutions to the global economic system is also significant factor, which highlights their power. Renato Ruggiero said it best when he explained to WTO members, “The global economy is only as strong as the global financial system which underpins it.”234 Gilpin drive to similar notion when he says, that “international finance is a major force in integrating the world economy.”235 However, we think the role of financial sector as the main catalyst for driving the world into a single economic system in more than that in a sense that such system could only be achieved by integrating various national financial systems into one harmonized global financial system that operates and function according to a uniform guideline and standard. In this respect, the global coordinating agencies like IMF and the World Bank can play a vital role in a sense that they can managed the whole integration affairs by speak for the world to the world. Rajan suggests that these agencies “In addition to trying to persuade finance ministers and head of state [to integrate into global financial system] they should go directly to the public, including political parties, nongovernmental organizations, and influential personalities in each country and explain their position. They need to become much more sophisticated about using Web-enable network to reach the connected citizen and find ways to enter school and university class-room, where students can be most receptive to ideas about global citizenship.”236 He further reasoned that action as such are extremely important because “The public has a longer-term horizon that the government in power and typically more idealism and concern for the global good.”237 In this respect, a single standard financial system that operates at global level not only established its’ important, but it also plays a major role in political development around the globe. The ability to excise power by these institutions has eventually created an environment that shapes the global system, or as John Kenneth Galbraith observed, “In Financial Sector we Trust.”238 Since the late 1960s, the world economy has danced more and more frantically to a tune played by the financial sector. Haldane’s chart makes this point somewhat obvious (see Fig. 2.1). This observation has also been confirmed by various sources and reports. However, here we only present two such studies that were prepared by insiders, men that are well connected to the financial world. First, is the report called “Banking on
234
WTO Press release, Address to the to the XII meeting of the common market council at the MERCOSUR Heads of State Summit in Asunción, Paraguay, 19 June, 1997. Renato Ruggiero is the former first director-general (1995–1999) of the World Trade Organization (WTO) in addition to Chairman of Citigroup in Switzerland, Vice Chairman of Citigroup’s European Investment Bank, Chairman of the International Advisory Board of UniCredit, and former Italy’s foreign minister in Silvio Berlusconi’s government. 235 R. Gilpin, The Political Economy of International Relations (1987), p. 206. 236 Raghuram Rajan, 2010, pp. 213–14. 237 Ibid., pp. 214. 238 We made snall modification of the phrase to fit the context. The actual phrase was “In Goldman Sachs we Trust,” see J. K., Galbraith, The Great Crash 1929, Penguin, 1954.
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Fig. 2.1 UK Banking Sector assets as % of GDP
the State” 239 by Andrew Haldane and Piergiorgio Alessandri, which are making waves in policy-makers and academic circles. Haldane, Executive Director for Financial Stability at the Bank of England, is widely regarded as both a technical expert and as someone who can communicate his points effectively to policymakers. According to their report, the boom-bust-bailout cycle is nothing more than a doom scenario in a sense that major financial institutions and banks have an incentive to take excessive risk, since they bailed out is most likely, and hence the conditions for the next crisis are created. The overall conclusion of the report can be summarized as follow: unless and until the political power of major financial institutions and largest banks is broken, the world will continue to struggle (or, rather, we are looping around the same doom). The second study is the book labeled 13 Bankers,240 which is written by former Chief Economist of the International Monetary Fund, Simon Johnson, and former McKinsey & Co. consultant, James Kwak. The book describes the rise of concentrated financial power and the threat it poses to our economic well being. According to the authors, over the past 3 decades, a handful of banks used their power and prestige to reshape the political landscape. By the late 1990s, the conventional wisdom in Washington was that “what was good for Wall Street was good for America.”
239
A. G., Haldane and P. Alessandri P, Banking on the State, London: Bank of England, 2009. Simon Johnson and James Kwak, 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown, Knopf Doubleday Publishing, 2010. 240
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In particular, Johnson has been quite outright about the power of financial institutions and banks to the extent that a year after the crisis hit the main street he warned that the US economic recovery would fail unless the “financial oligarchy” is dismantle.241 Additionally, the power of major financial institutions has already ratified by major industrialized economies’ bail out policies, which intended to ease the pain inflicted by the 2008 financial crisis, instead of addressing the underlying cause.242 In fact, the crisis can be served as the reveling indictor of financial sectors’ power. At each step of the way since crisis began, the major financial institutions and banks were seem to drive the policy objective to the extent that even the Governor of the Bank of England, Mervyn King, has stated, “The sheer scale of support to the banking sector is breathtaking. In the UK, in the form of direct or guaranteed loans and equity investment, it is not far short of a trillion (that is, one thousand billion) pounds, close to two-thirds of the annual output of the entire economy. To paraphrase a great wartime leader, never in the field of financial endeavor has so much money been owed by so few to so many. And, one might add, so far with little real reform.” More importantly, a simple comparison between the precrisis and post-crisis periods clearly illustrates the power of the “coordinator” agencies such as the World Bank and IMF in shaping the overall economic policies and objectives around the globe. As the Economists observed, “BEFORE the global economic crisis, the IMF’s slide into irrelevance seemed assured. Now, it is back at the frontline of gargantuan bail-out packages, wrangling over government spending and tax reform, and attempts to stop sovereign defaults further disturbing the jittery global financial system.”243 However, the involvements of these agencies were not limited to the 2008 crisis. For instance, the sovereign debt244 crisis in early 2010 amplified the role of agencies (and inability of nation-states to control their economic affairs) to ease
241
Simon Johnson, The Quiet Coup, The Atlantic Online May 2009. In the interview with Bill Moyers, Simon elaborated on his view. The following is an excerpt of the interview. BILL MOYERS: So you’re not talking about nationalization, are you? Simon Johnson. I’m talking about a scaled up FDIC intervention. I think we need the FDIC to be empowered. And to have the political support necessary to get this job done. Bill Moyers. Splitting this one powerful interest group into competing factions, and taking them on one by one. Simon Johnson. That is classic oligarchy breaking strategy. Now I do admit that once you’ve done that, you have to worry about the new oligarchs. That’s why you’re breaking up the banks. You don’t want to just change the owners of banks that are too big to fail, because they’ll be coming around in 5 years for another handout. 242 Which is politics. Unless and until we break the political power of our largest banks, broadly construed, the world is going nowhere (or, rather, we are looping around the same doom). 243 See The Russian default: Stumbling towards infinity, the Economists, Nov 25th 2010. 244 Or another way of saying the same thing is sovereign credit risk – ability of sovereign state to meet its promised payments to creditors (those investors in sovereign bonds, those issued by governments).
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the fear of government default and calm down the global financial circle through formulations of yet another rescue package for Europe Union members, particularly Greece and Ireland (while Italy, Spain, Portugal, and Belgium are allegedly waiting in the wings). The sovereign debt issue portrayed as a crisis of confidence, particularly in term of risk insurance on credit default swaps,245 among EU members. To meet the creditors demand and stabilized the financial situation, EU finance ministers and IMF approved rescue packages, on condition of severe austerity measures, in which the Greek government is expected to received 100 and 120 billion euros (133 and 160 billion dollars) and about 85 billion euros (112 billion dollars) will go to the Irish government. However, once the dust of anxiety settle down and debts are collected, it should become obvious that these rescue package, like the previous ones, do not intend to address the overall causes of problems but rather aimed to assist financial institutions and banks to collect payments promised to them by national governments, and hence as the phrase goes “restore the confidence in the financial market.”246 For one thing, the average interest rates charged on these rescue packages are well above the prevailing market rate. For instance, for the Irish package, EU and IMF will charge an average of 5.8%,247 in which the EU is contributing 45 billion dollars and the International Monetary Fund (IMF) 22.5 billion dollar (and Ireland will contribute 17.5 billion euros to the fund for the banks from its cash reserves and National Pension Reserve Fund). The economic rational to attached the notion of “rescue” to these type of packages commonly implies “saving an economy from default” instead
245
Credit default swaps (CDS) are financial instruments intended to provide risk insurance to banks and bondholders in case a particular bond or security goes into default (when there is not enough revenue behind the loan to meet the promised payments). Their purpose is to make it easier for banks to issue complex debt securities by reducing the risk to purchasers. For instance as of 2009, it costs about 2.6% of the principal each year for investors to insure Greek government bonds against default, according to CMA DataVision. By the way, these CDS are another brilliant invention of Wall Street in the late 1990s. For more information see Times Topics, “Credit Default Swaps,” The New York Times. Retrieved on May 11, 2009. 246 Apparently, no one in policy-making and financial institution circles, or global epistemic communities exposed to the Hyman Minsky concept of the instability of stability. As a student of Joseph Schumpeter, the noted Austrian economist who documented capitalism’s ceaseless process of “creative destruction,” Minsky spent more time thinking about destruction than creation. In doing so, he formulated an intriguing theory: not only was capitalism prone to collapse, he argued, it was precisely its periods of economic stability that would set the stage for monumental crises. Minsky called his idea the “Financial Instability Hypothesis.” In the wake of a depression, he noted, financial institutions are extraordinarily conservative, as are businesses. With the borrowers and the lenders who fuel the economy all steering clear of high-risk deals, things go smoothly: loans are almost always paid on time, businesses generally succeed, and everyone does well. That success, however, inevitably encourages borrowers and lenders to take on more risk in the reasonable hope of making more money. As Minsky observed, “Success breeds a disregard of the possibility of failure.” 247 Still there are report the interest charge may be even larger than this amount. For instance, Ireland’s RTE broadcaster reported that the country may have to pay a rate as high as 6.7% on some of the money.
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of “pushing an economy further into default,” which is certainly a possible scenario for these economies.248 It makes no economic sense to expect a indebt government to repay loans that charges well above an average market interest rates as a means to get out of insolvency.249 Moreover, the circumstances under which these European economies endure payment defaults were created partly by the global boom-bust-cycle, e.g., low/high interest rates, as well as EU membership restrictions.250 For instance, as part of these restrictions an EU member is deprived of using devaluation as a monetary instrument to meet her external financial obligations. More importantly, as a direct result of globalization of finance (international markets access to national economies) states cannot raise financial capital according to their own preferences251 and usually engage in what is known as “open market operation” in which state’s debt place in various financial markets, and hence adjustment to meet the promised payment is dictated rather than negotiated. As Nouriel Roubini observed, “In Greece or Spain or Portugal, the bond markets are forcing an adjustment. In spite of the recession, the markets are telling them to either straighten out their problems or go bankrupt.”252 It should be noted that as of the summer of 2011, we are genuinely convinced that chances of Greece not defaulting is really slime, regardless of the second round of bail-out, unless some kind of a fiscal consolidation, which means all of affairs that related to budget are government by some central consul, occurs. The arithmetic is such that default is inevitable since Greece faces the interest rate (on its 2 years loans) that has reached unprecedented 30%.
248
The post 2008 US FED policy provide an excellent case. As part of the economic bailout, the U.S. FED provided a discount rate well below 1%, while the banks in U.S are charging the public over 5% (on average). And yet, some major U.S. bank still holding back and not offering wide range of financial assistances. 249 Even if the underlying aim for such high charged interest rate is a punitive measurement since such “stick” is usually accompany with “carrot,” which in this is absent. 250 For instance, all EU member states required to relinquished their national currencies and adopt the single currency. By doing so states not only subordinate their monetary policy to the union central authority, but also forgo their sovereignty and make themselves vulnerable in time of economic stress, the process in which we are currently witness. 251 It is also important to remember, as Edward Harrison reminds us, that “countries like the U.S. or the U.K. can just print money to meet creditor demands. After all, the only financial obligation of government in a fiat currency system is the payment of more fiat money. This is a confidence game then. Creditors will only accept more fiat money from the debtor if they believe that the money represents good relative future value (i.e. when debt repayment occurs and where value is relative to other currencies or real assets at that time).” For full article see Edward Harrison, “On The Sovereign Debt Crisis”, Huffington Post.com, December 2, 2009. 252 Nouriel Roubini, “Greece debt is only the tip of the iceberg”, The Christian Science Monitor, April 29, 2010. The paper is available at: http://www.csmonitor.com/Commentary/GlobalViewpoint/2010/0429/Roubini-Greece-debt-crisis-is-only-the-tip-of-the-iceberg.
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Global Governance The globalization of economic has tilts the conventional perspective from state to markets. In this book, we concern with an emerging thinking that the world production and economic exchange driving nation-states toward “borderless world.”253 The internationalization of production and global exchange of goods and services have more direct implication for coalitions of national interests than for nation-states. The symmetry of this view indicates that there is substantial tilt away from the significant of autonomous national policy design and policymaking. This means power relationships and processes of opinion making and decision making are increasingly located in complex and transnational settings, characterized by shifting alliances among international as well as national stakeholders instead of nation-states. In light of this observation, the global governance shifts the location of authority in the context of both integration (globalizing) and fragmentation (localizing). This is the usage pioneered by James Rosenau. He brought the notion of global governance into popular mindset, a prominence if you would, in conjunction with a terminology intended to welcome the way in which global change is an encompassing phenomenon involving relocation of authority across multiple levels and areas. Rosenau describes the process as “a pervasive tendency… in which major shifts in the location of authority and the site of control mechanism are under way on every continent, shifts that are as pronounced in economic and social systems as they are in political systems.”254 Rosenau’s works on global governance reject the common presumption, wishful thinking in his term, that “somehow our messy, tension-ridden world must be undergoing governance on a global scale marked by a modicum of coherence,” the dismissal that we also subscribed to. While, he sees the emergences of global governance paralleled with the acceleration of globalization, the “inextricably linked” has to be examined, according to Roseau, in light of three sources. “One involves the need to refer to the exercise of authority to global governance inasmuch as such a structure neither exist nor hovers on the horizon. Second, the need to speak of transnational authority was intensified by the Apollo picture of the earth taken from outer space that depicted a lonely spheroid in a vast universe and thereby served to heighten a keen awareness of humankind as sharing a common life. Third, for a long time the world was described as increasingly interdependence, but not until the Cold War ended were people freed up to fully recognize that the dynamic of interdependency tended to have consequences that are global in scope.”255
253
See Kenichi Ohmae, The Borderless World: Power and Strategy in the Interlinked Economy, Harper Paperbacks; Revised edition, 1999. 254 James N. Rosenau, The Study of World Politics: Volume 2: Globalization and Governance, Taylor and Francis, Inc, 2006, pp. 126. 255 Ibid, pp. 147.
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The focus here on global governance is not in any way to imply a concern with some notion of world government. Indeed, in our opinion the prospects of a world government in the foreseeable future are nil, however, and at the same time we conceive of governance as occurring on a global scale to confront worldwide predicaments, e.g., financial crises, which cannot be address by nation-states alone or by a single agency of governance. In other words, governance occurs on a global scale through institutional arrangement that encompasses the coordination of nationsstates and vast array of rule and standards that intend to exercise authority preemptively in the pursuit of specific goals and “that function outside national jurisdiction.” The reader should note that in term of pursuing specific goals and objectives, such institutional arrangement does resemble a formal organization. While global and national mechanism differ in many respect, e.g., the extent of their control over economic affairs, both must face the similar challenges to governance. Both must deal with rapidly changing world in which goods, information, people and idea are in “continuous motion” that propels perpetual rearrangements of social, economic and political spheres. Both are challenged with the instability and disorder that at one end driven by the power, e.g., of financial institutions, and at the other end compelled by resource shortage (ranging from fiscal disarrays to rasping unemployment). Under these circumstances, it seems reasonable for an entity such as global governance “to consist of proliferating mechanism that fluctuate between bare survival and increasing institutionalization, between considerable chaos and widening degree of order.”256 In this respect, there is no center or supreme power, but only a multitude of groups (nation-states), in which all designated elements integrated in a game of quasi-reciprocal dependencies.257 The diffusion of power has taken the sting out of conflict. “And like a block of granite that is being eroded into sand, the imperial [global] age is dissolving conflict into a thousand impalpable fragments.”258 Indeed, when a system, like global system, is functioning by designated sets of rules and standards, there is no time for conflict to emerge, similar to the past-centralized mechanism, it is dissolved in a multitude of microdecisions within the existing hierarchy structure.
Global Neighborhood In 1994, Anthony Giddens proclaimed, “Globalization is really about the transformation of space and time. I define it as action at distance, and related its intensifying over recent years to the emergence of means of instantaneous global communication
256
Ibid, pp. 127. The Greece insolvency case present an ample example of such reciprocity, in which Greece failure to lead to Europe decline in value and hence hinder economic recovery at the global level. 258 Jean-Marie Guehenno, 2000, pp. 73. 257
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and mass transportation.”259 However, here the Giddens’ terminology intends to suggest that globalization becoming more and more a consequence of the prescribed institutional arrangements, which denies local context but promotes certain ideals. This is a process that driving nations states around the world towards the notion of “global neighborhood,” and hence entails to be managed by the global entity called the global governance. In this respect, action at distance is a process, which stretches national institutional arrangements in addition to removing economic and political relationships that govern people day-to-day lives from local contexts to distance global one. David Held also noted this development when he stated, “globalization can be taken to denote the stretching and deepening of social relations and institutions across space and time such that, on the one hand, day-to-day activities and increasingly influenced by events happening on the other side of the globe, and on the other, the practices and decision of local groups or communities can have significant global reverberations.”260 In light of these claims we began by understanding the notion of the “global neighborhood.” In 1995, the Commission on Global Governance261 published a report262 called “Our Global Neighborhood,” in which it underlined the rational and need for creation of global governance, as it observes, “The changes of the last halfcentury have brought the global neighborhood nearer to reality – a world in which citizens are increasingly dependent on one another and need to cooperate. Matters calling for global neighborhood action keep multiplying. What happens far away matters much more now.” The report also highlights certain issues of concern, which included (1) global security; (2) managing economic interdependence; (3) promotion of larger role for international agencies, e.g., UN and IMF; and (4) strengthening the rule of law worldwide.
259
Anthony Giddens, Beyond Left and Right: The Future of Radical Politics, Stanford University Press, 1994, pp. 4. 260 David Held, Democracy and the Global Order, Stanford University Press, 1995, pp. 20. 261 The Commission on Global Governance (CGG), was established in 1992 with the full support of the U.N. Secretary General Boutros Ghali and with the goal of strengthening global cooperation, securing global peace, achieving sustainable development and universalizing democracy. Chaired by Ingvar Carlson, the former Prime Minister of Sweden, and Shridath Ramphal, former Secretary General of the Commonwealth from Guyana, the commission is made up of 28 public figures from around the world, all of whom participated in or formally endorsed the Stockholm Initiative on Global Security and Governance. You may recognize some of the names on the commissions membership list, such as Jimmy Carter of the USA, Benazir Bhutto of Pakistan, Boutros Boutros-Ghali of Egypt, and Maurice Strong of Canada. The Commission received funding from several governments including, Canada, Denmark, India, Indonesia, the Netherlands, Norway, Sweden, and Switzerland. Funds from Japan were also made available through two United Nations trust funds. The Commission also received funds from the Arab Fund for Economic and Social Development (Kuwait) and the World Humanity Action Trust (UK), as well as from the MacArthur Foundation, the Carnegie Corporation, and the Ford Foundation (all based in the USA). Other countries also funded meetings and paid for travel costs and hotel accommodations. 262 The report can be accessed at http://www.gdrc.org/u-gov/global-neighbourhood/index.htm.
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To meet these challenges the report called for new global leadership, “As the world faces the need for enlightened responses to the challenges that arise on the eve of the new century, we are concerned at the lack of leadership over a wide spectrum of human affairs. At national, regional, and international levels, within communities and in international organizations, in governments and in non-governmental bodies, the world needs credible and sustained leadership.” It further explains, “This cannot be leadership confined within domestic walls. It must reach beyond country, race, religion, culture, language, and lifestyle. It must embrace a wider human constituency, be infused with a sense of caring for others, a sense of responsibility to the global neighborhood.” The foundation for global governance, according to the report is the belief that the world is now ready to accept a “global civic ethic” based on “a set of core values that can unite people of all cultural, political, religious, or philosophical backgrounds.” This conviction is complemented by another belief: “that governance should be underpinned by democracy at all levels and ultimately by the rule of enforceable law.” Few years later, in 2001, The EU study on global governance proclaimed, “The EU has a clear interest in promoting global governance as a means of achieving the core of objectives of sustainable development, security, peace and equity, objectives no territorial actor can secure alone. Positive transnational cooperation is possible and the EU should show a willingness to experiment in order to improve it. The external aspects must be key in any EU deliberations on governance.”263 In its annual Globalization and Development report published in 2002, UN Economic Commission for Latin America and the Caribbean (ECLAC) highlighted the striking “absence of a suitable form of governance in the contemporary world, in economic terms (as has become particularly evident in the financial sector), as well as in several other areas/sectors.”264 The report claimed that the lack of a suitable form of governance has contributed to the sharp divergence between the reality of global problems and the political processes that continue to be pursued within national and, increasingly, local frameworks.265 An important dimension of the globalization process, but certainly not one that has been discussed at length in the general populace popular discussion, is the gradual spread of values with regard to civil and political rights as well as certain economic and social “codes-of-conduct.” In fact, efforts have been put forward so that the basic objective of an international economic order, namely to conjure a “level playing field” for the efficient operation
263
White Paper on Governance Working Group N 5, An EU Contribution to Better Governance beyond Our Borders called Report of Working Group “Strengthening Europe’s Contribution to world governance”, 2001. It can be accessed at http://www.ec.europa.eu/governance/areas/ group11/report_en.pdf. 264 Globalization and Development, ECLAC, April 2002. The summary of the report can be accessed here: http://www.eclac.cl/cgibin/getProd.asp?xml=/publicaciones/xml/0/10030/P10030. xml&xsl=/tpl-i/p9f.xsl&base=/tpl-i/top-bottom.xsl. 265 Ibid.
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of free market forces, can be obtained.266 (ECLAC, 2002: 26). In other words, there are certain values/ideas that are valued above others – and these have become the norm in the global market. These sentiments as well as the role of the G20 in the global governance process were reaffirm and defined by Pascal Lamy, the Director-General of the World Trade Organization (WTO), when he defines what he intends through the concept of global governance: “For me, global governance describes the system we set up to assist human society to achieve its common objectives in a sustainable manner, that is, with equity and justice. Growing interdependence requires that our laws, our social norms and values, our mechanisms for framing human behavior be examined, debated, understood and linked together as coherently as possible. This, in my view, is the prerequisite for genuinely sustainable development in economic, social and environmental terms.”267 To complement the above arguments we must first take a peek at the notion of global governance. In doing so, we present a brief analysis of global governance by examine it in light of two schools of thoughts in international relations,268 realism and liberalism perspectives. Such examination should provide sufficient background for the reader to develop an understanding of the foundation on which global governance operates and function. Before we go forward, it should also be noted that although there is no shortages of appeals to the notion of global governance, and yet no generally accepted definition of the term exist. By tracing the origin of the term governance, some argue that the conceptual shift from government to “governance” is not as progressive as it may seem.269 Resulting in a blurring of the delineation of political responsibility, such a shift, it is argued, increases the difficultly in holding decision-makers accountable. Others argue that the meaning behind the term “governance” is, in fact, a retreat from earlier economic reform attempts to secure universal capitalistic hegemony, where globalization intensifies the need for regulation/governance at the international level.270
266
Ibid, pp. 26. See Pascal Lamy, “Global governance in the steps of William Rappard,” WTO News Speech, March 15th, 2010. 268 According to Cynthia Weber, “To try to make sense of international politics, we often turn to IR [International Relations] theory. IR theory makes organizing generalizations about international politics. IR theory is a collection of stories about the world of international politics. And in telling stories about international politics, IR theory doesn’t just present what is going on in the world out there. IR theory also imposes it own vision of what the world out there looks like.” (See Cynthia Weber, International Relations Theory: A Critical Introduction, Rutledge, 2001, pp. 2.) 269 See Christopher Chase-Dunn, Ellen Reese, Erika Gutierrez, Rebecca Giem, Christine Petit, and Linda Kim, Global Party Formation in World Historical Perspective, Working Paper no.21, The Institute for Research on World-Systems, University of California, Riverside, 2006. 270 See David Held and Mathias Koenig-Archibug, edited, Global Governance and Public Accountability, Blackwell, 2005. See also Slaughter, Ann-Marie, “Disaggregated Sovereignty: Towards the public accountability of global government networks,” Government and Opposition, 39, 2, 2004, pp159–190. 267
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Finally, there are those who believe that “…given its difficult translatability into languages other than English, it is reasonable to assume that the term global governance is culturally not neutral. Indeed, “governance” as opposed to “government” transports the very optimistic and typically Anglo-American belief that things can happily “work out” as the result of polycentric interaction, rather than always being the result of power relationships.”271 However, the consensus among skeptics is that the global governance system simply implies disaggregated sovereignty.272 In this book, we followed Wolfgang H. Reinicke’s central proposition in which the function of governance and government can be separated from one another. In Reinicke’s view, the forces of the prevailing area, e.g., economic interdependence, can (and not will) only affect operational sovereignty of a government (rather than the legal sovereignty of a state, which can be challenged only by other states), that is, “its ability to exercise sovereignty in the daily affairs of politics.”273 In this respect, governments have been able to make domestic public policy and also be independent actors in international political affairs. Governance, on the contrary, is a social function such as the regulation of economic affairs, and is
271
Michel, Callon, “the Sociology of an Actor-Network: The Case of Electric Vehicle” in Michel, Callon, H. Law, and A. Rip (eds.), 1986. Mapping the Dynamic of Science and Technology, Sociology of Science in the Real World, Houndsmills: Macmillan, pp.19–34. 272 See, for instance, David Held and Mathias Koenig-Archibugi, edit, Global Governance and Public Accountability, Wiley-Blackwell; 1 edition, 2005; and Anne-Marie Slaughter, “Disaggregated Sovereignty: Towards the Public Accountability of Global Government Networks”, International Journal of Comparative Politics, Spring 2005, Vol. 39, issue 2, pp 159–190. 273 Wolfgang H. Reinicke, “Global Public Policy”, Foreign Affairs, Vol. 76, no.6, Nov/Dec 1997, pp. 129. According to Reinicke, “Sovereignty has two dimensions, internal and external. The internal dimension is the relationship between the state and civil society. Following Max Weber, a government is internally sovereign if it enjoys a monopoly of the legitimate power over a range of social activities, including economic ones, within a given territory. That power is embodied in the domestic legal, administrative, and political structures that guide public policies. With respect to the economy, internal sovereignty takes effect when governments collect taxes or regulate private sector activities. The external dimension of sovereignty refers to relationships among states in the international system. These relationships are defined by the absence of a central authority. As Thomas Hobbes put it, anarchy is the rule of the international system. External economic sovereignty comes into play when, for example, countries collect tariffs and alter their exchange rates.” Ibid. For a detail analysis of this subject the reader is referred to Wolfgang H. Reinicke, Global Public Policy: Governing Without Government? Brookings Institution Press, 1998. It should be noted that Reinicke’s idea has been challenged. For instance, Anna Leander rebuff Reinicke idea when she observes, “a diffusion of authority is undermining the state capacity for legitimate violence. Globalisation creates new sources of authority both for states and those contesting states. And since state control continues to be quintessential, there is growing competition for the control over the state. The run on the state results in a portioning up (or privatisation/feudalization) of public authority by the groups or individuals struggling to control it. As political processes are controlled, or taken over, by non-state authorities, they also challenge the capacity of public authorities to preserve and use the state’s monopoly of violence.” (See Anna Leander, “Globalisation and the eroding state monopoly of legitimate violence”, presented at the conference “The Global Constitution of Failed States” at University of Sussex, 18–20 April, 2001).
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not necessarily the same as government.274 Accordingly, “Global public policy uncouples governance from the nation-state and government.”275 Governance, according to Reinicke, need not be equated with government but can be achieved through networks of public and private groups or institutions at national, regional and international level. Therefore, the global mechanism of governance can enjoy the benefits of governmental function, e.g., inner-security of a nation, without appealing to a formal governing structure.276 More importantly, in the globalized economic system, national independency does not exist in a sense that no nation is self-sufficient. Each nation is involved at different levels of interaction to sell what it produces, to acquire what it lacks and also to produce more efficiently in some economic sectors than its trade partners.277 More than ever, prosperity is driving force for nations.278 However, such prosperity entails order. In the prevailing global system, in which wealth of nation grows out of the multiplication of connections, it is necessary to avoid disruption, the unexpected, the uncertain, and the uncontrolled. In short, there must be new order at the global level. As Porter states, “Order is provided by the interaction of a wide variety of institutional forms and practices, which involves a shift from ‘command and control’ regulation to control at a distance.”279 Inevitably, ascertaining the global order demands the multilateral framework of the community of nations in a sense that public opinions and national interests are no longer accepted as a sufficient basis for unilateral action. The nation is no longer the natural framework of political discourse since as a civilization we are beginning to dream of a world government. Consequently, no system of government can be immune from the global fancy. This observation is quite recently illustrated by
274
As Reinicke observed, “Governance, a social function crucial for the operation of any market economy, does not have to be equated with government.” (Ibid, pp. 132). 275 Ibid. 276 Having said that we would like the remind the reader of what Hedley Bull observed, “The starting position of international relations is the existence of states, or independent political communities each of which possesses a government and asserts sovereignty in relation to a particular portion of the earth’s surface and a particular segment of the human population.” (See Hedley Bull, The Anarchical Society: A Study of Order in World Politics, Columbia University Press, 1997, pp. 8). 277 See Jean-Paul Rodrigue, Claude Comtois, and Brian Slack, 2nd edition, The Geography of Transportation Systems, Routledge, 2009, Chap. 5. This book can be access at: http://people. hofstra.edu/geotrans/index.html. 278 Without engaging in political and philosophical debate about the meaning of prosperity, in this book we are humbly submitted to the conventional wisdom that cast prosperity in economic terms – prosperity can be achieved through an increased in the gross domestic product. This view conveys sequential outcomes – higher income means increased choices, richer lives, an improved quality of life for those who benefit from them. 279 Toney. Porter, “Global Governance Theories, Complexity, and the Post-Crisis International Financial Architecture”, Paper prepared for International Studies Association Annual Meeting, New York, February 16, 2009.
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so called the “international community”280 when it dictates the well of the global system in Ivory Cost and Libya. By the same token, no nation, however powerful, can single-handedly assure stability of the global order because no nation has both the trust of others and the infinite means to fulfill the role of hegemonic power, like previous eras.
Conceptual Foundation of Global Governance With these observations in mid let us move forward with our analysis of global governance in light of the common philosophy of perception (known as international relations). According to Gilpin, the idea of a realist theory of global governance is a contradiction in terms because “the fundamental proposition of political realism is that the international system is anarchic.”281 Accordingly, in an environment that a legitimate authority is absent (anarchy exists)282 international affairs are no longer meaningful and differences between international and domestic affairs would disappear, and hence, the notion of global governance becomes null and void. However, the existence of anarchy does not prevent nation-states to work together in some area and create international institutions that reflect their mutual interest(s). Moreover, in the domain of realist thinking, a state main concern is related to its national interests, and military security as the most important of these interests, and therefore other factors such as “ideas,” “values,” and “moral” commonly play a trivial role in guiding national conducts. Indeed, the significant portion of criticisms of the major realist thinkers of twenty century is based on the notion that liberal
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Foreign Policy Magazine in its September 1, 2002, issue invited nine notable thinkers, activists, journalists, and policymakers from across the ideological spectrum to survey the international community and tell the reader what they see. Does such a community truly exist? If so, who is part of it? Who isn’t? Whose values does it reflect? And perhaps most important, how does it work? How should it work? According to the issue, invoking the notion of international community is a lot easier than defining it. Nevertheless, it observed, “We are supported by the collective will of the world,” declared US President George W. Bush as he launched the war against Afghanistan’s Taliban regime in October 2001. For many people, that collective will has a name: the “international community.” This feel-good phrase evokes a benevolent, omniscient entity that makes decisions and takes action for the benefit of all countries and peoples.” 281 Robert Gilpin, “A Realist Perspective on International Governance”, pp. 237, in Anthony McGrew and David Held (edited), Governing Globalization: Power, Authority and Global Governance, first edition, Blackwell Publisher, 2002. 282 According to Gilpin, Anarchy implies “the absent of a legitimate authority to which most states are subordinate and give allegiance”, Ibid.
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conviction on power of idea is misguided.283 Finally, concern with national security, and hence power, compels realists to think of power as vital importance in international affairs to the extent that “states must be continuously attentive to changes in power relations and to the consequences of their own national interests of shifts in the international balance of power among the members of international political system.”284 Having said that, it is noteworthy that even among realists there is no clear consensus on how to define the notion of power.285 In contrast, the common perception of liberalism, as an ideology, emphasized on the important role of the individual who should be relatively unconstrained by a minimalist state – a major theme in early capitalist writing.286 This emphasis received further boosted when essays of such Utilitarian as Jeremy Bentham that viewed people as rational, calculating individuals capable of deciding what was best for themselves without much government interference. It followed that liberals emphasized the positive role played by public opinion in providing guidance to state officials and producing good public policy. However, this view of the domestic policy was carried over into the international realm. Liberals recognized that was a defining characteristic of international politics. They also agreed with realists that the state of anarchy that characterized world politics contributed to suspicion and distrust among states and hence posing an obstacle to cooperation and peace. However just as it was assumed that there could be harmony of interest among individuals
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For instance, in 1946 Hans Morgenthau, one of the “founding fathers” of the realist school in the twentieth century, pointed out that liberal beliefs of Western democracies made them incapable of recognizing the threat of Nazism and fascism in 1930s, and hence he concluded that it was unwise to place one’s faith solely in the power of ideas (See Hans Morgenthau Scientific Man Versus Power Politics, University of Chicago Press, 1974. See also William Scheuerman, “Was Morgenthau a Realist? Revisiting Scientific Man vs. Power Politics” Paper presented at the annual meeting of the ISA’s 49th Annual Convention, Bridging Multiple Divides, Hilton San Francisco, San Francisco, CA, USA, Mar 26, 2008). In respond to these criticism, skeptics may point out that such neglect is trivial, at best, when one looks at the 1930s as a whole in a sense that liberal did recognized the rise of Third Reich, however, they realized the attractiveness of power of economic liberalism overcome political liberal rhetoric. For instance, one can points to the warm and friendly relation between capitalist industrialist Henry Ford with Nazis Germany well into the World War II and later on with Stalinist Soviet Union during the Post-War. 284 Gilpin, 2002, pp. 238. 285 According to Paul R. Viotti and Mark V. Kauppi, “Some realists understand power to be the sum of military, economic, technological, diplomatic, and other capabilities at the disposal of the state. Others see power not as some absolute value determined for each state as if it were in a vaccum but, rather, as capabilities relative to the capabilities of other states.” (See Paul R. Viotti and Mark V. Kauppi, 2ed edition, International Relations Theory; Realism, Pluralism, Globalism, MacMillan Publishing, NY, 1993, pp.44). 286 However, historical experiences changed this perception. As Anthony McGrew observed, “… the mass mobilization of societies demanded by industrial warfar altered liberal attitudes to state intervention. If the state could mobilized societal resources for the war effort, then government could act to improve the human condition.” See Anthony McGrew, “Liberal Internationalism: Between Realism and Cosmopolitanism”, pp. 271, in David Held and Anthony McGrew, edited, Governing Globalization: power, Authority and Global Governance, Blackwell Publisher, 2002.
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within a given state, so too did liberal thinkers argue that a harmony of interest among states was possible. Overall, Liberals made at least four arguments. First, they claim that the expansion of the international economy made it more costly for states to embark on war. As economic interdependence increased, there would be a reluctance to cut profitable economic ties.287 Second, they maintain that the spread of democratic (or more precisely republican or representative) political system meant that question of war and peace were no longer confined to small group of political and military elites, as in the past. Third argument is related to the benefits of international law, accepted “role of the game,” and international organizations would contribute to the peaceful settlement of disputes among states and enhance global cooperation.288 Finally, they argue that Western civilization had suffered enough from war and those leaders and citizens had learned how costly it was to wage. If classical liberal theorists were seeking peace through harmony of interest between states, the historical experiences of the twentieth century most notably two World Wars, the Great Depression in addition to the success of international public unions compels liberal thinkers to alter their view on world peace. The new brand of liberal thinkers, commonly known as liberal internationalists, begun to contemplate some form of international order, especially (as John Maynard Keynes and other argued) in respect of economic and social affairs.289 In short, liberal internationalists seek to achieve the promised peace by, what McGrew called, domestication of the world order. Accordingly, “the new liberalism advocates a form of international government which appropriate power and authority to enforce the peace.”290 This inclination, according to McGrew, advocated a decentralized and pluralistic system of international governance, which is empowered by supranational authority.291 Nevertheless, over the years, liberal thinking has changed according to historical experiences, their philosophical foundation remained intact – reason has been a substitute for the use of force in world politics and as Doyle asserts the world politics can be a state of peace.292 In this respect, Immanuel Kant’s work plays a major role in cementing the liberal base. For instance, Cederman points out, Kant’s essay “Perpetual Peace,”293 sets out three “definitive articles,” as joint conditions for truly
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A work in this tradition is; Richard Rosecrance, The Rise of the Trading System, Basic Book, 1986. 288 See Robert O, Keohane, “International Liberalism Reconsidered,” in The Economic Limits to Modern Politics, ed. John Dunn, Cambridge University Press, 1990, pp. 165–90. 289 It should be noted that while the majority perceived the Great Depression ended as a result of Keynes economic policy, others, like John Kenneth Galbraith, argue that the Great Depression ended as a result of the World War II. 290 Anthony McGrew, 2002, pp. 217. 291 Ibid. As an ample example of such system one can recalls Woodrow Wilson’s Fourteen Points. 292 Michael W. Doyle, Ways of War and Peace, W. W. Norton, 1997. 293 Immanuel, Kant, Perpetual Peace. Edited by Lewis White Beck, Macmillan, 1957.
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lasting peace.294 The first definitive article, “The Civil Constitution of Every Sate Should Be Republican” requires states to be republics, which in today’s terminology could be translated as representative liberal states.295 Jahn further explains, “Because citizens bears the burden of war, they are generally inclined toward caution; and republics, in which the citizens’ opinions are represented, are therefore less war prone than other forms of government.”296 Kant’s the second definitive, “The Law of Nations Shall be Founded on a Federation of Free States,” which a liberal republican form of government (that is, constitutional government based on the consent of citizens) was an essential building blocks of a peaceful international order. According to Kant. “This would be a league of nations, but it would not have to be a state consisting of nation.”297 Kant further explains, “This league does not tend to any dominion over the power of the state but only to the maintenance and security of the freedom of the state itself and of other states in league with it.”298 The third definitive, “The Law of World Citizenship Shall Be Limited to Conditions of Universal Hospitality,” advocated the importance of international law to the maintenance of international order. As McGrew observed, “Just as Liberal republic government required a constitutional order, so international politics required a codification of states’ rights and duties.”299 Hospitality, Kant explains, “means the right of a stranger not to be treated as an enemy when he arrives on the land of others.”300 Moreover, in this definitive article Kant proposed a framework of
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Lars-Erik Cederman, “Back to Kant: Reinterpreting the Democratic Peace as a Macrohistorical Learning Process”, The American Political Science Review, Vol. 95, no. 1, March 2001, pp.15–31. See also Paul R. Viotti and Mark V. Kauppi, second edition, International Relations Theory: Realism, Pluralism, Globalism, Macmillan Publishing Company, 1993, pp. 231–232. 295 See David Held, 1995, Introduction chapter. In fact, in the introduction, Held presents an interesting discussion of democracy, Globalization and Global Governance, in terms of: what is relevant constituency: national, regional or international; To whom do decision-makers have to justify their decisions; To whom they should be accountable; etc. Moreover, the term representative liberal states should not be confused with Jeffersonian democracy, a term used to indicate the period when the government was run by aristocratic learned men, as opposed to the period of Jacksonian democracy where the common man ran the government. 296 Beate Jahn. “Kant, Mill, and Illiberal Legacies in International Affairs”, International Organization, Vol. 59, No. 1 (Winter, 2005), pp. 180. 297 Immanuel Kant, 1957, pp. 16. 298 Ibid, pp. 18. 299 Anthony McGrew, 2002, pp.270. 300 Immanuel Kant, 1957, pp. 20. The acts that harm others are proscribed by Confucius’s Golden Rule, which stated, “Do not impose on others what you do not wish for yourself.” Adam Smith also expressed the similar sentiment: “Every man is, no doubt, by nature first and principally recommended to his own care (Smith, Adam, The Theory of Moral Sentiments, or An Essay Toward an Analysis of the Principles by which Men Naturally Judge Concerning the Conduct and Character First of the Neighbours and then of Themselves, 11th ed., Edinburgh: Bell and Bradfute, 1759; 1808, I, pp. 193), but he goes on: “Although the ruin of our neighbour may affect us less than a very small misfortune of our own, we must not ruin him to prevent that small misfortune, or even to prevent our own ruin” (ibid., pp. 194).”
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cosmopolitan law (ius cosmopoliticum301) that intended to achieve peace through the right and duties of both individuals and nations within his proposed league of state. The basic idea of cosmopolitan law302 involved the notion of each person is “a citizen of the world” and owes a duty, above all, “to the worldwide community of human beings.”303 As Kant expressed, “Since the narrow or wider community of the peoples of the earth has developed so far that a violation of right in one place is felt throughout the world, the idea of a law of world citizenship is no high-flown or exaggerated notion.”304 The concept of citizen of the world further strengthen the liberal notion in a sense that a stable peace can only be realized by abounding power politics and constructed an ideal that distinguishes them from “realist” thinker who promotes the balance of power as the best way to reached lasting peace (or prevent war by deterrence). And yet, these hypothetical conditions presented by the liberal ideal can only prevail in a representative liberal democracy (according to Kant’s first article). Another way of saying the same thing is that a world lasting peace is only a possible in a liberal-harmonized-world. In this respect, effectiveness of liberal global institutions, e.g., global governance, in pursuing their objective to create a stable-world can only be realized through a systematic promotion of “liberal principles abroad.” This can be accomplished only through selection of liberal thoughts and practices, an argument that was put forward by State of World Forum’s Commission on Globalization in 2003, “As the twenty-first century unfolds, an ever more integrated global system demands an ever more inclusive and holistic approach to global governance. More than ever before in history, we need the rigorous application of best thinking and best practices to the management of global systems. Nothing less will suffice, if we are to secure the well-being of our children and protect the fragile web of life that supports and nurtures humanity’s existence on this planet.”305 The spread of liberalism and effective promotion of liberal ideals by global governance, however, entails establishment of certain necessities both in terms of overall orientation and implementation of policy objectives. First, target nationstates have to be identified, and therefore the world must be separated into two stratums, namely, liberal and nonliberal states. Second, credibility of the policy declaration must be established – the nonliberal states should be hold to the same standard that expected of liberal states, as Doyle observed “there are no special
301
Kant defines ius cosmopoliticum as the “constitution conforming to the law of world citizenship, so far as men and states are considered as a universal state of men, in their external mutual relationships.” See Kant, Perpetual Peace, Section II, Note 3. 302 For comprehensive analysis of the notion see David Held, “Cosmopolitanism: Ideas, realities and Deficits”, in Anthony McGrew and David Held, 2002. 303 M. C., Nussbaum, “Patriotism and Cosmopolitanism” pp. 4, in J. Cohen, edited, For Love of Country: Debating the Limits of Patriotism, Beacon Press, 1996. 304 Kant, Immanuel, 1957, pp.23. 305 “Commission Overview: Strategic Context – The Challenged of Globalization,” at http://www. worldforum.org/Commission-On-Globalisation/overview/main.htm.
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geopolitical clients, no geopolitical enemies other than those judge to be such by liberal principles.”306 As mentioned before, to ascertain the value of policy objective, nation-states “requires abandoning the national interests” as a guidelines to policy-making. Doyle further explains that in the global system of governance, “we must have no liberal enemies and no unconditional alliances states.”307 Even in various technical areas such as financial stability, trade rules, monetary regime, or accounting standards, the national policy guidelines including the choice of goals and outcomes, should reflects the liberal values, which mirror of the interest of those who control the process, namely, global mechanism of governance.308 In short, a nation-state, as a sovereign entity, turns into coordinating entity to meet the global economic demands. This recipe, however, does not fit well with the original idea that put forward by liberal thinkers.309 What prevails, observed Guehenno, “is not a political body but an apparently seamless fabric, an indefinite accretion of interdependent elements.”310 These prerequisites intend to imply that the membership in prosper liberal zone is exclusive right of those with whom global governance share similar values. More importantly, the creation of different zones (us vs. them) does indicate that beneficial economic outcomes, which can only be realized in the liberal market economic system, go only to the liberal family of nation-states.311 This is an incentive for nations-sates to converge into the liberal zone, and hence form the notion of “global economic system.” This system is also replete with its own global mechanism of governance, whether it is international institutional setting like G-20, coordinating agencies like the World Bank, or disciplines of the neoliberal economic principles, such that nation-states and people are increasingly the subject of prevailing global
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Michael, Doyle, 1996, pp. 50. Ibid. 308 See David held and Anthony McGrew, 2002, pp. 37. 309 For instance, Schmitt argues in Political Theology that legal order ultimately rests upon the decisions of the sovereign. According to Schmitt, only the sovereign can meet the needs of an “exceptional” time and transcend legal order so that order can then be reestablished. Convinced that the state is governed by the ever-present possibility of conflict, Schmitt theorizes that the state exists only to maintain its integrity to ensure order and stability. Suggesting that all concepts of modern political thought are secularized theological concepts, Schmitt concludes Political Theology with a critique of liberalism and its attempt to depoliticize political thought by avoiding fundamental political decisions (see Carl Schmitt, George Schwab, Tracy B. Strong, Political Theology, University Of Chicago Press; 1 edition, 2006). 310 Jean-Marie Guehenno, 2000, pp. 59. 311 It is interesting to note that a creation of a especial zone has been topic of discussions among liberal economists for many years. For instance, one early venture into this line of investigation was Robert Mundell’s “optimum currency area” (see Robert. A. Mundell, “A Theory of Optimum Currency Areas,” American Economic Review, September 1961, 51, 657–65). Mundell initiated a discussion of how large the area for a single currency should be. He defined an optimum currency area as one where labor moved freely within the area, but not between it and other areas, taking us back to the Ricardian criterion distinguishing domestic from foreign trade: factor mobility within but not between countries. 307
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authorities. The sentiment for global system is also reaffirmed by the State of World Forum (SWF) World-view; the belief that the ill afflicting humanity are “problem” that can be solve if the right principles and tools lead in setting goals and “exercising will.”312 We are closing this section by pointing out the obvious, the difference between what we intend to do and what is possible under prevailing circumstances. While conceptually setting up conditions to achieve various objectives is similar to create a wish list, in practice these requirements and objectives formulation bear major predicaments and immediate shortfalls, both at national and global levels. At the national level, no matter the expectations laid on governments, especially those of nonliberal states, they are unlikely to comply with the prescribed scenario because (1) government cannot perform certain tasks adequately due to a weak institutional capacity; (2) resource deficiency in a sense that possible governments failure is related to their material, organizational or epistemic resources, which are not sufficient to perform adequately particular functions; and (3) unwillingness of governments in carrying out specific task.313 Globally, the liberal argument rests on several presumptions. First, it is the manageability of international affairs through reason and rationality, which are necessary and sufficiently requirements. In effect, through the pursuit of enlightened self-interest and rational consideration, conflict between nation-states can be resolved or/and mutual interest mediated without recourse to power politics (force or war). Second, growing economic interdependencies between nation-states and people entails the necessity for the international regulation (of their common affairs). Third, global institutions contributes to peace and world order either through taming the powerful by creating international norms, incentive and new patterns of multilateral politics which limit the scope of power politics; or/and providing mechanism for preventing/managing interstate conflict. Fourth, “progress is possible in world politics in so far as power politics (and thereby war) is not regarded as a an immutable property of the interstates order (as realism presumed) but on the contrary can
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State of the World Forum, “1997 State of the World Forum,” at http://worldforum.percepticon. com/1997forum/index.html. However, the form further hints at more general direction, namely “global citizen”, as a statement issued by the SWF after its 1997 meeting said: “This effort is being developed in the conviction that the process of globalization is in essence the challenge to envision and create the first global civilization: that the problem of the world are for the first time in history essentially manageable. Given the scientific, political and social tools at our disposal; and that humanity, already cooperation in so many areas, stands potentially ready to envision and implement a common vision of the future. The question is not whether we can accomplish these things. We know we can. The question is that of setting priorities, reaching consensus, mobilizing and exercising will.” 313 As Jahn observed, “While democratic peace theorists do not discuss the question of consent explicitly in this context, it nevertheless lies at the heart of liberal thought in general and of the democratic peace thesis in particular. After all, liberal constitutions derive their legitimacy from consent, and the presumed lack of consent in nonliberal states deprives the latter of this legitimacy.” (see Beate Jahn. 2005, pp. 181)
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be mitigated, if not transcendent, through the progressive reform or domestication of international affairs (the rule of law, universal human rights, etc.). In this respect liberal internationalism reflects a distinctly Enlightenment commitment to the improvement of the human and global condition.”314 Fifth, governments expect to respond to global economic interdependency by seeking to strengthen and institutionalize cooperation at the international level. This multilateralism will place a new emphasis on global institutions like UN, NATO, the IMF, Bank of International Settlement (BIS), the World Bank, WTO, etc. The expectation is, as Ngaire Woods observed, “multilateral negotiations and a sharing of technical expertise will provide solutions to the new vulnerabilities created by globalization, and that international agencies will then be able to implement these solution.”315 Finally, the global system assumed to operates independent of the structure of global production and underlying economic power of transnational corporations. Such omission is particularly significant in the prevailing global economic system since change in the structure of global production occurred from “production mostly designed and destined for one local or national market, to production mostly designed and destined for a world market, or at least for several national markets. In short, it is not the enterprises that are multinational. It is the market.”316 Indeed, economic interdependence, or more accurately described integration of the world economy through internationalization of production has shifted the balance of power away from nation-states and toward global markets and global markets agents. This is the topic that will be address in the following section.
Structure of Global Production: Post-Industrial Age In many respects, there are irrefutable similarities between today world and what is known as the post-industrial era. Most apparent among these resemblances are the increase technical requirement of knowledge, which in turns underlines professional as the central person and the role of services as the pillar of economic system. To confirm these observations, we follow one the most influential studies on the postindustrial society by Daniel Bell. In his classic work, The Coming of Post-Industrial Society, Bell claims that the concept of post-industrial society must be examined in light of past trends and evolutions, “the concept of a post-industrial society gains meaning only when it’s attributes compare with those of an industrial society and preindustrial society.”317 For him, preindustrial are agrarian-based societies that
314
Anthony McGrew, 2002, pp. 268. Ngaire Woods, “Global Governance and the Role of Institutions”, pp. 29, in Anthony McGrew and David Held, Governing Globalization: Power, Authority and Global Governance, Blackwell Publisher, 2002. 316 Susan Strange, 1996, pp. 44. 317 Daniel Bell, The Coming of Post-Industrial Society: A venture in Social Forecasting, Basic Book, 1973, pp. 126. 315
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structured “in traditional ways of routine and authority.” And yet, the common attribute between preindustrial societies and today world is related to the fact that large portion of labor force is still engaged in extractive industries, as he observed a portion of life today is still “primarily a game against nature.” Bell’s Industrial societies are goods producing society, which more or less can be grouped around the North Atlantic littoral in addition to former Soviet Unions and Japan.318 In these societies, raw muscle is no longer provides the power for the basis of productivity, but instead “energy and machines transform the nature of work.” The Industrial world, “is a world of organization – of hierarchy and bureaucracy – in which men are treated as ‘things’ because one can more easily coordinate things than men”319 The attribute that is intrinsic to a capital-based market system. However, and as the twentieth century ended, the failure of industrialization to deliver the prosperity at the global level stunned many. As Alvin Toffler observed in 1980, industrialization “left behind a world in which one quarter on the [people] live in relative affluent, three quarter in relative poverty – and 800, 000,000 in what the World bank terms ‘absolute’ poverty. Fully 700,000,000 people were underfed and 550,000,000 illiterate. An estimated 1,200,000,000 human beings remained without access to the public health facilities or even safe, drinkable water, as industrial age ended.”320 Bell also observes that educated and skillful individuals play major role in operation of the post-industrial society to the extent that professionals make up the core of guiding principles. This, in turns, requires greater technical requirements of knowledge (professionalization, meritocracy, epistemic community) in the decision making of organization that control individual lives like education, health and wellbeing, operation of economic, etc. According to Bell this “knowledge class” has becomes the central occupational category in society today to the extent that it “has outdistanced all other major occupational groups in recent decades.”321 Consequently, as Bell observed, what matter the most in the postindustrial society is not a raw muscle power, or energy, but information, “Information becomes a central resource, and within organizations a source of power.”322 Bell, like some others, e.g., Warren Weaver, sees progress within the knowledge class as well as advancements in science as the vehicle to solve the major problem, or using Weaver’s metaphor “organized complexity,” of the postindustrial era.
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However, Bell later clarified his position and pointed out, “if an industrial society is defined as a good-producing society – if manufacturing is central in shaping the character of its labor – then the United States is no longer an industrial society.” Ibid. pp. 133. 319 Ibid. pp. 127. 320 Alvin Toffler, The Third Wave, William Morrow and Company, 1980, pp. 345. 321 Daniel Bell, 1973, pp.137. 322 Ibid. pp. 128. The reader should note that professionalization of policy decision making means breaking down of the process into information bits, which in turn implies simplification of perception – whether knowledge class does considered an issue or not (or talk about or not) – for an issue that is not considered (talked about) does not exist.
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Using Weaver writing Bell explains organized complexity as, “the management of large-scale system, with large number of interacting variables, which have to be coordinated to achieve specific goals.”323 In his view, the application of what he called “intellectual technology,” that is, progressions of knowledge like information theory, decision theory, utility theory in addition to technological advancements like cybernetics and stochastic processes, have been successfully applied to resolve organized complicity.324 The striking distinctive of the prevailing decision-making process, and more importantly its knowledge-class, is its given right to define these rational instructions and uncontested (assumed) will to identify the means of implementing them.325 This alteration in a decision making process, in fact, magnified the important of an epistemic thinking and community in decision-making and policy formulation (both at national and international level) to the extent that political power has passed to a new class of technical experts who dominate access to information and knowledge.326 More importantly, technological developments, e.g., communication infrastructure, interaction and communication led to interconnections of vast population of the globe, and hence established the global network that bears profound consequences. For instance, internet “changes the nature of the ‘gatekeepers’, the one who determine or shape the tastes of those within a like-mind circle, who influence the acceptance or rejection of new style, products, entertainment, and so on.”327 For one thing, the global network initiates the process that underlines the importance of social networking and social influence, and hence raises the awareness of new possibilities. Indeed, the political movements, also known as “twitter revolution,” in North Africa and Near East in recent months are ample indication of this trend.328 These developments, in turn, lead to uncertain outcomes. For instance, they may tend to drive other nations to follow the same path, just like the similar movements
323
Ibid. pp. 29. The reader should note that these developments share one common theme, that is, technical decision making of the post-industrial era is stripes from the ideological-base. Unlike traditional thinking that bears emotional and expressive notions, technical decision-making is algorithms embodied in set of rational instructions. 325 However, it is important to note a fundamental shortfall in such procedure. The prevailing knowledge class is obviously made up of various groups, where each group does not have to give up its own rationality since each quite easily accepts (does not dispute) the rationality of others. In this respect, there are no incentives to improve these rational instructions since for their construction, there are only methods put forward by progress of science. 326 The reader should note, however, that knowledge in the present content does not consist in discovering some essential truth, but in collecting new information. It is never ending search since the primary goal of knowledge in the network society is gathering information to no end. 327 Daniel Bell, The Coming of Post-Industrial Society: A Venture in Social Forecasting, Foreword 1999, Basic Book, 1976, pp. vii. 328 For instance, read the Washington Times editorial comment called, “Iran’s Twitter revolution, Tuseday, June 16, 2009. It can be accessed at http://www.washingtontimes.com/news/2009/jun/16/ irans-twitter-revolution/. 324
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within the West did, in a sense that no established institutions will be immune from consequences of their repressive actions. Or, as observed by Guehenno observes, “Like the Roman citizen of the time of Caracalla, the citizen of the imperial age of the networks defines himself less and less by his participation in the exercise of sovereignty and more and more by the possibility he has to act in a framework in which the procedures obey clear and predicable rules.”329 And yet, one, with significant degree of certainty, can noted that professionals (individuals) create a field of forces, of information/knowledge imbalances (tensions), wherein the tendency to increase the one’s dependency is offset by anxiety of losing control of the networks that have already become inseparable part of the global economic system. In this respect, the global system is becoming a perpetual stock exchange of information. The more information there is, the more imbalances there are. For instance, October 1987 crashed provides an ample evidence of these imbalances; as Edward Lorenz observed, “one flap of a seagull’s wings could change the course of weather forever.”330 In terms of the second similarity (services and their impacts), Bell’s analysis of the post-industrial society declared, “A post-industrial society is based on services.”331 However, since Bell mainly concerned with the social structural and political consequences of the post-industrial society, he neither examined the attributes of services industry, nor its possible impact on production structure as well as structure of economic system. Consequently, he only sees significant of services by the change in sector distribution – the places where people work as well as pattern of occupation – the kind of work they do. In spite of Bell’s analysis, services imply much deeper alteration an economic system to the extent that one can claims that the rise in services is the major part of the prevailing global economic system both in terms of the production as well as the structure of economy.332 According to the World Bank Atlas of Global Development “Service, the most rapidly growing sector of the global economy, now account for almost 70% of world output… In many high-income economies more than 70% of GDP is produced in the service sector… Services now account for 54% of output of
329
Jean-marie Guehenno, 2000, pp. 58. This is commonly known as the butterfly effect. It is a metaphor that encapsulates the concept of sensitive dependence on initial conditions in chaos theory; namely, a small change at one place in a complex system can have large effects elsewhere. For more information see Wikipedia, under the subject Butterfly effect. 331 Bell, 1973, pp. 127. 332 The reader should note that this rise implies declined in other economic sectors like manufacturing. Some believed the prevailing gap can be due to the fact that while official data on manufacturing is precise and clear, measurement of the service sector is vague and imprecise. This is due to the fact that for many decades official data were mainly concerned with measure of manufacturing sector. For more information on this topic see David M. Smick, The World Is Curved: Hidden Dangers to the Global Economy, Penguin, 2009. 330
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middle-income economies.”333 This change is associated to the rise post-industrial economy.334 As Held and McGrew observed, “Over recent decades, the core economies in the global system have undergone a profound economic restructuring. In the process they have been transformation from essentially industrial to post-industrial economies. Just as the twentieth century witnessed the global diffusion of industrial capitalism, so at the century’s end post-industrial began to take its place.”335
Mode of Global Production There is no such thing as a consensus when one considers the prevailing trend in the global economy. A dozen experts will arrive at 12 different conclusions. It often happens that a few moments later each would alter his/her verdict if given a chance to reconsider because of a sheer size of the global system and speed in which things can happen. Nevertheless, one thing is certain, that is, “value” is less and less associated with production. This is due, partly, because traditional sectors like agriculture and industry represent a decreasing part of global economic system. Today, “Information and Communication technologies provide the backbone for the knowledge economy. They account for around half of the productivity growth in modern world.”336 However, and more importantly, scarcity does not determine the value any longer since we are encountering immaterial economy at the global scale.337
333
Atlas of Global Development: A Visual Guide to the World’s Greatest Challenges, 2ed edition, World Bank Group publication, 2009, pp. 56–7. See also Francisco J. Buera, Joseph P. Kaboski, “The Rise of the Service Economy,” NBER Working Paper no. 14822, March 2009. 334 In fairness to the reader, we should like to note that there are those who not only refute such conclusion but also considered the entire notion of post-industrial economy as a myth. For instance, Cohen and Zysman, observed that “the growth of service employment, even of white collar employment, has not put an end to labor struggles and class conflicts of earlier industrial period. Whatever its merits as a principle for organizing our understanding of sociological change, we have yet to arrive at post-industrial politics. Nor is there post-industrial economics.” See Stephen S. Cohen and John Zysman, Manufacturing Matters: The Myth of the Post-Industrial Economy, Basic book, 1987, pp. 260. 335 David Held and Anthony McGrew, “The Great Globalization Debate: An Introduction” in David Held and Anthony McGrew, edited, The Global Transformations Reader: An Introduction to the Globalization Debate, 2edn, Polity Press, 2003, pp. 25. 336 ICT – Information and Communication Technologies, European Commission, Working Program 2007–2008, Draft version 1. Can be access at docs.thinkfree.com/tools/download.php?mode= down&dsn=454628, pp. 4. See also http://www.global-production.com/electronics/trendstudy/. 337 For instance, domination of the service industry implies immaterial products, which drive their development from exchange – value is drive more from a transaction than production. Consequently, since they are immaterial, orthodox economic policies such as lowering custom tariff are ineffective since they never physically cross a border. However, harmonization of internal regulation relative to global standard is effective practice to expand services, so that a bank or an insurance company can install itself in the country of its choice.
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In this respect, Guehenno observed, “This revolution of the economy diminishes the value of space and increases the value of men – for rarity, which determines value, has changed, for space as it has for men.”338 For instance, following the trend of the past 50 years, the price of land, on average and over time, is not related to what it can produce, but rather to people who can settle on it (real states). Or, in car manufacturing, one of the major industrial productions of the first half of the twentieth century, raw materials represent between 30 and 40% of its value. Today, however, in production of electronic components, the major component of knowledge economy and the symbol of the new age, raw materials barely represent 1%.339 This trend suggests global production becoming more abstract, more immaterial in a sense that wealth of nation has become less and less tangible. As Klein observed, “many of today’s best-known manufactures no longer produce products and advertise them, but rather buy products and bran them.”340 In related issue, the 2006 World Bank study called, “Where is Wealth of Nations?” explores this question: “Why do highly industrialized economies like the U.S., succeed economically while some less developed economies with ample resources do poorly?” The study concludes that the difference is that the USA and other industrialized economies enjoy an enormous amount of “intangible wealth.” The rise of intangible wealth bears two distinct consequences. First, in the formation of value, it is increasingly difficult to determine locality of its material components. Guehenno sees the main cause of this development in telecommunication revolution, the network economy and rise in the capacity to be accessed. He claimed, “Someone who has access to the files of the fifty thousand richest people in France is wealthier than a jeweler who owns a gold brooch: as soon as penury disappeared, value, was created in bringing the right offer with the right demand.”341 Second, institutions and institutional settings/environments become dominating force in the global economic system. As David Smick concludes, “Total wealth is an economy involves more than compiling a list a country’s physical and financial assets. Wealth involves intangible assets such as property rights, an honest and efficient judicial system backed by the rule of law, a workable government, an appreciation for and nurturing of human capital, and I would add, a tolerance of and even appreciation for entrepreneurial creativity and risk.”342
338
Jean-Marie Guehenno, 2000, pp. 9. ICT – Information and Communication Technologies, European Commission, Working Program 2007–2008, Draft version 1. Can be access at docs.thinkfree.com/tools/download. php?mode=down&dsn=454628. See also http://www.global-production.com/electronics/trendstudy/. The report also stated, “Information and Communication technologies provide the backbone for the knowledge economy. They account for around half of the productivity growth in modern economies.” 340 Naomi Kline, No Logo, 10th Anniversary Edition, Picador, 2010, pp. 5. 341 Jean-Marie Guehenno, 2000, pp. 8. 342 David M. Smick, The World Is Curved: Hidden Dangers to the Global Economy, Penguin Group, 2008, pp. 85. 339
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In the related literature, these developments were introduced through various descriptions, such as “global information capitalism,”343 “manic capitalism,”344 “turbo-capitalism,”345 or “supra-territorial capitalism,”346 all of which sought to capture the essence of the change in structure of global production and the dynamic of global organization. Yet, most descriptions lack clarity and preciseness either in their descriptions, or in their illustrative language (terminologies). Thus, to avoid similar pseudo observation, or usage of imprecise terminologies let us review the meaning of “change” in the “structure” of global “production,” and hence reached an accurate understand of the notions under consideration. Changes, like disturbances, generally are integral part of natural evolution of any mechanism, which either can be offset by mobilizing strength from other parts of the system or create new set of conditions as a result of their interactions with the other components of the system. Change does occur at all levels – in structure of productions, in social relations, and in political orders and mechanisms of governance. However, the point is that in today global arrangement, the notion of economic “change” is mostly due to change in global economic exchanges. We can no longer considered economics within countries – or what traditionally call “domestic” or “national” – without taken into consideration the nature of the linkages between national economies and the global economy, and alterations in such linkages. In this respect, a change in a country’s production structure often reflects a boarder changes that occurs in the global economic system in a sense that competition (between various economies) for wealth-producing resources occurs in the world market. Central to this argument is the fact that prevailing change in world production structures created both new possibilities for wealth-creation, and new challenges for states as to how to balance the often confliction demands of their national and international agendas. By definition, the structure of an economy is a function of the sum of all the different economic activities in the geo-political boundaries of that area. Respectively, structural features are the outcome of the dynamic interaction of economic, social and political factors, which defined particular periods and are always changing.347 For instance, one of the main structural features of the prevailing global economic system is the explosive growth of the financial system relative to manufacturing and the economy as a whole. Generally, these features may be restructured either by
343
For instance see Eric Louw, The Media and Cultural Production, Sage Publications Ltd, 2001. For instance see Jean Hillier, Jean Hillier, and Emma Rooks, edited, Ashgate Publishing, 2005. In this book “manic capitalism” is described as “a frenetic economic system embodying an intense and uncontrollable dynamic of competitive activity driven as much by corruption, marketeering, speculation, profiteering and mismanagement as by genuine ordered economic exchange,” pp. 96 345 For instance see Edward N. Luttwak, Weidenfeld and Nicolson, Turbo-Capitalism: Winners and Losers in the Global Economy, Harper Perennial, 2000. 346 For instance see by Jan Aart Scholte, Globalization: A Critical Introduction, Palgrave Macmillan, 2000. 347 Joyce Kolko, Restructuring the World Economy, Pantheon Books, 1988, pp. 9 344
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objective forces or by subjective design, which in this case outcome is rarely achieved as intended.348 They also can be introduced by historical events, e.g., economic crisis, by major development in science and technology, or by more change in the political order. However, it is imprudent to formulate a theoretical ground to explain structural features during a pacific period since they are not static and various factors (both within and outside their locality) may alter, reconstructed or even replace them. Having said that, to define the specific character of a period one can and should identify these features in the context of political economy, which deals with production and distribution and consumption of goods and services and their management. In the prevailing global economic system, because of sheer number of economies operating in the global system, the structural features do not evolved in sequential and connected order – an evolutionary process that one can observed and extrapolate into the future – but rather they changed according to their interactions within the global system as whole, which usually resulted in creation entirely a new setting(s). For instance, the wide spreads of financial crises (from 1990s onward) occurred in different geographical locations with quite different governmental structures, create a new feature called global governance as expression of necessity to find new methods of corporation and regulation for collective problems. The global governance created through dialectical interactions349 among major economic powers of global system to prevent or/and manage future crises. What emerges is a new setting that intends to secure a stability of post-change, in which one cannot extrapolate into the future development but rather observed as a spontaneous reaction to concurrent events. Finally, the process of production in the conventional literatures is commonly reviewed and categorized as an economic concept.350 However, to find a mere definition of the term one should go back to Carl Menger’s Principle of Economics published in 1871. Production, according to Menger, is defined as the process of transforming higher-order goods (refer to goods furthest from consumption) into successively lower-order good (refer to goods closer to consumption).351 Menger
348
Ibid. A dialectical interaction usually means that two or more groups [representatives of nation-states, global institutions, etc.] with roughly equal status but alternative viewpoints and interests intend to solve a problem or perform a task. 350 In general, the term production – in German Produktionverhältnisse – refers to those relationships which arise out of the actual production process and also, of course, to ownership relations of which the most important is property. In the domain of conventional economic, the notion of production is perceived as mathematical derivative, which either takes a functional form, i.e., production function, or as curvature arrangement, i.e., production possibility curve, which indicates the different mixes or ranges of goods (usually two) that could be produced if an economy exploited all available workers, technologies, land, capital, and other resources to the full. 351 In terms of terminology used, Mark Skousen explains, “Menger’s choice of terminology ‘higher’ and ‘lower’ orders has been criticized as confusing. Higher order goods may be confused with, e.g., highly finished goods. Perhaps ‘early’ and ‘later’ stages are more appropriate.” See Mark Skousen, The Structure of Production, New York University Press, 1990, pp. 39 ft. 20. 349
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viewed economic production as “the process by which goods of higher order are progressively transformed into goods of lower order and by which these are directed finally to the satisfaction of human needs.”352 Production also bears political flavor, that is, inputs involved in the production of goods and services, or commonly known as factors of production.353 For instance, according to Marx, the most fundamental ownership relation, under capitalism at least, is national bourgeois ownership of the means of production, an ownership, which also manifests itself in a monopoly of political power.354 Ensuing the Marx’s argument, Cox observed, “Production creates the material basis for all form of social existence, and the way in which human efforts are combined in productive process affect all other aspects of social life, including the polity. Production generates the capacity to exercise power.”355 Cox further explains that production is not only taken place through a power relationship, but it “also creates resources that can be transformed into other forms of power – financial, administrative, ideological, military, and police power.”356 In this respect, the control over production process is a direct challenge to authority of a state. Historically, a state acquires its essential material basis from production, which in turn enables it to make a choice regarding various modes of development (prosperity) for the society as a whole. In fact, the core structures of production have been either created, or sustained by any form of state. Competitive capitalistic state “required a liberal state in order to break through the shackles of mercantilism.”357 Bolshevik state created a central planning to nationalized production, that is, state taken over the private production, banking system and the industrial sector. State corporatism of the fascist state, which according to Ludwig von Mises never “tolerates anybody’s interference with [state] absolute control of
352
Carl Menger, The Principle of Economics, Ludwig von Mises Institute, 1976, pp. 67. According to Oxford Dictionary of Politics, “Sir William Petty (1623–1687) first defined land and labour as factors of production. The factors of capital and entrepreneurship were added by the French physiocrats. ‘Land’ includes resources within the land such as mineral deposits like coal and iron ore. Labour is the human effort, whether manual or mental, that contributes to production. Capital is usually denoted as machinery or tools, which are used in combination with labour for the purpose of making goods. There can be fixed or circulating capital. The former relates to goods such as buildings or machinery while the latter refers to the stock of goods a firm has ready for use in the future. Capital is the only factor of production which itself is created in the production process. Entrepreneurship refers to the managerial, innovative, and risk-taking qualities which an individual displays when combining the other factors of production in order to generate output. The returns or payments to each of these factors are rent for land, wage for labour, interest for capital, and profit for entrepreneurship.” See www.answers.com/topic/factors-of-production. 354 See Karl Marx, Capital: A Critique of Political Economy, Chapter one. 355 Robert Coc, 1987, pp. 1. 356 Ibid, pp. 5. Moreover, it is noteworthy that Cox’s description of production trivialized the Marxian view of national bourgeois ownership, since (as we see in the following pages) ownership of factors of production, land and labor in particular, can be owned locally but significant benefits of their production have been sourced out. 357 Ibid. 353
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production.”358 Accordingly, an alteration in a structure of production implies an alteration in authority of state to exercise power, particularly over economic organization over national production. This led us to the next issue of our concern, which concerns with economic organization of a society (or simply organization of production). To address this issue, we go back to basic economic lessons and appeal to three influential economists, Karl Marx, Frank Knight and Paul Samuelson. One of the Marx’s great contributions to the discipline of economics is his realization that distribution of power can only be achieves through change in ownership of means of production, or simply reorganization of production.359 Marx, in his analysis of production, points out that a position of power is only sustainable through ownership of means of production, and to change this position one must reorganizes production. Indeed, it is the relations of production, which determine the distribution of power. “The subdivisions and organization of distribution are determined by the subdivisions and organization of production not only insofar as the [distribution of] material goods are concerned; but also as regards its form, since the definite manner of participation in production determines the particular form of distribution.”360 In this respect, if the objective of various, and often common, economic policies or programs is to address a socio-economic mechanism and achieve progressive redistribution and empowerment, they are ill equipped and policy-makers are misinformed. This is the historical lesson that hardly ever has been learned. Knight’s understanding of economics, as expressed in The Economic Organization, is short and to the point, “Economics deals with the social organization of economic activity.”361 For Knight, the problem of organization, which sets the problem of economics, therefore, “deals with the concrete means or mechanism for dividing the general function of making a living for people into parts and bringing about the performance of these parts in due proportion and harmony. More specifically, it is a problem of social machinery for accomplishing five fairly distinct functions.”362
358
Ludwig von Mises, 2nd edition, Socialism: An Economic and Sociological Analysis, translated by J. Kahane, Liberty, Indianapolis, 1932, pp. 527. 359 As we will show later, the concept of internationalization of resources, that is, reorganization of production and its ownership (from national sovereign state to international economic entities) is an ample example of such redistribution of power from national authorities to international sources, e.g., corporations. 360 Karl Marx, A Contribution to the Critique of Political Economy, translated from the Second Edition by N. I. Stone, Charles H. Kerr and Company, Chicago, 1904, pp. 284. 361 Frank Knight, The Economic Organization, Harper and Row Publishers, 1933, pp. 6 (italics in original). 362 Ibid, pp. 7 (italics in original). The reader should note that Roos Emmett used the exact quotation to illustrate why Knight does not perceived economics as a equivalent to the science of rational action. As Emmett observed, “The first reason Knight gives is that economics deals with social organization of human economizing activity – ‘the concrete means or mechanism for dividing the general function of making a living for the people into parts and bringing about the performance of these parts in due proportion and harmony’ – rather than with the process of making a living itself.” See Roos B. Emmett, Frank Knight and the Chicago School in American Economics, Taylor and Francis, Inc. 2009, pp. 166.
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For our purposes here, we only focus on the second function, the function of organizing production, which implies “putting them [production] to use in accordance with the scale of values thus established.” Knight breaks this function into two features (a) the assignment or allocation of the available productive forces and materials among the various lines of industry, and (b) the effective coordination of the various means of production in each industry into such a groupings as will produce the greater result.”363 While, Knight did not explicitly indicate who is responsible to conduct these tasks, his definition of economics as a social organization and his trust on a liberal society means that the capable body to take on such responsibility and to exercise power over the economy is the state. Accordingly, a state that is incapable to exercise power over the economic affairs will eventually failed not only to meet, but also to conduct, these tasks. Finally, in 1948, Paul Samuelson in his introductory economics textbook, underlined the fundamental problem of economic organization, in which he explains, “Any society, whether it consists of a totally collectivized communistic state, a tribe of South Sea Islanders, a capitalistic industrial nation, A Swiss Family Robinson or Robinson Crusoe, and one might almost add, a colony of bees, must somehow meet three fundamental economic problems. (1) What commodities shall be produced and in what quantities? That is, how much and which of many alternative goods and services shall be produced? (2) How shall they be produced? That is by whom and with what resources and in what technological manner are they to be produced? (3) For whom are they to be produced? That is, who is to enjoy and get the benefit of the goods and services provided? Or, to put the same thing in another way, how is the total of national product to be distributed among different individuals and families?”364 Samuelson concern with the fundamental problem of economic organization was with; what should be produced in the economy; how within the existing factors of production (land, labor, capital, and technology) should be produced; and for whom the output should be produced. In short, who does what to whom and who must paid for it?365 Addressing the Samuelson’s questions, in turn, paved the path to the fundamental realization of the global economic system. There is the global production structure, in which power is exercised over what is to be produced, where, and by whom on what terms and conditions. Another way of saying the same thing is that power is exercised, within and across national boundaries, by those who are in position to change structure of production and organization of an economy for their own advantage.
363
Ibid, pp. 10 (italics in original). Paul Samuelson, Economics: The Original 1948 Edition, first edition, McGraw-Hill/Irwin, 1997, pp. 12–13. 365 It should be noted that the interpretation of these issues is matter of expertise and field of studies. For instance, in political science the issue concerning for whom deals with whose interest are being served (through policy decisions and formulation) and Whose welfare is being ignored (See Eyal Benvenisti and Georg Nolte, edited, The Welfare State, Globalization, and International Law, Springer-Verlag, 2007; and Dexter Whitfield, Public Services Or Corporate Welfare: Rethinking the Nation State in the Global Economy, Pluto Press, 2001). 364
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Contributing Factors to Change in Structure of Global Production The change in structure of global production can be direct result of several factors, e.g., declined in transportation cost, advancements in technology, significant of service industry, but most importantly the rise of global production sharing, as a new form of production.366 This new form as Wim Naude suggested, is unbundling of production processes, which enable firms greater mobility and increased spatial concentration of industry.367 In the related literature, this new form of production is known as international sourcing in which “a good may be assembled in one country from components produced in other countries, and these in turn may be assembled
366
Some authors used the notion of Internationalization, to illustrate various denotations and implies numerous connotations, all of which depend on the context, in which the notion is defined. Respectively, the term used here is utterly different from terms like internationalization of production, which is measured by the ratio of direct investment abroad to domestic wealth or assets, or of assets or employment abroad to that at home (see Robert E. Lipsey, “The Internationalization of Production,” NBER Working paper no. 2923, April 1989). The term is also used to illustrates submissiveness of national policies to international order (see Robert O. Keohane and Helen V. Milner, edited, Internationalization and Domestic Politics, Cambridge University Press, 1996) or generally applied in business and management field (see David Frederick Ross, Distribution: Planning and Control – Managing in the Era of Supply Chain Management, 2nd edition, Springer Netherlands, 2004, pp. 683). By the same token, international sourcing can be equivalent of several commonly used terminologies like outsourcing. According to CIO site, “There are as many definitions of outsourcing as there are ways to screw it up. But at its most basic, outsourcing is simply the farming out of services to a third party. With regards to information technology, outsourcing can include anything from outsourcing all management of IT to an IBM (IBM) or HP, to outsourcing a very small and easily defined service, such as disaster recovery or data storage, and everything in between. The term outsourcing is often used interchangeably – and incorrectly – with offshoring, usually by those in a heated debate. Offshoring (or, more accurately, offshore outsourcing) is, in fact, a small but important subset of outsourcing: It’s where a company outsources services to a third party in a country other than the one in which the client company is based, primarily to take advantage of lower labor costs. Offshoring has proven to be a political hot potato because unlike domestic outsourcing, in which employees often have the opportunity to keep their jobs and transfer to the outsourcer, offshore outsourcing is more likely to result in layoffs (See http://www.cio.com/article/40380/Outsourcing_Definition_and_Solutions#1). Finally, there are still more terminologies that implies the similar connotations, terms such as licensing; direct investment; joint venture; and a new growing phenomenon of late 1980s – the establishment of new venture that are international from inception, often raise capital and sell products on several continents – known as new international venture (NIV). For more information on NIV see Benjamin M Oviatt’ and Patricia Phillips McDougall, “Toward a theory of international new venture,” Journal of international Business Studies, 2005, vol. 36, pp. 29–41. For definition of various terms see Richard L. Daft, Management, 9th edition, South Western Educational, 2009. 367 Wim Naudé, “New Challenges for Industrial Policy,” UNU-WIDER, working paper no. 2010/107 September 2010.
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from subcomponents produced in yet other countries.”368 For instance, Volkswagen’s international sourcing network covers four continents, from Asia to Africa and from Europe to North and South America.369 Another example of international sourcing can be found in Joseph Stiglitz’s Principle of Macroeconomic textbook in which he illustrated that the production of a Ford Escort in Europe involves 13th European countries plus Japan and the USA.370 David Levy’s work on international production and sourcing in OECD economies also illustrated that the ratio of goods sourced aboard to goods sourced nationally continuously increased in each of the survey countries.371 The process of international sourcing bears significant consequences, most importantly among them is the affect it has on a national government to the extent that state’s authority to exercise power over the national economic affairs and structure has diminished. Of course, the observation that the territorial boundaries of sates no longer coincide with authority over economy is not original. Indeed, similar opinions are on rise since study of globalization enters into its maturity and consequences of the single economic system become more apparent both in their formation and their impact. Held and McGrew called subscribers of this view, “hyper-globalizers” who “argue that economic globalization is bringing about a ‘denationalization’ of economies through the establishment of transnational networks of production, trade and finance.”372 Mann also observed that, “For much of the world a true nation-state remains more aspiration for the future than present reality.”373
368
Wolfgang H. Reinicke, Global Public Policy; Governing without Government, Brooking Institutions Press, 1998, pp. 27–8. The reader should note that international sourcing trends are also observed by many scholars. For instance, Paul Krugman, Richard N. Cooper, and T. N. Srinivasan noted that as a result of international sourcing, the trade involve in the global production of a finished good may easily be several time the value added through all the stages of its production, or what they called the slicing-up of value added (See Paul Krugman Richard N. Cooper, T. N. Srinivasan, “Growing World Trade: Causes and Consequences,” Brookings Papers on Economic Activity, vol. 1995, no. 1, 25th Anniversary Issue, 1995, pp. 327–377.) Finally, for more information on international sourcing strategies see Per Servais, “International Sourcing: Entering and Exiting Different Networks,” in C. P. Rao, edit, Globalization and Its Managerial Implication, ABC-Clio, 2000. In this paper, Servais, discusses the complexities on international sourcing strategies by proposing and outlining a portfolio model with a network approach. 369 Manfred B. Steger, Globalization: A Brief insight, Sterling, 2009, pp. 65. 370 Joseph E. Stiglitz, 2nd edition, Principle of Macroeconomic, W. W. Norton, 1997, pp. 49, Fig. 2.7. 371 David Levy, “international Production and Sourcing: trends and Issues,” Science Technology and Industry Review, no. 13, December 1993, pp. 31, Table 1. 372 David Held and Anthony McGrew, 1999, pp. 3. See also Saskia Sassen, “Globalization or denationalization,” Review of International Political Economy, 2001, Vol. 10, Issue 1, pp. 1–22; Michael Z Rn, “Globalization and global governance: from societal to political denationalization,” European Review, 2003, vol. 11, issue 03, pp. 341–364; Markus Jachtenfuchs, “The monopoly of legitimate force: denationalization or business as usual,” European Review, 2005, vol. 13, issue S1, pp. 37–52; and Michael Zurn, with assistance from Gregor Walter, Edited, Globalizing Interests: Pressure groups and Denationalization, State University of New York, 2006. 373 Michael Mann, “Has Globalization Ended the Rise and Rise of the Nation-State,” pp. 137, in David Held and Anthony McGrew, edited, The Global Transformations Reader: An Introduction to the Globalization Debate, 2nd Edition, Polity Press, 2001.
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Manns’ sentiment, however, does not accurately reflect the view we hold or advocate in this book. Our perception is not based on the notion that a nation-state has become redundant or outdated, but rather built on the observation that role of the state in managing economic affairs has declined significantly (in the prevailing structure of global production).374 This view is supported by both critics of globalization as well as leading political scientists like Robert Gilpin or prominent liberal politicians like Vincent Cable. Gilpin believed that “a profound shift is taking place from a state-dominated to a market-dominated international economy.”375 Gilpin further points out that “the impact of the global economy on individual nations is highly uneven,… While globalization has reduced some policy option, the degree of reduction is highly dependent on national size and economic power.”376 Similarly, Cable observed, “some companies have moved beyond the stage of having subsidiaries in a variety of market (what have been called ‘multidomestic’ companies) to becoming globally integrated, exploiting advantages of communications technologies and flexible production methods to achieve major economies of scope and coordination, as well as scale. An example is the recent change in the Ford Motor Company’s strategy to produce ‘global’ cars from its several European and American operations.”377 It is obvious that any assessment of a change in structure of global production and its impact on nation-state is daunting task that entails extreme caution in approach and analysis of the subject.378 Having said that, however, we must analyze syntax of what is occurring, instead of what “we” hope to occur. In this respect, the prevailing notion of economic interdependence is much-misused concept. For one thing, in the prevailing global environment economic interdependence is the fact. In this context, interdependence necessarily involved closer interaction between nation-states, between nation-states and international organizations, e.g., WTO, between nationstates and firms (including domestic and foreign as well as transnational corporations), and between firms and other firms. These interactions necessarily entail negotiation of the terms of a transaction or agreement. Some of these bargaining are
374
For instance, state is still in position to used armed force or not to use it; it has also the right to tax and to print national currency. 375 Robert Gilpin, Global Political Economy: Understanding the International Economic Order, Princeton University Press, 2001, pp. 8. 376 Robert Gilpin, “The Nation-State in the Global Economy,” pp. 351, in David Held and Anthony McGrew, edited, The Global Transformations Reader: An Introduction to the Globalization Debate, 2nd Edition, Polity Press, 2001. Gilpin, further elaborate (and not explains) that the USA and Western Europe are much less vulnerable to such reduction in “policy option” than are small economies. 377 Vincent Cable, “The diminished nation-state: A study in the loss of economic power,” Daedalus, Spring 1995, 124, 2; Alumni-Research Library, pp. 30 378 For instance, we refer the reader to Michael Mann, who supports the notion of declined of nation-state authority, but caution us to distinguish: (a) differential impacts on different types of state in different regions; (b) trends weakening and some trends strengthening nation-states; (c) trends displacing national regulation to inter-national as well as to transnational networks; (d) trends simultaneously strengthening nation-states and transnationalism (see Michael Mann, 2001, pp. 145).
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struck within boundaries of the countries, and therefore bear the flavor of “domestic policy option.” However, the overwhelming portion of these interactions take place outside national foundries, e.g., between various states representatives or between these representatives and international organizations, and hence must be examined and understood in terms of the current international system/order and transnational politics. Under this circumstance, asymmetry of governmental power is bounded to happen and has been a topic of debates for more than 50 years.379 Accordingly, decline in nation-states authority over national economies, in terms of what, how and for whom to produce, is the uncontested fact in globalized economic system. Respectively, various scholars and academicians with divers ideological background and affiliations also express the above observation. The only differences among them are their realm of interest and ideas they try to convey to their audiences. For instance, Stopford and Strange explains, “No longer can national boundaries define the rule, for the game is now one where negotiation and action is carried out on triangular basis. The traditional players in the embassies and foreign ministers are still in business, but they have been joined by members of other government ministers and by the executive of firms, both local and multinational. All are now involved in both bilateral and multilateral negotiation.”380 Similar sentiments, which indicate nation-states lost their autonomy and power over their national economic affairs, can also be find among conformist thinkers. Milner and Keohane observed “change in the world economy can alter domestic politics: by creating new policy preferences and coalitions, by triggering domestic economic and political crisis, and by undermining government control.”381 Vincent Cable the current Business Secretary in British Government, in his research for the Royal Institute of International Affairs, underlined two main developments in globalized world, one of which is change in the policy environment, or as he called it “liberalization revolution.” According to Cable, the liberalization revolution “freeing up of markets and reduction in the role of government in terms of ownership and control over production of goods and services.”382 Elsewhere, Cable elaborates on the foundation of his
379
For instance, the literature on the European Community, pioneered by Ernst B. Hass, focused on how economic interdependence affected arrangements for governance (see Ernst B. Hass, The Uniting of Europe: Political, Economic, and Social Forces, 1950–1957, Stanford University Press, 1958). Moreover, Karl Kaiser, in 1971 was the first to open discussion on the meaning and significant of interdependence, and pointed to the asymmetry of government power in transnational politics (see Karl Kaiser, “Transnational Politics: Toward a Theory of Multinational Politics,” International Organization, vol. 25, 1971, pp. 790–817). Later on, in 1977 Keohane and Nye illustrated that interdependence is frequently asymmetrical and highly political: indeed, asymmetries in interdependence generate power resources for both state and nonstate actors (see Robert O. Keohane and Joseph S. Nye, Power and interdependence). 380 John M. Stopford and Susan Strange, Rival States, Rival Firms: Competition for World Market Shares, Cambridge University Press, 1991, pp. 21. 381 Robert O. Keohane and Helen V. Milner, edt, Internationalization and Domestic Politics, Cambridge Studies in Comparative Politics, Cambridge University Press, 1996, pp. 243. 382 Vincent Cable, Globalization: Rules and Standards for the World Economy, The Royal Institute of International Affairs, Cassell, 1999, pp. 15.
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thinking, “[t]he sheer scale of profit-seeking finance capital that can be mobilized in currency markets far exceeds what any government, or even governments acting in concert can put against it. Foreign exchange trading in the world’s financial centers exceeds a trillion dollars a day, a multiple of 50 times, or more, of the daily amount of world trade and greater than the total stock of foreign exchange reserves held by all governments.”383 Guehenno described all that survives, in the prevailing global landscape, “are a plethora of governmental apparatuses, which function according to a patrimonial model of power that is increasingly being liberated from its national dimension.”384 He then continues, “the economy of drug is a good illustration of this bypassing of state by transnational games that are more powerful than are the states themselves. Everywhere that the state is weaken or the climatic conditions are favorable, drugs take root, profoundly transforming society.”385 Paul and Ikenberry, the well-known advocates of nation-state, also indulged the notion of nation-state demised and observed, “Liberalism before nationalism may allow for containment – that is. Respect for historical liberties might allow multinational frames to exist. Voice might create loyalty and so rule out the attraction of exist. Differently put, multinational entities rather than homogeneous nation-states may after all be possible.”386 Oscar Schachter takes on a different angle but makes the similar conclusion by claiming, “A new business class tends to identify itself with the global aims of its transnational companies rather than with the political objectives of its particular countries. The state no longer command the primary allegiance of this class though businessmen will still turn to the state for intervention when it seems useful.”387 The point we are trying to convey is merely the notion that suggests that decline in national authority to exercise power over the economy should be considered as the natural evolution of the prevailing conditions of globalized economic system.
383
Vincent Cable, “The diminished nation-state: A study in the loss of economic power,” Daedalus, Spring 1995, vol. 124, no. 2, pp. 27. 384 Jean-Marie Guehenno, 1st edition, End of the Nation-State, University Of Minnesota Press, 2000, pp. 3. 385 Ibid. 386 T. V. Paul, G. John Ikenberry, The Nation-State in Question, Princeton University Press, 2003, pp. 4. 387 Oscar Schachter, “The Decline of the nation-State and its Implication for International Law,” pp. 16. in Jonathan I. Charney, Donald K. Anton and Mary Allen O’Connell, edit, Politics, Values and Functions: International Law in the 21st century, Kluwer Law International, 1997.
Chapter 3
“Good Governance,” Institutions, and Global Rules
Concept of “Good Governance” The 1980s end with many scholars and practitioners of economic transition and development expressed real alarm about the failure of prescribed economic policies, e.g., structural adjustment, of so many economies to reap the fruits of a decade stringent reform.1 Thus, came the question: “Why is it that even when the recommended policies were implemented (often under the guidance of conditionalities from the IMF and the World Bank), the results hoped did not materialized?” By 1990s the consensus emerged that underlined the importance of institutional economics, and hence a plausible explanation for the 1980s failures discovered – economies taking on reforms simply did not have adequate institutional depth and capacity.2 In short, the answer to 1980s failures was “institutional weakness” or “bad governance” to
1
For instance see G. Corina, R. Jolly and F. Stewart, eds, Adjustment with Human Face (2 Vols), Clarendon Press, 1987; Joan M. Nelson, ed, Economic crisis and policy choice: the politics of adjustment in the third world, Princeton University Press, 1990; and Paul Mosley, Jane Harrigan and John Toye. Aid and Power: The World Bank and Policy-Based Lending (2 Vols), Routledge, 1991. However, the reader should note that if the 1980s programs and policies are examined in light of their “implicit objectives,” then they do illustrate tremendous success. For instance, adjustment programs facilitated opened up national economies, liberalized balance of payment system, which in turn facilitates capital in-flows and out-flows, and created middle class that did not existed prior to these programs, all of which indicates successful implementation. For more information see, for instance, Lynn Ilon, “Structural adjustment and education: Adapting to a growing global market”, International Journal of Educational Development, vol. 14, Issue 2, April 1994, pp. 95–108; Ibrahim Saif and Yasmeen Tabbaa, “Economic Growth, Income Distribution and the Middle Class in Jordan (2002–2006)”, Center for Strategic Studies, University of Jordan, 2008; V. Eudine Barriteau, “Structural Adjustment Policies in the Caribbean: A Feminist Perspective”, NWSA Journal, Vol. 8, no. 1, Global Perspectives (Spring, 1996), pp. 142–156; and Martin Carnoy and Carlos Torres, “Educational Change and Structural Adjustment: A Case of Costa Rica”, UNESCO, Bureau for the Co-ordination of Operational Activities (BAO), Paris, September 1992. 2 Loan. M Nelson, ed, Intricate Links: Democratiation and Market Reforms in Latin America and Eastern Europe, Transaction, 1994. E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0_3, © Springer Science+Business Media, LLC 2012
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the extent the World Bank declared, “Underlying the litany of Africa’s development problems is a crisis of governance.”3 Oliver Williamson reflected these sentiments when he observed “There is growing consensus that the institutional environment (laws, polity, etc.) and the institutions of governance (markets, hierarchies, etc.) matter a lot and in ways that are pertinent to industrial organization and much else, such as economic history, comparative economic system, labor economics, economic development and reform, health care, business strategy, multinational business, and even aspect of corporate finance.”4 Coincidently, importance of institutional thinking was also reinforced by two developments. First, general interest was revived in institutional school – from Nobel-prize winning economists, to international relations experts.5 Second, and more importantly, the emphasis on institutional building and governance emerged because of worldwide interest in democracy and democratization in the wake of end of the bipolar global order.6 Respectively, the notion of “good governance” begun to be perceived not only as a necessary condition to implement effective reforms but also as a concept, an ideal if you will, that fitted well with a new rhetoric about democratic participation, transparency, and accountability.7 As Umpleby observed, “The current discussions of an emerging global economy remind me that we are living in a time when people feel that progress is possible and that each individual can make a difference. These are quite modern beliefs. It is also apparent that many people sincerely would like to devote at least a part of their lives to improving life
3
See World Bank, Sub-Saharan Africa: From crisis to sustainable growth, World Bank, Washington, 1989, p 60. Many believed that this publication should be considered as the kick-off for the process of embracing governance issues in the development debate. 4 Oliver E. Williamson, The Mechanism of Governance, Oxford University Press, 1999, pp. 4. 5 Douglas North, Institutions, Institutional Change and Economic Performance, Cambridge University Press, 1990; Robert Keohane, International institutions and state power, Westview University Press, 1989; John Mearsheimer, “The false promise of international institutions”, International Security, vol. 19, no. 3, 1994/5, pp. 5–49; Eva Bertram, “Reinventing Government: The Promise and Perils of Peace building,” Journal of Conflict Resolution, Vol. 39, No. 3, September 1995, pp. 387–418. 6 Larry Diamond, Promoting democracy in the 1990s; actors, instruments, issues and imperative, Carnegie, 1995; Doll Chull Shin, “On the third wave of democratization: a synthesis and evaluation of recent theory and research”, World Politics, vol. 47, no, 1, 1994, pp. 135–170. 7 As one would have thought, there is a significant cynicism in term of the compatibility between democracy and good governance, which surprisingly goes back to centuries ago. As an example, one can points to the passage “For forms of government let fools contest, That which is best administered is best,” which is a paraphrase of Alexander Pope’s An Essay On Man, which Alexander Hamilton (author of Federalist No. 68) uses to talk about the Presidential selection process as a model for producing good administration. In Pope, That which is replaced by Whatever. John Adams, also described Pope’s aphorism, “flattery for tyrants” and stated, “Nothing can be more fallacious than this: But poets read history to collect flowers not fruits – they attend to fanciful images, not the effects of social institutions. Nothing is more certain from the history of nations, and the nature of man, than that some forms of government are better fitted for being well administered than others.” (See John Adam, Thoughts on Government, Chap. 4, document 5. Available at http://press-pubs.uchicago.edu/founders/documents/v1ch4s5.html).
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for other people.”8 Aligned with these inclinations, a whole new literature and set of prescription about governance and good governance was unleashed. In some agencies, the corporate language dominated the new idea of “governance” or “good governance,” which simply implies good quality management.9 This narrow definition of governance, while ensuring the necessary framework of policy and institutions for market to flourish, placed constrain on the role of state. Apparently, the main reason for limiting the role of state was rapid increase in incidence of corruption within states, as Michel Camdessus observed, “in a world in which private capital has become more mobile, there is mounting evidence that corruption undermines the confidence of the most serious investors and adversely affects private capital inflows.”10 Institution, in this view, exist only to correct imperfections in the marketplace, and to provide a limited range of what economists define as “public good.” A slightly broader version of this definition emphasized the need to strength the “institutional capacity of the state,” through, for instance, efficiency, rationality, and training.11 A broader perception, and hence an alternative understanding of good governance links institutions and society with wider conception of government. In this view, governance is concerned, as Oran Young defines it, with the “establishment and operation of…the rules of the game that serve to define social practices, assign roles, and guide interaction.”12 This broader notion of governance, however, entails involved parties (scholars, practitioners, international organizations, etc.) to draw upon political and sociological literatures, which are necessary to not only reflect, but also mediate the vast and competing array of interests in a democratic society.13
8
Stuart A. Umpleby, “Strategies for Regulating the Global Economy”, Future, December 1989, pp. 585. 9 IMF, Good Governance: The IMF’s role, Washington, D.C., IMF, 1997; Edgardo Boeninger, “Governance and Development: issue and constraint”, Proceeding of the World Bank Annual Conference on Development Economics, Washington, D.C., World bank, 1991. 10 The IMF and Good Governance, Address by Michel Camdessus, Managing Director of the International Monetary Fund at Transparency International, Paris, France, January 21, 1998. Moreover, IMF studies have shown that where governance is poor, domestic investment and growth suffer. See, for example, Mauro, Paulo, “Why Worry About Corruption” Economic Issue No. 6, Washington, D.C., February 1997. 11 P. Landell-Mills and I. Serageldin, “Governance and the External factors”, Proceeding of the World bank Annual Conference on Development Economics, Washington, D.C., World bank, 1991; A. Israel, “the Changing Role of the State: Institutional Dimensions”, PPR Working Paper WPS 495, Washington, D.C., World bank, 1990. 12 Oran Young, International governance; protecting the environment in a stateless society, Cornel University Press, 1994, pp. 15. 13 Leila Frischtak, “Governance capacity and economic reform in developing countries”, World bank Technical paper no. 254, Washington, D.C., World bank, 1994; Fernando Calderon, “Governance, competitiveness and social integration”, CEPAL Review, December 1995, pp. 45–6; G. Hyden, “Creating an enabling environment” and “The changing context of institutional development in Sub-Sahara Africa”, in the Long term perspective study of Sub-Sahara Africa: Institutional and Socio-Political Issues (Volume 3), Washington D. C., World bank, 1990.
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As a direct result of wider understanding of governance, different and more broaden approaches have emerged, perceptions begun to change, and more comprehensive indictors are designed. For instance, the approach to achieve both good governance and socio-economic development is based on the assumption that a conscious link needs to be made between economic growth and human welfare and such connection cannot be left to market mechanism.14 The perceptions of what governance means has augmented. UNDP, for instance, states that governance is, “The exercise of political, economic, and administrative authority in the management of a country’s affairs at all levels: comprising the complex mechanisms, processes, and institutions through which citizens and groups articulate their interests, mediate their differences, and exercise their legal rights and obligations.”15 Finally, international organization such as the World Bank is driving a check-list of factors which, in their experience, are useful indicators of “good governance,” these include key principles such as participation, accountability, and fairness.16 Over this time, these developments in addition to daunting global problems such as series of financial crises or the climate change and ozone depletion soften the more stringent attitudes, and eventually have link the literatures about governance, good governance, and institutions to international organizations.17 This nexus also provides analysts ample incentives to examine the prevailing interaction between nations-states and international organizations, and highlighted the importance of the mechanism that constitutes the concept of control at the distance, which can occur through legal bindings, regulations, standardizations, etc. For instance, Abbott and Snidal used the rational choice tradition to illustrate this notion by emphasizing on hard and soft law in international governance.18 Like most similar rational/economic models19 that focus on interest and intentionality, Abbott and Snidal assumed nation-states as rational actors with clear, consistent, stable goals, scoring high on rational calculation and social control and hence able to fulfill their interest. Principle-agent theory employed to explore the dialectic of control and autonomy in the relationship between states and
14
This kind of thinking were heavily influenced by the works of Amartya Sen, Paul Streeten, and Mahbubul Huq, which questions the sole focus on economic growth and instead proposes a broader concept of development that includes expanding choices in social, political, and economic realms. (See John Degnbol-Martinuissen, Policies, Institutions and Industrial Development: Coping with Liberalisation and International Competition in India, Sage Ltd, 2001.) 15 UNDP, Governance for Sustainable Development, New York. UNDP Policy Document, 1997. 16 World Bank, Governance and Development, Washington D. C., World bank, 1992; World Bank, Governance: The World Bank’s Experience Washington D. C., World Bank, 1994. 17 The clearest attempt is probably Commission on Global Governance, Our Global Neighborhood, Oxford University Press, 1995. 18 See, for instance, Kenneth W. Abbott, and Duncan Snidal Duncan, “Hard and Soft Law in International Governance,” International Organization, vol. 54, no. 3, Summer 2000, pp. 421–56. 19 For a detail examination of these model, see R. Dahl and C. Lindblom, Politics, Economics and Welfare, Harper & Row, 1953.
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international organizations.20 However, in general, the principle-agent theory “has especially focus on formal institutional design of delegation and on when and why political executives create agencies and transfer formal power to them.”21 It should be noted that the institutional perspective challenges the authority of the rational and principle agent models and rejects the functional view of agencies underlying the rational approach. For instance, Brunsson and Olson embraced the idea that reforms are the result of attempts at modernization, shifts in administrative fashions, the existence of insoluble administrative problems in organizations, and the organizational tendency to forget previous reform.22 The Literature on regulation and regulatory capitalism has concentrated on the hybrid and disaggregated character of the prevailing regulation.23 While regulations are commonly perceived to be designed and implemented by the state, there is growing focus on private regulation of the public sector from distance.24 In sociological and public choice domains, concept like networks is used to identify and respond to the potential problems of government networks (by suggesting means to increase their accountability and proposing norms to govern the relationship of members of government networks with one another), or develop the concept of disaggregated sovereignty (by arguing that government networks have the capacity to enter into international regulatory regimes of various types and thereby are independently bound by the existing corpus of international law).25 Poststructuralist concepts like Foucauldian governmentality is used to underline the way power is perceived and can operate through very dissimilar and even disaggregate practices and discourses.26 For instance, governmentality can be compared to sovereignty in a sense that it can
20
See, for instance, Darren G. Hawkins, David A. Lake, Daniel L. Nielson, Michael J. Tierney, edit., “Delegation under Anarchy: States, International Organization, and Principle Agent Theory”, in Darren G. Hawkins, David A. Lake, Daniel L. Nielson, Michael J. Tierney, edit., Delegation and Agency in International Organization, Cambridge University Press, 2006, pp. 3–38. 21 Tom Christensen and Per Laegreid, “Agencification and Regulatory Reforms” in Tom Christensen and Per Laegreid, eds, Autonomy and Regulation: Coping with Agencies in the Modern States, 2006, pp. 16. 22 See Nils Brunsson and Johan. P. Olson, The Reforming Organization, Handelshojskolens Forlag, 1997. 23 See, for instance, David Levi-Faur, “The Global Diffusion of Regulatory Capitalism.” The Annals of the American Academy of Political and Social Science, 2005, vol. 598, pp. 12–32. In this paper, authors suggest that change in the governance of global economy is best captured by reference to (1) a new division of labor between state and society (e.g., privatization), (2) an increase in delegation, (3) proliferation of new technologies of regulation, (4) formalization of interinstitutional and intrainstitutional arrangements of regulation, and (5) growth in the influence of experts in general, and of international networks of experts in particular. 24 See, for instance, C. Scott, “Private Regulation of the Public Sector: A neglected Facet of Contemporary of Governance”, Journal of Law and Society, Vol. 29, no. 1, 2002, pp. 56–76. 25 Anne-Marie Slaughter, “Disaggregated Sovereignty: Towards the Public Accountability of Global Government Networks,” Government and Opposition. Vol. 39, no. 2, Spring 2004, pp. 160–90. 26 Wendy Larne, Global Governmentality: governing international spaces, Routledge, 2004.
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be perceived as a different regime of power, which concerns “how to perpetuate one’s rule over a given territory and its subjects”; or in light of the contemporary discourse concerning globalization and global governance, “state is not necessary or logical center but one among many historical configuration of government.”27 Faced with new predicaments, the notion of good governance is being challenged in two fronts. At the global level, nonstate actors and power global lobbies such as financial institutions transforming the very foundations of world order and the place of nation-state within it. At a more conceptual level, where the good governance agendas can be applied to prescribe democracy (greater participation), accountability, and transparency among nation-states, resistances have been built. Various actors are contesting the credibility/legitimacy of the idea of good governance, which they perceived it as a linear, top-down model with predefined objectives and messages to persuade individual nation-states to change – instead of a more horizontal, open-ended one to engage nation-states in defining goals and participate on it. Put it differently, “if good governance is largely about strengthening citizens’ voices on the demand side, which in turn will also help enhance accountability and transparency on the supply side, it is clear that the traditional conception of communication – transmitting messages through given channels to ‘target audiences’ – is not enough to achieve the intended results.”28 More importantly, and despite the ways in which legitimacy can be seen as important in traditional international relation setting, some may argue that the premade prescription of good governance often neglect to take into account that notions sugh as democracy, accountability, and transparency are not absolute, and hence they may perceive differently in many traditional domestic authority structures. However, and in respond, one can point to the disaggregated character of global governance. Unlike the 1980s experience, e.g., structural adjustment, where economic isomorphism did occur through coercive pressure such as conditionality, the today notion of good governance is closely related to soliciting consent or selfregulation. To confirm this observation, we point to various studies in which “the role of global civil society has been explored, typologies of accountability and legitimacy have been identified, conceptions of democracy that can be applied to global governance have been developed, and a greater deal of empirical work on the role that these play in particular issue has been carried out.”29
27
Ibid, pp. 3 and 4, respectively. Paolo Mefalopulos, “A Major Challenge in Good Governance: The End of Communication as We Know It (Part I), World Bank, Oct 20, 2008, at http://blogs.worldbank.org/publicsphere/majorchallenge-good-governance-end-communication-we-know-it-part-i. 29 Tony Porter, “Global Governance Theories, Complexity, and the Post-Crisis International Financial Architecture”, Paper prepared for International Studies Association Annual Meeting, New York, February 16, 2009, pp. 5. For examples of these studies see: John S. Dryzek, “Transnational Democracy in an Insecure World”, International Political Science Review, Vol. 27, no.2, April 2006, pp. 101–119; Ruth W. Grant and Robert O Keohane, “Accountability and Abuses of Power in World Politics”, American Political Science Review Vol. 99, no. 1, February 2005, pp. 29–43; David Held, Democracy and the Global Order: From the Modern State to Cosmopolitan Governance, Polity, 1995; and Tony Porter and Ronit Karsten, eds., The Challenges of Global Business Authority: Democratic Renewal, Stalemate, or Decay? State University of New York Press, 2010. 28
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All things considered, advocating good governance raises a host of questions, most significant of which deal with what needs to be done, and how it needs to be done. Achieving good governance calls for improvements in all aspect of the mechanism of governance that virtually includes entire aspects of the public sector. However, in the context of this book, we call attention to the importance of institutional environments that set the rules of the game for economic and political interaction. And yet, the reader should note that the immense difficulty of changing the institutional environments in order to achieve set of objectives, including good governance, helps explain North’s conclusion that “economic history is overwhelmingly a story of economies that failed.”30 Institutional environment can be viewed as a concept that deals with ways in which social phenomena develop. In this respect, institutional environment is perceived as a social constructivist approach “focusing on external norms and different ways of constructing and interpreting regulatory reality.”31 The general argument is that normative structures lead to symbolic diffusion and borrowing of the autonomous regulatory form.
Institutional Environment: Rules of the Game While institutions are perceived differently among scholars and practitioners, there is a consensus that most views fall within two categories, namely, institutional environment (or as Williamson called “rules of the game”), and institutions of governance, which is more micro-analytic such as markets, hierarchies, hybrid, etc. The differences between institutional environment and institutions of governance were highlighted by Williamson, as he observed, “One of the salient differences between the institutional environment and the institutions of governance is that the former mainly defines – can be thought of as constraints on – the environment of the latter… The second difference is that the level of individual transactions. The institutions of governance operate at the level of individual transactions, whereas the institutional environment is more concerned with composite levels of activity… And the third difference is that the two operate differently with respect to intentionality.”32 This book is mainly concerned with institutional environment. For purpose of clarity and issues involved, we chose the following descriptions in order to illuminate the concept, and more importantly to conceive the idea that institutions are the mechanisms of governance.33 In this respect, we start with one of the founding father
30
Douglas North, “Institutions”, Journal of Economic Perspective, vol. 5, Winter 1991, p. 98. Tom Christensen and Per Lægreid, “Agencification and Regulatory Reforms”, Paper prepared for the SCANCOR/SOG workshop on “Automization of the state: From integrated administrative models to single purpose organizations”. Stanford University, April 1–2 2005, pp. 12. 32 Oliver E. Williamson, The Mechanism of Governance, Oxford University Press, 1999, pp. 5. 33 For an interested reading on this topic see also Oliver E. Williamson, “Economic Institutions: Spontaneous and Intentional Governance”, Journal of Law, Economics, & Organization, Vol. 7, Special Issue: [Papers from the Conference on the New Science of Organization], January 1991, pp. 159–187. 31
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of the institutional school. According to Douglas North, institutions are “the humanly devise constraints that structure political, economic, and social interactions. They consist of both informal constraints (sanctions, taboos, customs, tradition, and code of conduct) and formal rules (constitutions, laws, property rights).”34 Elsewhere he argues that “institutions consist of a set of constraints on behavior in the form of rules and regulations; and, finally, a set of moral, ethical, behavioral norms which define the contours and the constrain the way in which the rules and regulation are specified and enforcement is carried out.”35 Others like Allan Schmid departs from conventional economics, i.e., Coase rule, and defines institutions as “sets of ordered relationship among people which define their right, exposures to the right of others, privileges, and responsibilities.”36 Andrew Schotter uses game theory to analyze the creation, evolution, and function of economic and social institutions.37 He used David Lewis’s definition of social conventions, and views institutions as “regularities in behavior, which are agreed to by all members of a society and which specify behavior in specific recurrent situations.”38 However, he clarified his position by stating, “social institutions are different from social conventions in terms of the mechanism necessary to enforce them.”39 Schotter believed “social conventions are fundamentally self-policing,” while social institutions are not necessarily self-policing to the extent that they may require some “external authority, such as the state, to enforce them.” Finally, Daniel Bromley indicates that institutions fall into two categories, namely, conventions and rules, or entitlements.40 In doing so, he neglected the notion of power and only discussed it in the context of legal extension (and restrictions) or right, and John Kenneth Galbraith’s “public purpose.”41 And yet, he alluded to importance of power, which pervades our institutions (both conventions and entitlements) and our public choice process, by identifying two types of generic public choice: “redistribution of economic advantage” (REA) and “reallocation of economic opportunity” (REO). The first type, REA, results from successful attempt by
34
Douglas North, “Institutions”, Journal of Economic Perspective, vol. 5, Winter 1991, p. 97. Douglas North, “transaction Cost, Institutions, and Economic History.” Journal of Institutional and Theoretical Economics, vol. 140, March 1984, p. 8. 36 Allan Schmid “Analytical Institutional Economics: Challenging Problems in the Economics of Resources for a New Environment”, American Journal of Agricultural Economics, Vol. 54, 1972, p. 893. 37 Andrew Schotter, The Economic Theory of Social Institutions, Cambridge University Press, 1981. 38 Ibid., pp. 9. 39 Ibid. 40 Daniel Bromley Economic Interests and Institutions; the conceptual foundations of public policy, Basil Blackwell, 1989, p. 41. 41 It should be noted that by neglecting power, Bromley facilitates his argument in a sense that he can then retain the neoclassical assumption that the individual is the “raw datum” of economy and society, making free, informed choices and “voting” her preferences in markets and at the polls. 35
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special interest to have the rules changed in their favor. The second type, REO, results from a change in the (ability to realize a) public purpose. Considering the content of this book, we attached a significant importance to the concept of REA, which include rent-seeking, or directly unproductive profit-seeking activities (DUPs)42 that are usually defined as income or profit-generating activities without producing goods and services (in a conventional utility function). In Bromley analysis of institutions, REA is a broader category than DUPs because he rejects the narrow Hicks–Kaldor potential compensation yardstick as a measure of social progress, and repeatedly reminding the reader that society has objective (in its “social utility function”) in addition to increased national income.43 If the capture of right by a special interest leads to an increase in national income (thus “measuring up” the narrow efficacy standard of conventional cost–benefit analysis), economic advantage has nonetheless been redistributed (REA), however, social goals are compromised. The 2008 episode provides an ample illustration of this point in a sense that financial institutions (special interests) capture the right to change rules in their favor (bailout) that leads to immense profit gains (an increased national income), and distressed homeowners were disallowed to include their mortgage debts in personal bankruptcy. While we considered institutions as the mechanism of governance, the analysis is not complete without taking into account the importance of organization. As Elster observed, “Institutions keep society from falling apart, provided that there is something [organizations] to keep institutions from falling apart.”44 Scott also reflects the same sentiments, but at the conceptual level, as he sees the ascendance of institutional theory as a continuation and extension of the study of organization.45 Gradually, others adopted the similar stand and came to realization that organizations not only transformed production system, but they are also integral part of social and cultural system.46
Organizations and Institutional Perspectives Although a wide range of organizations exists, when we talk about an organization it is quite clear it has something to do with how human conduct becomes socially. Following this broad definition, one can observe that whenever men gathered and
42
For more information on DUPs see Jagdish N. Bhagwati “Directly Unproductive, Profit-Seeking (DUP) Activities”, The Journal of Political Economy, Vol. 90, No. 5 (Oct., 1982), pp. 988–1002. 43 Kaldor–Hicks assumed that an outcome is more efficient if a Pareto optimal outcome can be reached by arranging sufficient compensation from those that are made better off to those that are made worse off so that all would end up no worse off than before. 44 Jon Elster, 1st edition, Explaining Social Behavior: Nuts and Bolts for the Social Sciences, Cambridge University Press, 2007, ch. 15. 45 Richard W. Scott, 3rd edition, Institutions and Organization: Ideas and Interest, Sage Publication, 2007, introduction. 46 Ibid., pp. x.
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lived together “social organization” emerged. The notion of social organization, therefore, refers to the way in which human conduct becomes socially organized, that is, “to the observed regularities in the behavior of people that are due to the social conditions in which they find themselves rather than to their physiological or psychological characteristics as individuals.”47 There are many social conditions that alter such regularities in the behavior of people, however as Blau and Scott observed, these conditions can be divided into two main types, “which constitute the two basic aspects of social organizations: (1) the structure of social relations in a group or larger collectivity of people and (2) the shared beliefs and orientation that unite the member of the collectively and guide their conduct.”48 In this light, there are organizations that have been deliberately established for a certain purpose, and hence there are the goals to be achieved, the rules in which the members of the organization are expect to follow, and consciously designed the status structure that defines the relationship between them (the organization chart). For instance, as the main part of their organizational culture,49 banks and financial institutions are established in order to render intermediary services for a profit. Such organization is known as formal organization, “Since the distinct characteristic of these organizations is that they have been formally established for the explicit purpose of achieving certain goals, the term ‘formal organization’ is used to designate them.”50 In short, formal organization represents the structure of duties, responsibilities, and working relationships formally prescribed in the organization. By the same token, “institutionalization,” according to Meyer and Rowan, “involves the processes by which social processes, obligations, or actualities come to take on a rulelike status in social thought and action.”51 As an example, they claimed that a No Smoking sign is ample example that bears legal status and implication as well as an attempt to regulate behavior. Following this train of thoughts institutional theory, according to Scott, considers the processes by which structures (including schemas), rules, norms, and routines, become established as authoritative guidelines for social behavior.52 In this respect, if formal organizations are perceived
47
Peter Blau and W. Richard Scott, Formal Organization: A Comparative Approach, Stanford Business Books, 2003, p. 2. 48 Ibid. 49 According to Pettigrew, “Organizational culture consists of the behavior, actions and value that people in an enterprise are expected to follow” (see A. M. Pettigrew, “On Studying Organizational Cultures”, Administrative Science Quarterly, Vol. 24, no. 4, December 1979, pp. 570–581. 50 Peter Blau and W. Richard Scott, 2003, p. 5. Interestingly, in 1907 Sumner made the distinction between social and formal organizations but he termed them “crescive” and “enacted” institutions, respectively (see William Graham Sumner, Folkways: A Study of Mores, Manners, Customs and Morals, Boston, 1907, p. 54). 51 John W. Meyer and Brian Rowan, “Institutionalized Organization: Formal Structure as Myth and Ceremony” in Walter W. Powel and Paul J. Dimaggio, eds., The New Institutionalism in Organizational Analysis, University of Chicago Press, 1991. pp. 42. 52 W. Richard Scott, “Institutional theory” in George Ritzer, ed. Encyclopedia of Social Theory, Sage, 2004, pp. 408–14.
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and understood to be systems of coordinated and controlled activities, then in postindustrial society (Bell 1973) they arise in highly institutionalized context. In a similar manner in which products and services are produced, so professions, polices, and standards are created and designed for specific objectives. As Meyer and Rowan argue, “the formal structures of many organizations in postmodern society dramatically reflect the myths of their institutional environment instead of the demands of their work activity.”53 This inclination facilitates many new organizations to emerge and drive existing ones to incorporate new practices and procedures – organizations are driven to integrate (adopt) institutionalized rules, which distinguished sharply prevailing behaviors. As Meyer and Rowan reveals, “Institutionalized rules are classifications built into society as reciprocated typifications or interpretations. Such rules may be simply taken for granted or may be supported by public opinion or the force of law.”54 Under this circumstance, and in the context of institutional environments, organization are evaluated by the appropriateness of their form in a sense that they compete for ideal fitness, so they can be rewarded for incorporating institutionalized rules.55 In this respect, organizations gain legitimacy, and hence increased survival prospects. In the related literatures, this phenomena is known as conformity or/and institutional isomorphism, which is portrayed as the basic principle and distinct attribute of the institutional theory. Conformity has been conceived as the arm’s length stick that is used to determine the legitimacy in a sense that it establishes the traditions (myth) in which it is expected (rational) that an organization would incorporate certain social norms, rules, and requirements into its mission and goals. In order for an organization to be endorsed as a legitimate entity, it must conform to this procedural inclusion. Meyer and Rowan reaffirmed these inclinations by stating, “organization are driven to incorporate the practices and procedures defined by prevailing rationalized concepts of organizational work and institutionalized in society. Organizations that do so increase their legitimacy and their survival prospects, independent of the immediate efficiency of the acquired practices and procedures.”56 Christensen and Laegreid observed, “Institutional isomorphism can occur through coercive pressure – pressure from superior public organizations – normative pressure from professional networks, or mimetic pressure, whereby consulting firms and intergovernmental organizations offer organizational solutions that are said to decrease insecurity.”57 In addition, DiMaggio and Powel add that rate of institutional isomorphism is increased when organizations/firms are highly dependent on the
53
John W. Meyer and Brian Rowan, 1991, pp. 41. Ibid, pp. 42. 55 Steve Weber, “Origins of the European Bank for Reconstruction and Development”, in Timothy J. Sinclair, ed., Global governance: critical concepts in political science, Routledge, 2004, pp. 74. 56 John W. Meyer and Brain Rowan, “Institutionalized Organization: Formal Structure as Myth and Ceremony”, American Journal of Sociology, Vol. 83, No. 2, Sep., 1977, pp. 340. 57 Tom Christensen and Per Laegreid, Autonomy and Regulation: Coping with Agencies in the Modern World, Edward Elgar, 2006, pp. 20. 54
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institutional environment; exist under high uncertainty or ambiguous goals; and rely extensively on professionals. Emergence of the notion of conformity can also be viewed, as yet, another rejection of the rational-actor models of classical economics in which need of efficiency and competition are replaced by the importance of collectivity and homogeneity. As Dimaggio and Powel argue, “Today, however, structural change in organizations seems less and less driven by competition or by the need for efficiency. Instead, we contend, bureaucratization and other forms of organizational change occur as the result of processes that make organizations more similar without necessarily making them more efficient.”58 We argue that as a direct result of globalized economic system and global governance in which preemptive policies such as international standards are promoted as the vital anticipatory mechanism in face of future crises, many national institutions and organizations began to conform to the rules and belief systems prevailing in the global environment.59
International Financial Standards and Regulations International financial regulations and standards as a policy instrument is an integral part of Global Governance System. As a developmental tool for international agencies and institutions, they are more relevant to the prevailing globalization process than ever before. More importantly, and in complete departure from the past several decades, regulations and standard setting are generally perceived as proactive policies. They intend not only to converge the functions of national institutional policymakers in international standard settings but also to prevent behaviors that destabilize the global system.60
58
Paul J. DiMaggio and Walter W. Powel, “The Iron Cage Revisited: Institutional Isomorphism and Collective rationality in Organizational Field”, American Sociological Review, 1983, Vol. 48, April 1983, pp. 147. On the notion of bureaucratization, it is also important to note Peter observation, which claimed, “Attempt at bureaucratic “empire building” may be closely related to the desire of the agency to survive and also to perform function that it considered essential to a high quality of life for the society…Or, as Cleaves once wrote of the Chilean bureaucracy: Derogatory comments on bureaucracy’s tendency to consolidate its power (e.g., empire building, prestige accrual) are value judgment to the extent that they are not examined in context of the agency’s need to increase its capacity for goal-oriented behavior”. In other word, Peters elaborates, “one person’s empire building is another person’s need for survival, or even public services.” (See Guy Peters, 6th edition, The Politics of Bureaucracy: An introduction, Routledge, 2009, pp 23–24. The source for Cleaves is; Peter S. Cleaves, Bureaucratic Politics and Administration in Chile, University of California Press, 1974, pp. 310–11). 59 Excluding the global aspect, a similar argument is presented by Scott (see W. Richard Scott, “Unpacking Institutional Argument” in Walter W. Powel and Paul J. Dimaggio, eds., The New Institutionalism in Organizational Analysis, University of Chicago Press, 1991. pp. 164–182). 60 Indeed, they not only depart from the past but also create new and unanticipated consequences (see Wilks & Bartle, 2002, p. 148–72).
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Contrary to popular belief, the rise of global systems and free market capitalism has, in fact, led us into an unprecedented age of regulations.61 The consensus among experts is that the increasing integration of the world has spawned a period of intense rule-making activity.62 From financial regulation to trade guidelines, environmental protection to consumer protection and safety, health and labor standards, no government activity has grown faster since 1980 than government regulatory functions.63 In this section, we briefly examine the intended objective(s) of the prevailing standards setting and regulations, which are integral part of many assistance packages of international organizations. Our hope is to provide the basis for a better understanding of the logic and the overall objectives of these regulations and standards settings. First, it is important to clarify some important issues related to definition of regulations, standards, and their interpretations. Following the general consensuses, the notion of regulation should be considered as a policy instrument,64 and as such, it can be implemented to achieve different objectives, even if these objectives are sometimes at odds with (opposite of) each other. For instance, under certain conditions, regulations and regulatory mechanisms can restrict incentives, and hence hinder economic productivity and growth. In this case, removing specific regulations can facilitate economic productivity, and hence promotes growth. For instance, removing regulations and regulatory mechanisms during transition of former planned economies to a market-based economy has produced an expansion of economic productivity and hence increased growth in these countries (Khemani 1994; Alesina et al. 2003). Similarly, promoting certain regulations and standards can be used to encourage convergence of the various functions of policy-making institutions in a country toward international norms, and hence improve its institutional capacity in terms of international financial relation and trade with the rest of the world.65 Second, certain terms are erroneously used interchangeably, which often contribute to a flawed evaluation. For instance, deregulation and liberalization are often considered to be synonymous. However, deregulation is different from liberalization because a liberalized market, while often having less and simpler regulations,
61
See Scott, Jacobs, “The Second Generation of Regulatory Reforms,” Paper presented at IMF Conference on Second Generation Reforms, 8–9 November 1999, Washington, D.C. The paper can be found at: www.imf.org/external/pubs/ft/seminar/1999/reforms/jacobs.htm. See also the series of OECD multidisciplinary reports on regulatory reform in Japan, USA, Netherlands, Mexico, Spain, Korea, Hungary, and Denmark, which can be ordered at: http://www. oecd.org/subject/regreform. 62 See OECD, Regulatory Co-operation for an Interdependent World, OECD, Paris, 1994. 63 Dieter, Kerwer, “Rules that Many Use: Standards and Global Regulation”, Governance, October 2005, vol. 18 (4) pp. 611–632. 64 It is important to note that an instrument is a tool; it is the responsibility of policy-makers to assess the choice of instrument based on certain criteria. For example, efficiency versus equality or against potentially conflicting measures like cost and benefits. 65 See Toye (2003).
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can also have regulations (like anti-trust legislation) in order to increase efficiency and protect consumer rights. Finally, considering the present state of global system any analysis of regulations and standards must reflect the fact that these notions are driven by the emergence of a new convention on the best practice in economic governance, and hence they must be identified as a global phenomenon instead of a local development. In retrospect, it is futile to offer one authoritative definition that holds across various interests and disciplines, since many variations in a definition of standards setting and regulations can be found in the literature. For instance, Majone (1994) provided us with a general definition, “regulation refers to sustained and focused control exercised by a public agency over activities that are social valued…sustained and focused…regulation is not achieved simply by passing a law, but requires detailed knowledge of and intimate involvement with the regulated activity. This requirement will necessitate, sooner or later, the creation of specialized agencies entrusted with fact-finding, rule making, and enforcement” (p. 81). Moreover, it is not possible to determine the validity as well as the popularity of a specific definition. As a result, in this section of this book, I have not looked for a comprehensive and consensual definition across different disciplines and research agendas, but rather included notions that reflect a specific context and goal. Another reason for exclusion of an absolute definition in this book is based on the fact that an absolute definition frequently reflects specific disciplinary concerns, and hence their intended objectives are oriented toward unique and often incremental circumstances of the benefactor of regulation. To illustrate various characteristics of a regulation, I primarily draw on the identification of Baldwin et al. (1998), as well as discussions of Doerm and Wilks (1998), and Ogus (1994). It consists of three main classifications: (1) targeted rules; (2) various modes of state intervention in the economy; and (3) all mechanisms of social control, by whomever exercised. Accordingly, regulations and standard setting cover a wide range of issues and disciplines, from an instrument intended to goal-specific objective (the first definition) to almost all mechanisms of control (the third definition). These broad definitions echo one distinct trend. There are on-going changes in the economic and social context of regulations around the globe, particularly the perception of policymakers and regulation setters in terms of policy agendas and objectives.66 To highlight this observation, let us start with the pre-1990s transatlantic difference in the meaning of regulation. In 1970s, and until the end of the 1980s, policymakers as well as scholars, particularly outside the USA, tended to use regulation and intervention almost interchangeably (Majone 1994). In fact, the word regulation more or less signified a general mode of government for control over an economy (the second definition). In the USA, however, the notion of regulation simply implied a more restricted meaning in response to the rise in the number of independent regulatory institutions and the consequent crystallization of regulatory practices into a theory of governance – the first definition (Jacint and Levi-Faur 2004, p. 4).
66
See Scott (2004) for a comparative analysis of regulation.
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However, by the end of 1990s, two distinct but interrelated developments caused convergence in the meanings of regulation (on both side of the Atlantic) toward the narrowest definition (and closer to the first definition). First, and in the aftermath of several global financial crises such as East Asian crisis and Russian crisis, semiconsensual international regimes, particularly among G-8 economies, led to the creation of the notion of global governance, which in turn set in motion targeted standards setting and regulation in order to prevent future “global financial crisis.”. In short, global governance led to the creation of a vehicle to build the minimum legal architecture for global markets. Second, the notion of targeted rule was also strengthened by a shift in the way that international institutional members of global governance, like the World Bank and IMF (and more specifically their experts – epistemic communities), promoted standards setting and regulations that intend to address specific rules. Consequently, these organizations place greater emphasis on issues such as: fiscal transparency, anticorruption, banking supervision, accounting and auditing, etc. In fact, the dominant thoughts in these institutions and other major international organizations like OECD indicated that targeted rule regulation achieves similar, if not more, advantage for an economy than a policy that intends to increase the efficiency of a market or boost exports. They came to a unique realization that benefits of market-based economy can appreciate more under conditions in which corruption, for instance, is absent than under a circumstance, where goods and services are produced efficiently (Mauro 1996, 1998; Tanzi and Davoodi 1997). This takes us to the next issue under consideration in this study, namely, intended objective(s) of the prevailing standards setting and regulations (targeted rules). The prevailing trend in target rule regulatory mechanism seems to proceed as a mean to establish certain rules and procedures through standardization in a recipient country. The term standardization can have several meanings depending on its context. Common use of the word standard implies that it is a widely agreed-upon set of guidelines for interoperability, and standardization is the process of selection of better choices and ratification of consistent decisions, as an obtained standard. According to Wikipedia, “In social sciences, including economics, the idea of standardization is close to the solution for a coordination problem, a situation in which all parties can realize mutual gains, but only by making mutually consistent decisions” (http://en.wikipedia.org/wiki/Standardization). In this book, we define standards as technical specifications drawn up with the cooperation and consensus of all interests affected by it, based on the consolidated results of science, technology, and experience, and approved by a body recognized on the regional or international level. In fact, under certain condition, the global governance body insists that international conventions incorporate these standards and regulations into, bilateral treaties, or retain the nonbinding form of these recommendations. In this respect, an important instrument in standardization is the package (document), which consists of various regulations, and standards that are selected by regulatory organizations. These packages can be generally categorized into three main groups: (1) those responsible for developing documents for ensuring compliance when they are of a mandatory nature; (2) those who apply the provisions of the documents in practice;
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and (3) those who are affected by the results of their application. These package can be described as procedural information (standards), which put together by international agencies and organizations for standardization of procedures at the level of national policy-making institutions (and developmental agencies) as well as guide recipient countries to adapt the selected international norms.67 Following the analytical language developed by Timmermans and Berg (2003), procedural standards specify the actions or protocol that must be followed in given situations. They commonly have accompanied and have depended on the development of (1) design standards that define the elements of complex system of action and allow them to function, (2) terminological standards that fix the terms classifying and describing phenomena and permit their comparison, and (3) performance standards that define outcomes or results acceptable in particular context. It is important to note that one of the reasons behind the formulation of this type of package is the fact that internationally accepted procedural standards, e.g., accounting and auditing standards, are often absent in the institutional policy making of most targeted (recipient) countries.68 While examining the features of standard as a package (document) is beyond the scope of this book, it may suffice to note a few aspects that affect the treatment of “standard” as procedural information. First, a financial standard may be formulated with clear instruction but important embedded information that entails comprehensive understanding of the subject. For example, guidelines to create a financial statement convey both implicit and explicit knowledge about financial functions of an enterprise. A typical financial statement usually come packaged inside an annual report, which contains various information about an enterprise that are vital for investors and other interested parties. For example, adjacent to the financial statements is Management’s Discussion and Analysis (MD&A). This is a section (which usually is required by the Securities and Exchange Commission) intended to provide insights into the financial statement with analytical data and commentary. In the beginning and before the financial section, there is typically a soft information that tells the company’s story in narrative terms. Second, some standards, like legislations, need frequent adjustment and up-dating. Once standards are adapted into a national institution, they will need constant attention to ensure that the information is correct, complete, and up-to-date; otherwise, the user will be misled. For instance, General Agreements on Tariffs and Trade (GATT) should receive constant attention and be updated; otherwise, it will lose its relevance to variable global conditions. Finally, some standards, especially those intended to assist institutional-capacity-building, are inter-related, and can be linked to a group of documents known as technical regulations. Generally, technical regulation is defined as a regulation containing a technical specification and requirement. For instance, a gas board may refuse to allow an appliance to be connected to
67
See, for instance, Development Committee (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund On the Transfer of Real Resources to Developing Countries), Sixty-Fourth meeting, Ottawa, Ontario Canada, November 2001. 68 Perhaps because of standards peculiarities as documents and the complex interactions between the various institutions or organizations involved at the international and the national levels.
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the mains gas supply if it does not comply with certain technical regulations. In this respect, a standard can be a technical regulation when the provisions it includes are mandatory. Standards and technical regulations can also relate to each other in a number of ways. For instance, a document can be simultaneously a standard and a technical regulation. A standard may be referred to in a technical regulation, or most importantly, standards and technical regulations usually knit together to a form a coherent package. In this respect, if one of these standards is amended or withdrawn, a number of other standards and their applications may have an adverse impact. In this case, regulatory organizations need to be aware of this possibility. All things considered, this book considers the process of acquiring these standards as similar to a transfer of information between two entities. The main reason for this consideration is related to the way in which standards are integrated into functions of national policy-making institutions (see Chap. 5 on Policy Convergence). In short, these norms and practices are generally put together as a package of specific regulations and guidelines and ultimately transferred from one party (regulatory setters and/or international organizations) to another party (recipient countries). Among the common objectives of targeted-rule regulations, accounting and auditing notions have global significance, particularly in terms of their possible regulatory (as well as transparency) roles. According to Seiler (1990), accounting is “the systematic process of gathering, condensing, reporting, and analyzing the results of events which have affected the company.” The essence of accounting, therefore, is the process that illustrates how (results of) business transactions are recorded, verified, and disseminated to a wider range of business and investment actors, who use this information for their decision-making. In short, accounting processes require provision of information and evaluation of the action to be taken. Since financial reports are “information outcomes” of the accounting process, the term “financial reporting” has been used interchangeably with the term “accounting” in the regulatory context.69 The primary objective of financial statements is to provide information on the strength, performance, and changes in the financial position of an enterprise that is useful, particularly to a wide range of foreign users, in making economic/investment decisions.70 Financial reports, therefore, are a major source of accurate and transparence information for equity markets, whose effective functioning is crucial for the global financial system. However, it should
69
According to Wikipedia, financial reports, “…are formal records of a business” financial activities. These statements provide an overview of the profitability of a business and its financial condition in short term as well as long term. There are four basic financial statements: (1) Balance sheet – also referred to as statement of financial position or condition, reports on a company’s assets, liabilities and net equity as of a given point in time; (2) Income statement – also referred to as Profit or loss statement, reports on a company’s results of operations over a period of time; (3) Statement of retained earnings – explains the changes in a company’s retained earnings over the reporting period; and (4) Statement of cash flows – reports on a company’s cash flow activities, particularly its operating, investing, and financing activities. For detailed analysis of the subject see Fridson, Alvarez, and Fridson (2002). 70 See “The Framework for the Preparation and Presentation of Financial Statements”, International Accounting Standards Board at: www.iasplus.com/standard/framewk.htm.
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be noted that there are differences in commitment, for provision of these kind of information, among nations. For instance, nations have different commitments because of, among other things; differences in nature of ownership (governmental vs. private sector), degree of openness among national governmental agencies, national institutional capacities, political preferences, etc. (Leebron 1996, p. 67–70). In this respect, there could be potential conflict-of-interest between national regulatory institutions and global institutions. In this case, financial reports bear not only financial but also political as well as societal ramifications of accountability. According to Wikipedia, “Accountability is a concept in ethics with several meanings. It is often used synonymously with such concepts as answerability, enforcement, responsibility, blameworthiness, liability, and other terms associated with the expectation of account-giving. As an aspect of governance, it has been central to discussions related to problems in both the public and private (corporation) worlds.” The debates about the meaning of accountability have not reached a verdict perhaps because accountability is a contestable concept par excellence. Anyone studying accountability will soon discover that it can mean many different things to many different people (see Mulgan 2000; Behn 2001; Dubnick 2005; Pollitt 2003). Indeed, the notion of accountability often serves as a conceptual umbrella covering various other notions that are often highly contested, such as transparency or trustworthiness. For example, when the European Commission (2001, 2003) uses the notion of accountability, it serves not only as a synonym for clarity, transparency, and responsibility, but is also equated with much broader concepts such as involvement, deliberation, and participation.71 Furthermore, some questions, specifically in terms of financial accounting such as who is accountable and transparent; to whom and on what terms, still remain unsettled. Interestingly and in relation to this study, one of the reasons for conceptual ambiguity and diversity of accountability is the fact that “accountability” is an AngloNorman concept, which has no semantic equivalents on other languages (Dubnick 2002). For instance, languages such as French, Portuguese, Spanish, German, or Dutch, do not distinguish semantically between “responsibility” and “accountability” (Mulgan 2000; Harlow 2002; Dubnick 2002). This is an important concern, in standardization as well as knowledge transfer process, which is often neglected because popular policy (theory, idea) frequently disregards cultural aspects (communication) with procedures. It is important to note that language is also a factor in determining transfer cost. To identify the cost determinants associated with transfer of regulations and standards, one common approach is to illustrate the elements that affect the cost of the knowledge transfer process. In this respect, and by utilizing the communication theory, variances in the countries’ attributes such as languages, laws, and norms may influence cost determinants negatively. These characteristics can also shape the context or what is known as the institutional environment. Indeed, when language is properly taken into consideration, it not only has important implication in terms of procedural standards (more precisely in terms of terminological standards), but also
71
See also Harlow (2002).
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plays a vital role in the transfer of these standards (from international organizations to recipient countries). Interestingly, a rising number of global companies are aware of this issue and responding accordingly (Cremer and Willes 1998; Tsang 1999). For instance, Daimler–Chrysler are adopting English as their corporate language in order to avoid misinterpretation of their regulations, guidelines, and standards. Having said that, there is no doubt that regulatory mechanism is widely pervasive across regions, sectors, and countries. Very few countries are distant from this prevailing trend. A substantial consensus emerged from this development and testified to the fact that any regulatory system requires three main elements: standards setting, behavior modification, and information gathering (Martin 2004). Holding these three elements accountable, transparence is crucial for the functioning of the new regulatory trend. This is particularly important since almost all regulatory programs, supported by international organizations such as the World Bank and IMF, are based on voluntary participation. Accordingly, without accountability and transparency, any nonarbitrary enforcement of selected regulations would be impossible. Moreover, some scholars point at notable policy issues that are yet to be resolved. For instance, how accountability and transparency are incorporated into national regulation schemes, which differ greatly in terms of who holds whom accountable and for what kind of activities and consequences (Martin 2004, p. 127). Nevertheless, Perks (1993, p. 24) identifies four dimensions of accountability: (1) the subject (who is accountable); (2) the receiver of an account (to whom); (3) the means of accountability (how): and (4) the object (for what). He also observed that accountability fails when either or all of the following holds (1) the information produced maybe inadequate or misleading; (2) the auditing maybe subject to severe limitations like lack of proper information to facilitate auditing and lack of auditors’ independence from his/her employers; (3) the information is published in such a manner that it is not accessible in public domain or to those to whom the business is accountable like the shareholder, either physically or intellectually; and finally (4) the accounting officers prepare fake records that actually appear to be authentic when they are not. At the extreme end is the total absence of files necessary to depict accountability. This may be due to failure by individuals or systems to make records in the first place. Accordingly and from the perspective of Anglo-Saxon models, accountability implies that managers provide third parties (mainly owners, potential investors, and creditors) with information that describes in detail how the company in which they are interested has performed during the reporting period; how it is currently doing; and how it is likely to do in the future; what it has accomplished; what are its economic stocks of resources and obligations; and so on.72 For this purpose, financial
72
This model is selected for two reasons. First, the growing importance of International Accounting Standards Board (IASB) on the world scene and the recognition that capital markets are increasingly dominated by companies who prepare their financial statements according to an Anglo-Saxon model of accounting. Second, the Anglo-Saxon model of corporate governance is an important part in global governance and the global system, which this study intends to analyze. For a detailed analysis of this model, see Demski & Christensen (2002, p.2); Henrekson & Jakobsson (2003).
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reports narrate the financial history of an organization. In doing so, a range of established evaluation techniques and rules (standards) are used to translate various business transactions into numerical values (numbers). It should be noted that these standards entail judgment and discretion by only those who apply them. For instance, international independent regulators and standard setters – like the International Accounting Standards Board (IASB), the Accounting Standard Boards (ASB) in the UK or the Financial Accounting Standards Board (FASB) in the USA – focus on the management of a (joint stock) company, which is accountable to its shareholders (Karsten and Schneider 2000). In its implementation, this concept of accountability has three aspects: it consists of (1) rules on how to produce accounting information (area of standard setting); (2) enforcement of their qualitatively high application (by means of auditing); and (3) regulation on how to disseminate (disclose) this information. In short, these agencies intend to establish the “code-of-conduct.” Finally, and in relation to policy implication of regulation and standards setting, there is an ongoing debate in terms of effective compliance by regulated economies. Some believed that rendering incentives (rewards) for compliance is more useful than meting out punishments for noncompliance, particularly in terms of motivating institutional behavior. Others pointed out that the proincentive view, which followed the classical tradition, generally articulated with respect to an operation of market (or business activity) in the presence of competition; for instance, potential rewards for patent, copyright (creative or individual capital), and trademark (social trust or social capital). In the presence of competition, the rewards provided by markets, generally, but not always, work in motivating productive efficiency. In regulating business unity, the reward approach usually overcomes the treat of punishment. For instance, a regulator puts in place a system of rewards. For example, tax incentives for achieving an outcome like pollution reduction.73 Therefore, they claimed, under a nonmarket setting (and absent of competition), we cannot expect the optimal outcomes. As Jeremy Bentham observed, while rewards are powerful in markets and may have some positive application in Law, they are less valuable for the institutional settings, i.e., legislator, than punishment.74 Interestingly, Bentham and Adam Smith share the same sentiments on the former point, but Bentham did not share Smith’s enthusiasm for rewards in regulation.75 A sensible position in this debate is that it is best to try persuasion first and reserve punishment for times when persuasion fails. Persuasion is a cheaper and a more respectful way of treating the regulated actor. In short, persuasion usually is more effective when it is backed up by punishment.76 Since adaptation of the prevailing targeted
73
For detailed analysis of this topic see Sowell (1974). Jeremy Bentham, The Rationale of Rewards, eds, J. and H. L. Hunt (1925) 6, 51–2: Jeremy Bentham, Collected Works of Jeremy Bentham: Principle of Legislation: A Comment on the Commentaries and a Fragment on Government, eds, J. H. Burns and H.L.A. Hart (1977), p. 29. 75 Ibid (1825), p. 52. 76 N. Gunningham and P. Grabosky, Smart Regulation: Designing Environmental Policy, Clarendon Press, Oxford, 1998. 74
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regulation and standards setting are based on voluntary agreements (and without recourse to strong monitoring) the obvious policy dilemma is the choice between compliance versus cooperation, coordination in relation to internationally accepted norms and standards. The two predominant perspectives in this debate are the enforcement approach and the management approach.77 The enforcement approach is based on the political economy traditions of game theory and collective action theory.78 States are perceived as rational actors and, therefore, have costs and benefits considerations that alter behavioral choices for making compliance decisions in cooperative situations. Both the sources of, and solutions to, noncompliance are based on incentive arrangements. For instance, states choose to defect when the benefits of shirking exceed the costs of detection. Accordingly, compliance problems can best be resolved by increasing the costs of detection through monitoring and threat of punishment like sanctions. However, cost–benefit calculations show that sanctions are usually more successful against economically vulnerable and politically weak states.79 The presumption that states may deliberately choose not to comply stems from the recognition that the interests of states may include only signing the treaty but not compliance with its content. “Even if a state may believe that signing a treaty is in its best interest, the political calculations associated with the subsequent decision actually to comply with international agreements are distinct and quite different.”80
77
See Chayes, Abram, and Antonia Handler Chayes, The New Sovereignty: Compliance with International Regulatory Agreements. Cambridge, Mass, Harvard University Press, 1995; and Downs, George W., David M. Rocke, and Peter N. Barsoom, “Is the Good News about Compliance Good News about Cooperation?” International Organization 1996, 50 (3):379–406. 78 See Olson, Mancur, The Logic of Collective Action: Public Goods and the Theory of Groups, Cambridge, Mass, Harvard University Press, 1965; Axelrod, Robert, The Evolution of Co-operation, London, Penguin, 1984; Axelrod, Robert, and Robert O. Keohane, “Achieving Cooperation Under Anarchy: Strategies and Institutions”, in Cooperation Under Anarchy, edited by Kenneth A. Oye, 226–54. Princeton, N.J, Princeton University Press, 1986; Yarbrough, Beth V., and Robert M. Yarbrough. 1992. Cooperation and Governance in International Trade: The Strategic Organizational Approach, Princeton, N.J.: Princeton University Press, 1992; Bayard, Thomas O., and Kimberly Elliott, Reciprocity and Retaliation in U.S. Trade Policy, Washington D.C.: Institute for International Economics, 1994; Downs, Rocke, and Barsoom 1996; and Dorn, A. Walter, and Andrew Fulton, “Securing Compliance with Disarmament Treaties: Carrots, Sticks, and the Case of North Korea”, Global Governance, 1997, 3 (1):17–40. 79 See Gary Clyde Hufbauer, Jeffrey J. Schott and Kimberly Ann Elliott, Economic Sanctions Reconsidered, 2d rev. ed., 2 vol, Washington, D.C., Institute for International Economics, 1990; Yaraslau Kryvoi, “Why European Union Trade Sanctions Do Not Work” Minnesota Journal of International Law, Vol. 17, 2008 and Robert A. Pape, “Why Economic Sanctions Still Do Not Work”, International Security, 1998, 23 (1), pp. 66–77. 80 Haas, Peter, “Compliance with EU Directives: Insights from International Relations and Comparative Politics”, Journal of European Public Policy, 1998, 5 (1), pp. 19. On the calculus of compliance, see Young, Oran R, Compliance and Public Authority: A Theory with International Implications, Baltimore, The Johns Hopkins University Press, 1979; Underdal, Arild, “Explaining Compliance and Defection: Three Models”, European Journal of International Relations, 1998 4 (1): 5–30.
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Political calculations underline a very important factor in decision-making process, namely, prioritization. The decision of a state may be reflective of its priorities since compliance entails committing resources that could be put to alternative use. States may also decide to defect (violate agreements) because they do not value the actual content of the agreements, but may still regard participation to be beneficial and signing the agreement to be important. Enforcement theorists generally stress that the likelihood of intentional shirking is conditioned by the problem structure of the particular cooperative context.81 For instance, in collaboration treaty, states have greater incentives to defect than in coordination situations,82 where states have all the reasons to cooperate in order to avoid common aversions.83 In collaboration situations, states have an incentive to renege on their commitments, since they gain more from an agreement if they reap all the benefits without putting in their own fair share.84 Since collaboration is a major issue in international regulation, the problem of free riding, according to enforcement theorists, must be the main concern to international cooperation. For cooperation to generate collective benefits, enforcement is a necessary condition to deter states from shirking. Monitoring and the threat of punishment like sanctions form the two central elements of enforcement strategy.85 Monitoring increases transparency and exposes possible defectors. The threat of punishments raises the costs of shirking and makes noncompliance a less attractive option.
81
Jonas Tallberg, “Paths to Compliance: Enforcement, Management, and the European Union”, International Organization 56, 3, Summer 2002, pp. 612. 82 In order to avoid confusion and misunderstanding about terminologies, it is imperative to define them before going any further. In this respect, I assume that coordination begins with an assumption of differences, where different units cause overlap, redundancy, and/or separation without coordination. Coordination is a framework used to ensure that each unit informs others as to how and when it will act (Leo, 1999). Unlike coordination, collaboration, “…is the process of shared creation: two or more individuals with complementary skills interacting to create a shared understanding that none had previously possessed or could have come to on their own. Collaboration creates a shared meaning about a process, a product, or an event. In this sense, there is nothing routine about it. Something is there that wasn’t there before” (Schrage, 1990, p. 140). Collaboration is about sharing and using information to create new learning. Finally, cooperation is about how the parts of a whole work or act together to achieve a common goal. 83 See Stein, Arthur A, “Coordination and Collaboration: Regimes in an Anarchic World”, in International Regimes, edited by Stephen D. Krasner, 115–40. Ithaca, N.J., Cornell University Press, 1983. For recent attempts to develop the notion of problem structure, see Mitchell, Ronald B, “Situation Structure and Regime Implementation Strategies”, unpublished manuscript, Stanford University, Stanford, Calif, 1999; Young, Oran R, Governance in World Affairs, Ithaca, New York, Cornell University Press, 1999; Miles, Edward L., Arild Underdal, Steinar Andresen, Jørgen Wettestad, Jon Birger Skjærseth, and Elaine M. Carlin, Environmental Regime Effectiveness: Confronting Theory with Evidence, Cambridge, Mass.: MIT Press, 2002. 84 Jonas Tallberg, 2002, pp. 612. 85 Olson, Mancur, The Logic of Collective Action: Public Goods and the Theory of Groups, Cambridge, Mass.: Harvard University Press, 1965; Axelrod, Robert, and Robert O. Keohane, “Achieving Cooperation Under Anarchy: Strategies and Institutions’, in Cooperation Under Anarchy, edited by Kenneth A. Oye, 226–54. Princeton, N.J., Princeton University Press, 1986; Downs, Rocke, and Barsoom 1996; Dorn and Fulton1997; Underdal 1998.
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Together, monitoring and punishments have the capacity to deter defections and compel compliance. “A punishment strategy is sufficient to enforce a treaty when each side knows that if it cheats it will suffer enough from the punishment that the net benefit will not be positive.”86 The management approach presents a perspective at odds with the claims of the enforcement approach.87 It is noteworthy that most managerial studies are conducted by political scientists and scholars interested in international law and organizations.88 Drawing on these studies, managerial theorists emphasize on the general propensity of states for self-preservation. Taken into consideration the interconnection between states and the global system, such propensity underline the inclination of states to comply with international rules and norms. Accordingly, noncompliance is not the result of a deliberate decision to violate treaties, but of capacity limitations and rule ambiguity. In this respect, noncompliance can be resolved through strategies like capacity building, rule interpretation, and transparency, rather than coercive enforcement. As Oran Young points out, “The effectiveness of international institutions varies directly with the capacity of the governments of members to implement their provisions.”89 Managerial description of capacity limitations is mostly based on political and economic limitations. Political capacity limitations
86
Downs, Rocke, and Barsoom 1996, pp. 385. See Young, Oran R, “The Effectiveness of International Institutions: Hard Cases and Critical Variables”, in Governance without Government: Order and Change in World Politics, edited by James N. Rosenau and Ernst-Otto Czempiel, 160–94. Cambridge, Cambridge University Press. 1992; Haas, Peter M., Robert O. Keohane, and Marc A. Levy, eds., Institutions for the Earth: Sources of Effective International Environmental Protection, Cambridge, Mass, MIT Press, 1993; Mitchell, Ronald B, Intentional Oil Pollution at Sea: Environmental Policy and Treaty Compliance, Cambridge, Mass, MIT Press, 1994; Chayes and Chayes 1995. 88 For example, see Arora, Seema, and Timothy N. Cason, “An experiment in voluntary environmental regulation: Participation in EPA’s 33150 program”, Journal of Environmental Economics and Management, 1995, 28:271–86; Chayes, Abram, and Antonio Handler Chayes, “From law enforcement to dispute settlement”, International Security, 1990, 14:147–64; Chayes, Abram, and Antonio Handler Chayes, The new sovereignty, Harvard University, Cambridge, Mass. 1993a; Chayes, Abram, and Antonio Handler Chayes, “On compliance”, International Organization, 1993b, 47:175–205; Duffy, Gloria, “Conditions that affect arms control compliance”, in U.S. Soviet Security Cooperation, edited by Alexander George, Philip J. Farley, and Alexander Dallin. New York, Oxford University Press, 1988; Haas, Peter M., Robert O. Keohane, and Marc A. Levy, eds, Institutions for the earth: Sources of effective international environmental protection. Cambridge, Mass, MIT Press, 1993; Hawkins, Keith, Environment and enforcement: Regulation and the social definition of pollution, Oxford Socio-legal Studies. Oxford, Clarendon Press, 1984; Mitchell, Ronald, “Compliance theory: A synthesis”, Review of European Community and International Environmental Law (RECIEL), 1993, 2:327–34; Mitchell, Ronald, Intentional oil pollution at sea: Environmental policy and treaty compliance, Cambridge, Mass, MIT Press, 1994a; Mitchell, Ronald, “Regime design matters: Intentional oil pollution and treaty compliance”, International Organization 1994b, 48:425–58; Scholz, John T, “Voluntary compliance and regulatory enforcement”, Law and Policy, 1984, 6:385404; Sparrow, Malcolm, K, Imposing duties: Government’s changing approach to compliance, Westport, Conn, Praeger, 1994; Young 1994. 89 Oran R. Young, “The Effectiveness of International Institutions: Hard Case and Critical Variables”, page 183, in James N. Rosenau and Ernst-Otto Czempiel, edt, Governance Without Government: Order and Change in World Politics, Cambridge University Press, 1992. 87
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arise when a government fails to ensure that public as well as private institutions and actors meet international commitments. Economic capacity problems may arise when financial constraints impinge on a state’s ability to fulfill international obligations.90 In analysis of international organizations assistance programs, both approaches are apparent. For instance, the World Bank development approach has evolved from the enforcement approach of early 1980s to the managerial approach in late 1990s. In early 1980s, the World Bank seems to have imposed restrictions on structural adjustment policies like privatization and maintained a high level of monitoring through conditionality like austerity measurements. However, as the direct result of change in the structure of global system and the new role of international organizations, the Bank now emphasizes less on enforcement and more on managerial approach. For example, Reports on the Observance of Standards and Codes modules. The Bank’s change of direction is not surprising for several reasons. First, enforcements are costly as well as controversial. For instance, according to one estimate, the price of sanctions to the USA is $18 billion annually in lost exports.91 In addition, the damage from sanctions to the targeted state can be devastating, as the case of Iraq made clear.92 Moreover, the enforcement approach faced mounting theoretical shortcomings.93 Second, the managerial school renders an alternative approach to the Bank’s expert community, which allows for a more flexible strategy suited to the twenty first century. To sum up the first two points, punishment is not only inappropriate in the global era (assuming the absence of any exploitative intent) but also too costly, too political, and too coercive. As Mitchell noted, “Retaliatory noncompliance
90
For instance, resource scarcity may directly hamper compliance efforts. However, there may be other concerns such as macroeconomic factors that contribute to the settings of national economic and political framework within which public and private actors operate. 91 Hufbauer, Gary Clyde, Kimberly Ann Elliott, Tess Cyrus, and Elizabeth Winston, “U.S. Economic Sanctions: Their Impact on Trade, Jobs, and Wages”, Working Paper 97–01, Washington D.C., Institute for International Economics, 1997. 92 Buck, Lori, Nicole Gallant, and Kim Richard Nossal, “Sanctions as a Gendered Instrument of Statecraft: The Case of Iraq”, Review ofInternationa1 Studies, 1998, 24 (1), pp. 69–84 and Garfield, Richard, Morbidity and Mortality Among Iraqi Children from 1990 Through 1998: Assessing the Impact of the Gulf War and Economic Sanctions. Available at www.cam.ac.uk/societies/casi/info/ garfield/dr-garfield.htm1. 93 As Drezner observed, “Game-theoretic approaches to studying economic sanctions argue that because of strategic interaction, one should observe most of the failures but miss most of the successes. The imposition of sanctions represents a deadweight loss of utility for both the sender and target, in the form of disrupted economic exchange. Therefore, the actors have an incentive to reach an agreement before imposition. If the sender prefers the status quo to imposing sanctions, then there should be no coercion attempt. If the target prefers conceding to incurring the cost of sanctions, it has an incentive to acquiesce before the imposition of sanctions. The difficulty of observing threats that never need to be executed, particularly threats made behind closed doors, raises the possibility that selection bias has seriously affected empirical studies of economic statecraft. If this is true, then the sanctions literature has grossly underestimated the utility of economic diplomacy”, see Daniel W. Drezner, “The Hidden Hand of Economic Coercion”, International Organization, Summer 2003, 57 (3), pp. 644.
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often proves unlikely because the costs of any individual violation may not warrant a response and it cannot be specifically targeted, imposing costs on those that have consistently complied without hurting the targeted violator enough to change its behavior.”94 Young also observed that, “arrangements featuring enforcement as a means of eliciting compliance are not of much use in international society.”95 Third, retaliatory actions against violators may cause further breakdown of current and future cooperation, and hence jeopardize the bank’s relationship with its clients. Finally, to many analysts, the policymaker’s reliance on sanctions is puzzling; the scholarly assessment of enforcement such as sanctions is that they fail to yield significant concessions. There is a long and distinguished line of authors, who argue that sanctions do not work.96 More importantly, the current history of imposing unilateral sanctions or even discussions of any possibility of such measurements clearly indicates that these actions or even discussions have damaged the retaliator organizations (and ironically present violators as political casualties). Chayes and Chayes summarize the last two points thus, “the actor considering retaliation must also think of the possible future costs. It may be dangerous to prejudice the possibility of support from the violator at some point in time in the future when it may be needed.”97 In this book, we restrict our attention to those regulatory guidelines that are supported by member organizations of global government, like the World Bank, which intend to encourage convergence of national institutional policy-making functions in client countries toward established international norms and standards. Moreover, such convergence requires a low level of compliance (the adaptation of guidelines is based on voluntary basis), but a high level of cooperation, and hence the amount of enforcement needed to maintain cooperation is modest.98 Ironically,
94
Mitchell, Ronald, “Compliance theory: A synthesis”, Review of European Community and International Environmental Law (RECIEL), 1993, vol.2, pp. 330. 95 Young, Oran, International governance: Protecting the environment in a stateless society, Ithaca, N.Y., Cornell University Press, 1994, pp. 74 and 134. 96 Galtung, Johan, “On the Effects of International Economic Sanctions: Examples from the Case of Rhodesia”, World Politics, 1967, 19 (3): 378–416; Knorr, Klaus, The Power of Nations: The Political Economy of International Relations, New York: Basic Books, 1975; Bienen, Henry, and Robert Gilpin, “Economic Sanctions as a Response to Terrorism”, Journal of Strategic Studies, 1980, 3 (1), pp. 89–98; von Amerongen, Otto Wolff, “Economic Sanctions as a Foreign Policy Tool?”, International Security, 1980, 5 (2): pp. 159–67; Lindsay, James M, “Trade Sanctions as Policy Instruments: A Re-examination”, International Studies Quarterly, 1986, 30 (2): pp. 153– 73; Doxey, Margaret P, International Sanctions in Contemporary Perspective, New York: St. Martin’s Press, 1987; Pape, Robert, “Why Economic Sanctions Do Not Work”, International Security, 1997, 22 (2): pp. 90–136; and Haass, Richard N, “Sanctioning Madness”, Foreign Affairs, 1997, 76 (6): pp. 74–85. 97 Chayes, Abram, and Antonio Handler Chayes, The new sovereignty, Harvard University, Cambridge, Mass. 1993, pp. 29. 98 Indeed, as a result of rising functional and operational linkages between national institutions and international regulatory bodies, a large portion of these guidelines require states to make only modest departures from what they would have done in the absence of an agreement. For instance, unlike previous policy that required states to wholesale SOE under privatization program, the selected guidelines provide actionable information intended for coordinated function of state institutional policymakers with international norms and conduct.
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this situation (low compliance and high cooperation requirement) may create an erroneous perception for client countries that benefits of cooperation are trivial, and consequently divergence can be left with impunity. While one may argue that there is nothing is wrong with such a perception, I believe that such observation will certainly send a wrong signal, in terms of international cooperation as well as successful economic integration of recipient economies into the global system. Even if there are convincing theoretical and practical evidences to confirm that the absolute value of the benefits generated by these guidelines (targeted regulations and standards setting) is relatively large, further progress in global crisis prevention, international regulatory cooperation, and global integration will almost certainly require conditions in which there is less enforcement and far greater incentive for client countries to cooperate. In retrospect, the strategies necessary to induce compliance and maintain cooperation involve several steps. The first and foremost is to improve dispute resolution procedures through international organizations and institutions. As Chayes and Chayes state, “As in other managerial situations, the dominant atmosphere is that of actors engaged in a cooperative venture in which performance that seems for some reason unsatisfactory represents a problem to be solved by mutual consultation and analysis, rather than an offense to be punished. Persuasion and argument are the principal motors of this process.”99 Second comes the provision of targeted assistance through knowledge/knowledge transfer in order to facilitate mutually beneficiary cooperation between international organization members of global governance and their clients. Finally, procedural transparency in client countries must be encouraged through adaptation of standards and norms of international community. The last two points are particularly important for a client country with institutional policymaking structures that still operate on traditional (outdated) norms, and hence deliberately or inadvertently contemplate divergence (violation). Steps that support cooperation and transparency would expose the conduct of the country, and also increase the probability of detection. Accordingly, exposure and probability of discovery will reduce expected benefits and increase cost will deter violation regardless of the prospect of sanctions.
99
Chayes, Abram, and Antonio Handler Chayes, “From law enforcement to dispute settlement”, International Security, 1990, 14:147–64.
Chapter 4
Epistemic Communities, Knowledge Transfer, and Institutional Learning
A core tenet of our argument relates to the capacity of national to learn and adapt to ever changing global environments that is now more and more determined by global governance frameworks that defines rules, transparency. There are three main arguments that we are making. First, global epistemic communities should promote institutional learning at the local level through knowledge transfer as a vehicle to establish national and local epistemic communities. Second, institutional learning results in improvements made to policies as outcomes but also the institutional arrangements in place without directly challenging the existing way of doing things. This approach assumes that learning is not a linear process but requires an interactive approach based on feedback and it build on multiactors involvement. Third, there are many actors involved in a process that involved a continuous feedback loop and the final result is reaching common views and understanding which provides the basis for changing processes and leads to policy convergence.
Internationalization and Technocratization of Policy Making In the previous chapter, we have discussed the trends in the new global systems that manifests into increasing economic interdependence and the deepening of economic integration among countries across the world. This is mostly due to the developments of the past several decades, which led to the dominant role of financial institutions, use of technologies to achieve specific goals, the reorganization of the global structure of production. We determined how these developments bring about certain conditions and institutional settings, which manifest their potential as sites for the practice of international regimes and global governance. The concept of global governance was introduced and defined as the minimum framework of rules necessary to tackle global problems, guaranteed by a set of institutions, formal and informal, international and local, and representing the interests of as many stakeholders as possible. Therefore, actors involved in global governance
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activities are a large number of international organizations, both governmental and nongovernmental, which vary widely in structure, procedures, and basis for participation.1 Within this context, we argued that an important consequence of these changes is the decreasing role of nation-states in controlling their own affairs, which have led to major changes of the national policy-making. Paralleling this process, the process of integration expands the role of international organizations, and a greater range of social organizations and interests, increasing their engagement in national policy-making processes. Indeed, this expansion not only applies to international organizations, but also to the notion of global governance. In this context, transfer of specialized and procedural knowledge from various international organizations and their own epistemic communities is becoming a policy tool to “convince” participants in the international system to have similar ideas about what rules will govern their mutual participation: everyone is expected to play by the same rules. Central to our argument is the notion that knowledge is not only held by individual entities, but can also be transferred and shared without impediment between individual members of the global community. Within this context, a form of horizontal interdependency is developed, whereby national policy makers need to mobilize resources outside of the national hierarchical political structure in order to perform their job effectively.2 The interdependency trend (a.k.a. the unbinding process) in national policy-making is simply the move toward collective consultations, interactions, and negotiation networks. This trend affects both public sector and private sector entities in a country. Because of the interdependency of institutions in the current era, one cannot separate anymore the entities involved in the public policy making arena. For example, while policy-makers need to establish the relevant regulations framework to enable corporate governance, the effectiveness of this framework depends highly on the willingness of organizations to comply and implement with this framework. That is why we believe that both type of actors in private and public sector are affected by the global governance, changes in knowledge distribution, and emergence in knowledge networks. In sum, we argue that the internationalization of policy-making challenges the traditional view that distinguishes between domestic/international, inside/outside,
1 For future information on this topic, see The United Nations Economic Commission for Europe (UN/ECE) at: http://www.unece.org. UN/ECE is one of the five regional commissions of the United Nations. Its member states, currently numbering 55, include not only Western, Central, and Eastern Europe but also Israel, the USA, and Canada. The UN/ECE Working Party on Technical Harmonization and Standardization Policies provides a unique forum for debating and anticipating problems that might otherwise arise, with equal participation by all governments concerned and by international, regional, and national organizations, and the private sector. 2 Tanja A. Börzel, “What’s so Special about Policy Networks? An Exploration of the Concept and its Usefulness in Studying European Governance”, EioP, 1997, Vol. 1, No. 16; and Nicolas Dahan, “The role of multinational corporations in transnational institution building: A policy network perspective”, Human Relations, 2006, Vol. 59, No. 11, 1571–1600.
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and territorial/nonterritorial policies. It is a challenge to the conventional wisdom of state-based policy making. However, international relations of today, Walker (1993) argues, should be understood more as characteristics of contemporary global systems than as theoretical explanations of traditional political science. In this sense, world order can no longer be conceived as purely state-centric or even primarily state governed, as authority has become increasingly diffused among public and private agencies at the local, national, regional, and global level.3 Nation-states are no longer the sole centers or the principle forms of governance or authority in the world (Rosenau 1997). This “unbinding” process of policy-making increases the range of actors serving as a monitor (or constraint) on decision-making. As a result of the move toward a global institutional framework, the current global system can be seen as a multiactor system, whose main goal is to diffuse elite national political interest and sources of bilateral decision-making (Rosenau 1997). As Rosenau (1997) states, [Globalization] refers neither to value nor to structure, but to processes, to sequences that unfold either in the mind or in behavior, to interactions that evolve as people and organizations go about their daily tasks and seek to realize their particular goals. What distinguishes globalization processes is that they are not hindered or prevented by territorial or jurisdictional barriers. They can be spread readily across national boundaries and are capable of reaching into any community everywhere in the world. They can be initiated from above by transnational elites or from below by ecologically oriented or other civic-minded local groups (p. 80).
Hence, some individuals believe that the locus of control rests in the hands of non-national interests. Obviously, a country can avoid this interdependency trend if it does not enter into global markets (Mayntz 1994). Therefore, if a country decides not to integrate its economy with global markets, the issue of control becomes irrelevant.4 Moreover, the unbinding process underscores the issue of accountability in national policy-making, and, more importantly, gives credibility to the role of laws and institutions. This is not only an ethical issue, but can also have direct implications for public confidence in national political institutions, which has been dismal for many countries around the world, and can strengthen a national government (Easterly 2002, 2006). Alongside these developments, several global phenomena have also contributed to the changing nature of national policy formation. The most important element of these global developments is the emergence of information networks, namely the Internet, and consequently knowledge transfer which function as a facilitator between knowledge providers and those who seek it. Indeed, the rapid expansion of knowledge networks has rendered unprecedented opportunity for national bureaucrats
3
This is not to say that governments are not powerful holders of national interests, but rather, they are among shareholders of these interests together with other organizations and institutions. 4 For more analysis of control see the regulation and standards setting section in this study.
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(including researchers, academics, and policy makers) in developing economies to have access to the most current policy experiences/developments, as well as policy documents that have been tested and implemented elsewhere. Thus, developing economies now have access to knowledge that was previously inaccessible or extremely difficult to access. In this respect, developing economies can build on newly available knowledge to design policies that facilitate local economic development. More importantly, these current developments point to the fact that both global and national policies are increasingly differentiated into highly complex, and often technical areas – need for interdependence and while national institutional frameworks are still working separately the commonality of these global issues create a common demand for the same type of technical content. This trend is manifested and defined through concepts such as technocracy, and epistemic communities that embodies the different modes of how expertise is applied to policy-making. As a prelude to this section, we wished to briefly discuss Frank Fischer’s classic book, Technocracy and the Politics of Expertise as it presents an excellent introduction to the subject that has annoyed social thought ever since Machiavelli pondered the question of whether the Prince, rather than his technical advisors, makes the crucial decisions in a policy.5 Fischer’s main point addresses the question: “Can democracy work in a complex technological society?”6 He is doubtful that it can. Drawing on an impressively broad range of sources, Fischer finds that virtually every “advance” in the policy and management sciences has led to the deliberate undermining of “democracy.” For instance, Fischer claims that Taylor’s scientific management was less about improved production and more about management controlling the emerging labor movements. Fischer highlights that most policy analyses ignore the value preferences of their alleged “clients” and that the increasingly technical nature of policy decisions renders them virtually indecipherable to many otherwise interested parties. Thus, an expert group of elites, dangerously distanced from its clients, is often created. Fischer is hardly alone in his somber assessment. Lasswell and Kaplan in their influential definition of the policy sciences, caution that the policy sciences were designed to provide “intelligence pertinent to the integration of values realized by and embodied by interpersonal relations [such as] human dignity.”7 Deleon observed that “in the analysts’ current positions (geographic and bureaucratic), they are effectively sequestered from the demands, needs, and (most critically), values of the people they are reputed to be helping.”8 More harshly, John Dryzek has charged that “most policy analysis efforts to date are in fact consistent with an, albeit subtle, policy science of tyranny.”9
5
Frank Fischer, Technocracy and the Politics of Expertise, Newbury Park, Calif.: Sage, 1990. Ibid, pp. 31. 7 Lasswell, H., and Kaplan, A., Power and Society, New Haven, Yale University Press, 1950, pp. xii. 8 Deleon, P. “The Democratization of the Policy Sciences.” Public Administration Review, 1992, 52 (2), pp. 163. 9 Dryzek, J. “Policy Sciences of Democracy.” Polity, 1989, 22, pp. 98. 6
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In the context of this book, however, we have underlined three conceptual flaws and omissions in the above analysis. First, Fischer neglects important differences, for example, between bureaucracy, scientific management, and technocracy. Bureaucracy is based on formal rationality, while Taylorism and technocracy are grounded in substantive rationality.10 Taylorism emphasizes the separation of conception from execution, technocracy seeks to integrate production and control, internalizing the latter into all phases of work. Both bureaucracy and scientific management assume and reinforce the rigidity of procedures and technology. Second, the changing role of professionals is not sufficiently clarified. Experts are not professionals in the sense of commanding technical, organizational, political, and interpersonal autonomy. For instance, professional power of international organizations is based on a globally based mandate and international-backed license to achieve the goals and practices of their domain. The power of experts, by contrast, is often based on their role and function in a self-controlling system that grants autonomy for limited tasks and specific problem-solving activities. Experts, are not typically, however, awarded power due to a position in a fixed occupational or hierarchical division of labor. Finally, Fischer, much like Weber and Marcuse, espouses a narrow perspective of control strategies. Fischer understands bureaucracy, elitism, centralization, and technocracy as aspects of the same phenomenon that is currently engulfing the political sphere of policy-making (and participatory politics). However, his perspective does not adequately address incompatible strands between national states and the global policies of strategic planning as they engage in technocratic crisis management. In our opinion, there are several characteristics of the technocratic-based policymaking process that we address below. First, there is the increasing technical complexity of the issues central to policy making, especially for development policy, which includes issues of transparency, macroeconomics, technology, environment, health, and population. Consequently, policy formulation, especially in developing countries, is increasingly dominated by highly complex technical ideas that place tighter constraints on a policy maker’s ability to choose the correct policy instruments. To enable a government to function in this new arena, fresh demands are being placed on national governments to foster new skills and knowledge. For instance, one of the main issues facing developing economies is the formulation of a developmental policy that is comprehensive in its vision and internationally compatible in its structure. In the global economy, change and adaptation occurs at a faster rate, and hence compatibility plays an important role in the success (or failure)
10 Formal rationality is a type of decision-making, which is subject to calculation that goes into an action to increase its chance of success. Its decisive feature is that it eliminates an orientation to values because they are nontechnical. Rationality is formal when problems are solved by the application of technical criteria. Substantive rationality is a type of decision-making, which is subject to values and an appeal to ethical norms. Substantive rationality does not take into account the nature of outcomes. Weber argues that formal rationality had replaced substantive rationality, because bureaucracy stresses a technical orientation to means and ends.
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of national policy implementation. If, for instance, a national accounting system is incompatible with those at the international level or national corporations do not follow the common international code-of-conduct, participation in the global market will be difficult and much less effective. A policy maker who wishes to facilitate international trade and capital flows by reforming national financial regulations and standards, e.g., accounting and auditing, must take into consideration the scope of international regulations as well as a national institutional capacity to adapt to these regulations and standards. He or she must ensure that every policy decision is made in accordance with internationally accepted standards and conduct. As a result, policy-makers need to consider the complex linkages embedded in today’s economic, political, and social global system.11 Equipping national policy-makers to deal with these demands requires creative thinking on consensual policy-making, learning, and training. Furthermore, to be globally competitive, government require the ability to quickly and continually add value to diverse policies in the face of rapidly changing needs, technologies, and environments. These competitive forces and increased complexity are prompting major changes in institutions.12 For this is to happen, governmental institutions – need to take the lead in an integrative and collaborative learning process and play a substantial role in transforming into a genuine knowledge creation system As such, institutional reform as well as nonformal learning, such as training sessions, begins to emerge (Levy and Kpundeh 2004). The new framework grants national policy makers and bureaucratic structures access to learning opportunities that focus on specific skills rather than general competencies. Moreover, the accessibility to information/knowledge enables national bureaucrats to learn about the new trends in the global system, the various effects of popular policy decisions, and how to develop regulations and standards that are consistent with the international code-of-conduct. In fact, this may be one of the main reasons why members in the bureaucracy – in the executive body, in governmental agencies, and in related interest groups and professional networks – often formulate policies that are quite often similar to those created outside the country. Furthermore, a system of governance, namely technocracy, has been established “in which technically trained experts rule by virtue of their specialized knowledge and position in dominant political and economic institutions” (Fischer 1990, p. 17). According to Fischer (1990), expert knowledge and technocratic practices are key factors in the national decision-making process. In sum, technocracy refers to the use of experts and their technical expertise in the pursuit of political power and the good society.
11 The reader should note that this observation is purely based on the prevailing trends in the global system, and therefore is free from the authors’ value judgment. 12 See Adler, N. and Bartholomew S., “Managing globally competent people”, Academy of Management Executive, 1992, 6(3), 52–65; Caligiuri, P. and Di Santo, V., “Global competence: What it is, and can it be developed through global assignments”, Human Resource Planning Journal, 2001, 24(3), 27–35; and Pfeffer, J. and Sutton, R. I., The knowing doing gap: How smart companies turn knowledge into action Boston, Harvard Business School Press, 1999.
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It is clear that the increased technocratization of national policy processes requires a greater cooperation with international organizations and their expert communities. The advice these expert communities provide to national policy makers is critical to the achievement of national developmental objectives. Knowledge and technical expertise provided by these experts can help national policy-makers define and understand the complexity and causal linkages of areas that require technical expertise, and engage in international development and play a more active role in the global system. Haas (1992) argues that at the heart of this argument lies the assumption of uncertainty, the existence of information asymmetry, the presupposition that decision makers are unfamiliar with the technical aspects of a specific problem as well as the implicit acceptance that policies that are provided by experts and informed by technical knowledge and expertise are better than alternatives. As a result, we argue that nation-states need to access and co-ordinate with external and specialized knowledge and expertise in order to be able to understand and implement policies to meet the increasing technical nature of the national and global policies and rules. Thus, the officials dealing with these areas became functionally dependent on various technocrats and professional groups for expertise and information.13 The importance of experts in decision-making processes is based on several observations. First, experts provide rationality to decision-making processes, and, therefore, transmit the intrinsic, hidden normative claim of the scientific evidence utilized (Fischer, Miller, and Sidney 2006; Lupia et al. 2000). The role of expertise in policy-making is based on the assumption of scientific rationality, where the analysis is based on data that is gathered through scientific procedures. Interpretations and predictions made by experts are perceived to be rational because they are based on objective evidence. The objectivity of scientific inquiries makes recommendations made by experts seems value-free and, therefore, policy decisions made by these experts appear technical rather than political (Lane 1966; Bell 1960). Thus, expert knowledge is used as a rational basis for substantive policy making, and as a means of defending the legitimacy of particular policy decisions (Crozier 1973).14 In this respect, one can argue that experts possess an ultimate authority in the policy-making process where expertise is used as a “rational” basis for making a specific decision and for ensuring the legitimacy of such a decision: “The capacity of science to authorize and certify facts and picture of reality [is] a potent source of political influence” (Ezrahi 1971, p. 121).
13 Regarding the complex technical areas, consider, for example, the increased complexity of categories and criteria for institutional regulation in terms of establishing a mechanism for intellectual property rights (IPR). 14 In fact, the existence of national bureaucracies is indeed directly related to their ability to control and monopolize expertise knowledge. A vivid example of the importance of this tendency to monopolize knowledge occurred during the energy crisis with the realization that the large oil companies possessed nearly exclusive knowledge on the state of oil reserves.
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Secondly, by virtue of being internationally recognized, an expert’s participation can earn legitimacy for the policy at hand, both internationally and nationally. Such recognition not only conveys credibility but also encourages others to realize a “good” intent. Therefore, in all likelihood it can open powerful channels to international resources as well as facilitate obtaining international support for various, and unrelated, national policies. In sum, the participation of experts in national policymaking bestows the legitimacy essential in building relational networks with the rest of the world.
Networks and Epistemic Communities As discussed in the previous section, it is clear that the increased technocratization and internationalization of national policy processes requires a greater cooperation with international organizations and their expert communities. The knowledge and expertise these expert communities provide to national policy makers is critical to the achievement of national developmental objectives and it can help national policymakers engage in international developments and play a more active role in the global system. It is within this sphere that national interests and international goals are identified and converge, permitting the formation of new global epistemic communities to emerge within specific standard areas of the global system. We argue that these global epistemic communities are promoted by international regulatory and financial organizations to play an essential role in converging the functions of government by transferring procedural knowledge to protect against adverse cross-border developments affecting global financial stability. Crises that affect a large number of people across national boundaries, such as financial crisis, hunger and destitution, wars and climate change, are beyond the capability of any one nation to resolve. It is clear that problems of such magnitude and reach require significant institutional capacity structural components that can only be formulated at the global level. In this respect, there are two emerging notions relating to role of epistemic communities. Firstly, the emerging economic as well as legal principle of “common but differentiated responsibilities,” and secondly the means of operationalizing this principle.15 The point is not to find interest-free, power-free domains but rather to establish fundamentals under which the need for effective policy decision making and policy implementation is oriented toward shared norms and goals different from the previous settings. New standards are needed to meet “sets of implicit or
15 It should be noted that in response to these issues, many important questions may arise that are not relevant to this study, and hence are left unattended. For instance, under the present condition, does formation of global solution contribute to a fairer world system in which all States recognize their historical responsibility for past neglect? Or is it simply an expedient means of ensuring the participation of developing economies in what are primarily developed economies concerns?
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explicit principles, norms, rules, and decision-making procedures around which actors’ expectations converge in a given area of international relations” (Krasner 1982: 186). In this respect, international organizations are experimenting with global expertise networks, which aim to provide access to standard guidelines and share the experiences of national economies and policy-makers around the globe.16 The purpose of networks in this content was motivated by the need to drive the learning associated with the process of standardization into a set of highly independent policy-makings and activities. International organizations appear to have realized that the success of a global strategy of gradual integration of a complex set of regulations and standards into national policy agendas and national institutional operations depends largely on the development of informal and formal networks, rather than conditionality or other means of compliance. As mentioned above, global knowledge and expertise with the purpose of creating uniform systems of rules and norms that will form the basis of a global policy making agenda are enforced and promoted by networks of experts belonging to diverse global institutions, from international organizations to universities and nonprofit organizations and multinational corporations. One common critique discussed in the literature on policy-making processes is the inadequate treatment of how ideas are introduced and successfully championed in the policy process (Hira 1999). Moreover, a key preoccupation of policy makers and policy implementers is the search for “best practices” in addition to the correct “fit” between policy objectives and organizational capacity (Pollitt and Bouckaert 2000). However, determining these concerns is a far from straightforward process and one that needs to be backed by credible, reliable, and objective evidence. This is particularly true if nations are to be persuaded to adopt policies that carry direct costs to them or challenge deeply embedded conducts or beliefs. Nevertheless, there is no doubt that the establishment of best practices emerges through debate within a policy network. Crucially, in such a complex global environment, the existence of international epistemic communities (Adler and Haas 1992), such as professional, knowledge-based networks, adds an extra layer to the policy process and can assist in the policy convergence process. In fact, it has been argued that the concept of epistemic communities is a major driving force in the decision to transfer policy especially within the context of global governance (Stone 2000). Before discussing epistemic communities, it is important to touch upon the construct that lies at its base, namely the idea of “networks.” Within the literature, networks are defined as new forms of social organization. The term is widely used across a number of disciplines including the sociology of science and technology (Callon 1986), the economics of network industries and network technologies (Katz and Shapiro 1985), business administration (Powell 1990; Thorelli 1986), and public policy (Marsh and Rhodes 1992; Lehmbruch 1991; Jordan and Schuber 1992).
16
For instance, see Paul R. Sparrow, Chris Brewster and Hilary Harris, Globalizing Human Resource Management, Routledge, New York, 2004.
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The term network appears to have become “the new paradigm for the architecture of complexity” (Kenis and Volker 1991). Yet, the use of the concept varies considerably between and within various disciplines. Relevant to our discussion and concept of network, is the emerging twenty-firstcentury innovation ecosystem (also called “Mode 3” Innovation Ecosystem) (Carayannis 2005; Carayannis and Campbell 2006; Carayannis and Campbell 2009; Carayannis and Campbell 2010) which is defined as follows: A twenty-first-century innovation ecosystem is a multilevel, multimodal, multi-nodal and multi-agent system of systems. The constituent systems consist of innovation meta-networks (innovation networks17 and knowledge clusters18) and knowledge meta-clusters (clusters of innovation networks and knowledge clusters) as building blocks and are organized in a self-referential or chaotic/fractal knowledge and innovation architecture, which in turn constitutes agglomerations of human, social, intellectual, and financial capital stocks and flows, as well as cultural and technological artifacts and modalities, continually coevolving, cospecializing, and coopeting. One of the basic ideas is: co-existence, co-evolution and co-specialization of different knowledge paradigms and different knowledge modes of knowledge production and knowledge use as well as their co-specialization as a result.
These innovation networks and knowledge clusters involving multitudes of professionals, belonging the same or related epistemic communities also form, re-form, and dissolve within diverse institutional, political, technological, and socioeconomic domains including government, university, industry, nongovernmental organizations and in a top-down, policy-driven as well as bottom-up, entrepreneurship-empowered fashion (Carayannis and Campbell 2006; Carayannis and Campbell 2009). These networks involve a structure, which is a fixed set of relations between the forms of knowledge and actors involved in the network. The structure enables the system to generate a function. The function may be some form of economically useful performance, like producing one or more competitive products or implementing policies. In the literature on policy-making, the concept of networks has been applied to characterize expert relational practices through two core constructs: policy networks and epistemic communities. “Policy networks” refer to a set of relatively stable, nonhierarchical, and interdependent relationships that link a variety of actors. The actors in a policy network share a common set of policy interests and exchange resources to pursue the shared interests. Through this practice, they acknowledge that co-operation is the best way
17 Innovation networks are real and virtual infrastructures and infra-technologies that serve to nurture creativity, trigger invention, and catalyze innovation in a public and/or private domain context (for instance, government–university–industry public–private research and technology development coopetitive partnerships) (Carayannis and Campbell 2006; Carayannis and Campbell 2009). 18 Knowledge clusters are agglomerations of cospecialized, mutually complementary, and reinforcing knowledge assets in the form of “knowledge stocks” and “knowledge flows” that exhibit selforganizing, learning-driven, dynamically adaptive competences and trends in the context of an open systems perspective (Carayannis and Campbell 2006; Carayannis and Campbell 2009).
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to achieve common goals.19 Within the political science literature, policy networks have become an important paradigm for the analysis of complex relationships between governmental departments and agencies, interest groups and other groups relevant to policy making. The policy networks model was developed by Rhodes (1997, 1986) and subsequently applied to the study of the EU by Peterson (1995). According to Rhodes’s model, a policy network is a set of resource-dependent organizations. Networks have different structures of dependencies that vary along five key dimensions: the constellation of interests; membership; vertical interdependence; horizontal interdependence; and the distribution of resources. He identified five types of networks – ranging from highly integrated policy communities to the loose affiliation of an issue network – which show different levels of interdependency engendered by specific configurations. The “resource-dependencies” that lie at the heart of policy networks appear to be the key variable in shaping policy outcomes. As Peterson and Bomberg (1993) put it, “They set the ‘chessboard’ where private and public interests maneuver for advantage” (p. 28). However, interdependence is “almost always asymmetrical” and in some cases it is possible to speak of ‘unilateral leadership’ within networks (Rhodes 1986, p. 5). It is important to note that a particular strength of the policy networks approach, in relation to this book, is its emphasis on policy implementation. This aspect of the approach provides policy-making actors with considerable discretion. Policy networks do not, however, constitute a predictive theory. They provide categories and tools with which to order and analyze information. The approach facilitates the mapping of various functions of national institutional policy-making and, through the notion of power dependence, aids the understanding of how policy outcomes can be shaped through changes in the distribution of different types of resources: financial, organizational, legal, political, and informational. Recognizing the importance of network integration highlights that implementation is more likely to be successful where the network is integrated and actors have a shared understanding of the policy problems they face and how to solve them within the governance framework. These understandings follow not only from formal constitutional or institutional arrangements, but also from informal understandings, which are enormously influential in how network actors interpret their roles and the governance rules of the game. If these rules are not clear or not shared, poor network integration will lead to difficulties in implementation.
19 Beyond this basic definition, which is debatable, a wide and often confusing array of different understandings and applications of the policy network concept can be found in the literature. Often authors have only a vague idea of what a policy network is and hardly ever make their definitions explicit. Whereas some consider policy networks to be a metaphor to denote the fact that policy making involves a large number and a wide variety of participants, others understand the networks to be a valuable tool for analyzing the relations between participants interacting with each other in a given policy sector. A third group sees policy networks as a method of social structure analysis, but do not agree on using network analysis as a quantitative or qualitative method. Yet most would agree that policy networks provide at least a minimally useful toolbox for analysis.
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Epistemic communities are a subset of policy networks. They feature additional characteristics such as a shared set of values, causal beliefs, and notions of validity. Holzner (1968, 1979) introduces epistemic communities as “knowledge-oriented communities in which cultural standards and social arrangements interpenetrate around a primary commitment to epistemic criteria in knowledge production and application” (p. 108). Haas (1992) has taken this definition one step further, applying it to international relations and policy-making. In his view, epistemic communities are networks of knowledge-based experts or groups with recognized expertise in a particular domain and an authoritative claim to policy-relevant knowledge within the domain of their expertise (Haas 1992, p. 3). The members of epistemic communities share a common set of values and beliefs, have a common theoretical understanding of causalities within policy measures and desired outcomes, share notions of validity and pursue the same policy enterprise. Haas (1992) underscores the role of epistemic communities as channels through which ideas, norms, values, and technical knowledge circulate from societies to governments and from country to country and influence policy outcomes. The epistemic community framework argues that a network of like-minded professionals in midlevel state bureaucracies possesses significant opportunities to influence policy making in various fields, particularly in highly specialized areas. Haas (1992) notes that the way in which governmental decision-makers define state interests and formulate policies is often heavily influenced by the way the issue is presented to them by specialists in that domain (Haas 1992). In this context, the epistemic community approach describes the roles played by networks of experts in international decision-making: the process by which they agree upon and articulate causal linkages within complex issue spaces; how they frame issues and define salient discourse; how they define and limit potential solutions or outcomes; and how they define state interests within the issue space. With respect to global governance, epistemic communities can be defined as transnational networks of knowledge-based experts. These experts define the particular problems facing decision-makers, and what the decision-makers should do about them, and as a result, they contribute to increasing the state’s capacity. The state’s capacity is relevant in at least two ways. First, a high level of state capacity is needed to be able to negotiate effectively with private investors, multinational corporations, and/or international organizations such as IMF and the World Bank. Extensive knowledge on the nature of national economies and the characteristics of productive sectors is a prerequisite for advantageous deals, next to strong bargaining skills. Secondly, in working with multilateral organizations, i.e., WTO, another type of capacity is useful – the ability to design economic programs according to a holistic vision and the State’s economic objectives. The prevailing perception is that countries that lack such a capacity are often left to the discretion of multilateral agencies in place of national ministries (Rakipi 2004). Epistemic communities are also relevant to the consideration of a global mode of regulation in that they are formed by international technical expertise rather than national political dynamics. Bennett (1991) speculates that this development presents the evolution of a technocracy that links policy with technical issues and specialized
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knowledge rather than with more general national interests. It seems plausible that conglomerations of technocratic networks with global identities would be a prerequisite to the functioning of an institutionalized global mode of regulation. It should be noted that for an epistemic community to be influential, it must have access to high-ranking policy-makers. The community must establish both formal and informal channels, and create a body of thought that it can “filter to them indirectly” (Drake and Nicolaidis 1992). Moreover, based on global interdependence and mutual interests, organizational members of global governance structures such as the World Bank play a valuable supporting role. Through the provision of various programs by such organizations, countries gain access to resources outside their own boundaries. This is achieved either by spot contracting (trade deals and consultancy jobs) or by entering long-term relationships with various international expert organizations such as the International Accounting Standards Board (IASB), the Accounting Standard Boards (ASB) in the UK, or the Financial Accounting Standards Board (FASB) in the USA. Thus, a principal characteristic of the policy-making process in countries that are clients to epistemic communities is the development of complex consultation relationships between experts and national governments. In sum, we argue that in the absence of an international analogue to a domestic government, networks of actors/experts are assembled to address interstate problems. This formation serves several main purposes: First, it creates a consensus on norms and practices, such as, for example, the creation and improvement of accountability and transparency mechanisms within national governments. Secondly, the creation of a network of actors/experts conveys the message that parts of the policymaking process are moving to the public domain. Thirdly, due to the processes of globalization, economies are linked, giving rise to various benefits and risks and increasing the need of nation states to access and co-ordinate with external resources. Therefore, institutions at the national level must increase their ability to access, synthesize, and effectively apply external and expert knowledge to create policy that complies with global rules and regulations. In the next section, we discuss in more detail how knowledge and institutional learning can help national institutions to achieve this goal.
Knowledge and Institutional Learning In this section, we present our theoretical framework for the analysis of knowledge, and institutional learning. In the previous section, we argued that the world is changing, and emerging trends imply strong internationalization and technocratization of policy-making governed partly by global epistemic communities. In an era of globalized, highly mobile financial capital, and multinational corporations, we argue that institutions in policy-making arena need multifaceted and highly specialized expertise and can and should essentially “arbitrage” across national borders to find the best knowledge to integrate into their mode of production. Only through the judicious and experienced application of knowledge can institutions hope to reach
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common views and understanding which provides the basis for changing processes in compliance to global norms.20 The postindustrial economy operates with dynamics which differ radically from those assumed by neo-classical economics. Economics since Adam Smith identifies three chief productive factors in any economy: land, labor, and capital. Thereafter, Schumpeter (1934) added technology and entrepreneurship as key inputs to economic activity and Drucker (1985) added knowledge. The shift in the West from an agrarian economy to one based on manufacturing was marked by the shift from land as the most important factor to physical capital – factories, machinery, and resources which composed these assets – and the financial capital to acquire those assets. The rise of a postindustrial society as described by Drucker (1985) suggests that other assets are approaching ascendancy as contributors to economic productivity.21 In postindustrial economy, wealth flows not to those who control financial capital, but to those who can acquire and direct intellectual capital. The term “intellectual capital” refers to intellectual assets (i.e., skilled workers, scientific knowledge, and business information) which create knowledge into the future through their utilization. Intellectual capital has been defined by analysts at Ernst and Young as “intellectual material that has been formalized, captured, and leveraged to produce a higher-value asset”.22 Unlike other forms of capital, intellectual capital is not only unevenly distributed, but it also tends to grow without physical limits. An organization which captures and exercises unique knowledge capabilities will tend to attract more expert employees, thus exhibiting “increasing returns to scale.” According to Arthur, this dynamic leads to a new form of economics – knowledge economics – that is very different from traditional, process-oriented economics. The rules of this new paradigm “call for different management techniques, strategies, and codes of government regulation.” The task of management becomes “a series of quests for the next technological winner.”23 The strategic goal of the organization is to establish a stream of innovations, each capitalizing on the success of its predecessor. Intellectual capital is thus the primary source of wealth creation, since it enables the generation of new knowledge within the organization to establish and maintain technological leadership. However, assessing the importance of knowledge is more difficult than comparing the importance of capital and labor. The operationalization of knowledge is more complex than that of capital or labor, as the latter is done through concrete
20 Carayannis, E. and Alexander, J. “Electronic commerce and knowledge economics: trust and co-opetition in a global business environment,” Journal of Internet Banking and Commerce, at http://www.arraydev.com/commerce/JIBC/9703–05.htm. 21 Drucker, P. (1991) Post-capitalist Society. Butterworth-Heinemann, Oxford. 22 Stewart, T. (1994) ‘Your company’s most valuable asset: intellectual capital’, Fortune, October 3, pp. 68–74. 23 Arthur, W. B. (1996) ‘Increasing returns and the new world of business’, Harvard Business Review, July–August, pp. 100–109.
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market prices (monetary units).24 Knowledge has different values in different situations, and therefore, the use of market prices (monetary measures) of knowledge are ambiguous/irrelevant and undependable.25 More importantly, and related to policy design and implementation, the notion of knowledge may not be political, but it conveys an important political message. As noted earlier, the introduction of “global governance” and a prevailing global system brought forth certain elements that have become widespread and seemingly accepted across all countries and institutional settings. According to these developments, knowledge is viewed as the quintessential resource, the key to success, which must be managed effectively.26 The very concept of “knowledge” invokes notions of insight, skill, prestige, and power.27 Indeed, there exists a certain peculiar insinuation associated with the term knowledge or its residuals like knowledge worker. Knowledge worker, a term invented by Peter Drucker,28 is, according to Drucker, “one who works primarily with information or one who develops and uses knowledge in the workplace.”29 In this respect, knowledge work is associated with those who occupy a privileged position within the division of labor, and, hence, are perceived to be highly qualified individuals who belong to or form a distinct component of an elite group of professional and managerial employees.30 As a result, conceptions about knowledge, knowledge workers, and expert communities become highly idealized.31 Given this, if knowledge is placed on a pedestal, and, as a result, insinuates power, is it not better/more desirable to be more rather than less knowledge-intensive? It is here that the concept of experts and expertise itself has become politicized. At a country level, national governments have been encouraged by
24
At best, prices reflect those values of input that could transfer easily from one firm to another. Thus inputs’ importance for intrafirm activities or for activities that are idiosyncratic to a single firm are ignored. 25 In fact, knowledge itself (in its many forms) is nearly as ambiguous as an idea, or the notion of value or importance. (see S. G. Winter, “Knowledge and competence as strategic assests”, in D. J. Teece, edit, The Competitive Challenge: Strategies for Industrial Innovation and Renewal, Cambridge, MA, Ballinger, 159–85). 26 For a review and classic example of what we call the “knowledge economy rhetoric” from an economic perspective see R.G. Harris, “The knowledge-based economy: intellectual origins and new economic perspectives”, International Journal of Management Reviews, 2001, vol3, no.1, pp.21–40. 27 F. Blackler, “Epilogue: knowledge, knowledge work and organizations”, in N. Bontis, and C.W. Choo (eds) The Strategic Management of Intellectual Capital and Organizational Knowledge, New York, Oxford University Press, 2002. 28 Peter, F. Drucker, Landmarks of Tomorrow: A Report on the New ‘Post-Modern’ World, 1959. 29 Wikipedia: Knowledge workers http://en.wikipedia.org/wiki/Knowledge_workers. 30 D. Knights, F. Murray and H. Willmott, “Networking as knowledge work: The study of strategic inter-organizational development in the financial services industry”, Journal of Management Studies, 1993, vol.30, no.6, pp.975–95; and U. Schultze, “A confessional account of an ethnography about knowledge work”, MIS Quarterly, 2000, vol. 24, no.1, pp.1–39. 31 Alvesson 1993.
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international organizations to embrace the importance of knowledge as the main source of development and well being in a postindustrial economy. For instance, the World Bank in its World Development Report declared the following: “Knowledge is critical for development because everything we do depends on knowledge.”32 In the same report, it is also claimed that “for countries in the vanguard of the world economy, the balance between knowledge and resources has shifted so far toward the former that knowledge has become perhaps the most important factor determining the standard of living – more than land, than tools, than labor. Today’s most technological advanced economies are truly knowledge based. And as they generate new wealth from their innovation, they are creating millions of knowledge-related jobs in an array of disciplines that have emerged overnight: knowledge engineers, knowledge managers, knowledge coordinators.”33 While the knowledge may be a meaningless category in the technical sense it is clearly meaningful to the many scholars, practitioners, and policy makers who continue to use the term. Knowledge is positively charged in the “knowledge economy” or “global governance” rhetoric34 and the role of knowledge has become an attractive topic of research. The concept clearly evokes particular meanings and promotes particular interpretations of knowledge. Its role in contemporary organizations that involve expertise development and knowledge transfer has visibly grown. While there are many conceptions of what knowledge is, we define knowledge in relation to learning in the following way: • Knowledge is the content of learning, where an organization gains competitive superiority by either knowing something that its competitors do not know, or by having a certain type of knowledge that cannot be easily replicated. • Learning is the process of gaining new knowledge, so that the organization is constantly accumulating and assimilating new knowledge which becomes the basis for creating and improving organizational routine. • Learning is the basis of what strategists are calling the dynamic capabilities of an organization, where organizations build new competences in an evolutionary cycle to maintain an edge in an ever-changing environment. Furthermore, we define institutional learning processes as knowledge creation, transfer, absorption, and use by individual or collective actors and leads to changes in their conduct and results in changed institutional arrangements. What qualify a learning process to be institutional are its social characteristics that assume that collective actors and norms exceed individual decision-making (Siebenhüner and Suplie 2005). How that occurs, that is, in more or less intelligent, effective, and efficient ways, is determined by both chance and necessity (Monod 1971) and in this
32
“Knowledge for Development”, World Development Report 1998/99, the World Bank, Washington DC, pp. 16. 33 Ibid. 34 Gregorio Martin de Castro (et al), Knowledge creation processes: theory and empirical evidence from knowledge-intensive firms, Basingstoke [England], New York, Palgrave Macmillan, 2007.
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context lie the concepts of strategic knowledge arbitrage and strategic knowledge serendipity (Carayannis 2004, 2005, 2008, 2009, 2010 ; Carayannis et al. 2003) as we discuss below. In this book, we argue that at the heart of a successful activity is a resident – and continually enhanced through learning – capacity to possess, manage, and leverage strategic knowledge serendipity and strategic knowledge arbitrage (Carayannis and Juneau 2003; Carayannis and Campbell 2006; Carayannis 2008, 2010). We define strategic knowledge serendipity, arbitrage, coevolution, cospecialization, and coopetition (SKARSE_C3) below: • Strategic knowledge serendipity: The unintended benefits of enabling knowledge to “spill over” between agents, groups, and functional domains (“happy accidents” in learning) or more specifically: – The capacity to uniquely identify, recognize, access, and integrate knowledge assets better and/or faster to derive, develop, and capture nonappropriable, defensible, sustainable, and scalable benefits (Carayannis, GWU Lectures 2000–2005; Carayannis et al. 2003a, 2005, 2005a; 2006a, b; Carayannis 2008, 2009, 2010). • Strategic knowledge arbitrage: The ability to distribute and repurpose specific knowledge for applications other than the intended topic area for that knowledge or more specifically: – The capacity to uniquely create, identify, reallocate, and recombine knowledge assets better and/or faster to derive, develop, and capture nonappropriable, defensible, sustainable, and scalable pecuniary benefits (Carayannis, GWU Lectures 2000–2005; Carayannis et al. 2003a, 2005, 2005a, 2006a, b, Carayannis 2008, 2009, 2010). • Strategic knowledge coopetition: Deriving new knowledge through the healthy balance between competition and cooperation involving employees and business partners (Carayannis et al. 2007; Carayannis 2008, 2009). • Strategic knowledge cospecialization: Learning and knowledge that encourages individuals or groups to expand their roles into new areas and new domains, in a complementary and mutually reinforcing fashion (Carayannis et al. 2007; Carayannis 2008, 2009, 2010). • Strategic knowledge coevolution: Creating new knowledge through a series of interactions and changes at various levels of the organization, spurred by the cogeneration and complementary nature of that knowledge (Carayannis et al. 2007; Carayannis 2008, 2009, 2010). This conceptual framework of knowledge and institutional learning calls immediate attention to the fact that knowledge is internal to the knower and includes the knower’s skills, experiences, values, and reasoning as well as information. Following the concepts introduced by Polanyi, many writers categorize knowledge into two types: tacit and explicit. Tacit knowledge is gained through “learning by doing”; it is knowledge that is internalized through practice and usually requires the “learner” to rub shoulders with the “teacher” to enable knowledge transfer. This knowledge is
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not easily depicted in words, diagrams, or other forms of communication, and may in fact not be verbalizable at all. In contrast, explicit knowledge is knowledge that can be identified, codified, and isolated more easily. For example, explicit knowledge can be captured in a database and transferred between individuals without the need for direct interaction. In one conventional view, these two forms of knowledge are distinct and exclusive. A new view of knowledge proposed by Tsoukas holds that “tacit and explicit knowledge are mutually constituted…the two are inseparably related.” From this perspective, the artificial representation of knowledge in explicit form distorts that knowledge. It ignores the tacit component of knowledge, consisting of intangible elements such as expertise, judgment, and intuition, which are necessary for the proper application of the explicit component. Therefore, in any case of knowledge transfer, direct interaction between people is necessary to capture the full benefit of the knowledge. Another perspective relevant to this book is the individual versus organizational knowledge. If, as Tsoukas (1996) states, the organization is a “distributed system of knowledge,” it can exploit individual knowledge only when transformed into organizational knowledge. That is, knowledge possessed by one employee needs to be readily accessible to anyone in the organization who needs it. The acquisition and integration of individual knowledge lead to the development of new competences through organizational transformation (Nonaka and Takeuchi 1995; Spender 1996). These processes of knowledge-based transformation are organizational learning activities. The result of improved organizational learning is enhanced “strategic flexibility,” (Sanchez 1993) meaning that the organization faces a greater range of potential options for action that can then be leveraged to achieve a better fit to its environment. Such a view of organizational learning is analogous to the general concept of learning advanced by Huber (1991): “An entity learns if, through its processing of information, the range of its potential behaviors is increased” (p. 89). An understanding of the dynamics of organizational learning help to provide a better grasp of the relationship between an organization’s ability to grow and change in its capabilities, and its future strategic performance. Analyzing how organizations learn new routines provides a map to the ways that organizations and the people therein generate, process, and alter their explicit knowledge and tacit skills, as well as the paths of change that such styles of organizational cognition can follow…and [thereby] create questions and motives for further research on the dynamics of the creation and evolution of organization core competencies (Carayannis 1994b). Organizational knowledge can be classified into three general categories: tacit, rule-based, and background. Tacit knowledge concerns the intuitive aspect of knowledge. Rule-based knowledge concerns the behavior and functioning of the organization, and can be both tacit and/or explicit. Finally, background knowledge provides the proper context for understanding other forms of knowledge. One implication of this typology is that any organization needs to be able to capture and transfer all three types of knowledge as effectively as possible. Focusing only on explicit knowledge is not optimal, because explicit knowledge is inherently less valuable when separated from tacit knowledge. Also, a organization is not optimizing if it has important knowledge “locked up” in the minds of a few individuals, because those
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experts can be hired away. Knowledge needs to be embedded in the organization to make it a true source of competitive advantage. While we have discussed above different typologies of knowledge and their relevance to institutional learning, one core aspect that is essential to our discussion is that knowledge has no value unless it is used (Glazer 1998). We must remember that knowledge in real-world context is not an abstract substance. We are not interested in knowledge from the perspective of stored symbols and texts, whether it is found carved into a stone, in a library, or in a hard-disk. Our interest is in living knowledge, used in practice for policy making and economic useful purposes, in contexts of shared understanding. It is the application of knowledge to solve a problem that is the essential feature of its definition. For knowledge to be properly applied, the concept of shared understanding is essential. Niklas Luhman argues that shared understanding is a basic form of autonomous human self-organization, which may be seen as a form of life. This should not be regarded as allegorical. Quite the contrary, shared understanding – or social systems – is created interactively, they evolve through reproduction – and they die when they go out of practice. For shared understanding to occur, we consider that one of the most important antecedents is the absorptive capacity of the actors involved. The notion of absorptive capacity refers to the capacity of the recipient to assimilate value and use the knowledge and information transferred (Cohen and Levinthal 1990). They observed that when the receiver did not understand the meaning of the knowledge transferred, this reflected the receiver’s inexperience with that particular knowledge and therefore pointed to a misfit between the knowledge and the receiver’s organizational absorptive capacity. Thus, core to absorptive capacity is the ability to recognize and assimilate relevant external knowledge and information, which is related to the internal levels of prior related knowledge. Therefore, it is important to emphasize that an organization’s pursue of external resources should be closely related to the organization’s current knowledge base: “When, however, a firm wishes to acquire and use knowledge that is unrelated to its ongoing activity, then the firm must dedicate effort exclusively to creating absorptive capacity” (Cohen and Levinthal 1990, p. 150). The higher the absorptive capacity, that is, the better the firm is at understanding the knowledge received and applying it successfully in development and commercialization of new technologies (Cohen and Levinthal 1990; Gallouj 2000; Zahra and George 2002). In addition to categorizing knowledge by its nature or type, one can also categorize learning based on its level of significance to the organization. Learning broadens the potential of an entity, giving it new strategic options to pursue and gain more operational flexibility. As stated by the management theorist Peter Huber, “An entity learns if, through its processing of information, the range of its potential behaviors is increased.” In this framework, learning can be observed at three levels of organizational dynamics: operational, tactical, and strategic: • On the operational learning level, we have accumulated experience and learning by doing: we learn new things (Carayannis 1994b). This is the short- to mediumterm perspective on learning, focusing on new or improved capabilities built
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through the content learned by an organization. This is an organizational-level improvement in how such tasks are conducted – for example, achieving better human resources management. • On the tactical learning level, we have learning of new tactics about applying the accumulating experience and the learning process: we build new contingency models of decision making by changing the rules for making decisions and/or adding new ones (Carayannis 1994b). This is the medium- to long-term perspective on learning. Tactical learning enables organizations to approach new organizational opportunities in a more efficient and more effective manner, and to leverage or combine existing core capabilities in novel formations for greater competitive advantage. This requires improvements in the integration and coordination of tasks, so that the business processes are more efficient across all future transactions. • On the strategic learning level, we have development and learning (internalization and institutionalization) of new views of our operating universe; hence, we learn new strategies of learning (Cole 1989). This is the very long-term perspective on learning that focuses on reshaping, reinventing, and reengineering our organizational “tools” (methods and processes). This level of learning requires that the organization gains a better understanding of synergies and how to produce them, or shows superior judgment in selecting organizational goals that will provide sustainable increases in competitive advantage. These three levels of learning activities are linked through a series of feedback and feed-forward loops so that cumulative learning at lower levels may lead to improved learning at higher levels, while learning at higher levels can reconfigure learning processes occurring at lower levels. In this regard, the institutional learning processes are essential in enabling and streamlining the recombination and reallocation of strategic tangible and intangible assets and in this sense is a central valueadding process for organization and entire economies alike.
Formal Knowledge and Institutional Learning as Related to Global Standards In the previous section, we provided an integrated theoretical framework for institutional learning and its different typologies. However, in this section, we argue that in the context of current global systems with its characteristics described previously, the promotion and adoption of international rules of conduct manifests itself in a more limited version of institutional learning conceived as one-way transfer of formal knowledge from global epistemic communities to local actors with the ultimate goal of enabling local epistemic communities. However the process of establishing local epistemic communities follows a more comprehensive view of interactive learning manifested via strategic knowledge serendipity, arbitrage, coevolution, cospecialization, and coopetition processes as described above.
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A core construct relevant to our argument is the idea of epistemic community that is concerned only with scientific knowledge concerning the policy domains relevant to the international standards that are being investigated. Therefore, a further important typology of knowledge relevant to our book relates to the construct of formal knowledge (also called theoretical knowledge, scientific knowledge, technical knowledge, or intellectual knowledge) as opposed to common sense, everyday knowledge or nonformal specialized knowledge.35 It is important to define this construct in relationship to the concept of “profession,” or “discipline.” Freidson (1994: 10), defines a profession as “an occupation that controls its own work, organized by a special set of institutions sustained in part by a particular ideology of expertise and service.” Schein (1978) introduces the construct of professional identity as an important component to the definition of profession. Professional identity is seen as the relatively stable and enduring constellation of attributes, beliefs, values, motives, and experiences with which people define themselves in a professional role. Core to a profession is the characteristics of the knowledge they generate and consist of a predominantly technical–professional base codified in general principles (Torstendahl and Burrage 1990). Freidson (1988, p. 3) calls formal knowledge “higher knowledge formalized into theories and other abstractions, on efforts at systematic, reasoned explanations, and on justification of the facts and activities believed to constitute the world.” According to Robertson, Scarbrough and Swan (2003), the epistemological base of the profession has an impact on the methods that are used in knowledge creation and legitimization. Formal knowledge is related to the Western approach of Scientific Thinking and the Scientific Method. The most important features of formal knowledge are rationalization and empirical evidence. Rationalization consists in the pervasive use of reason, sustained where possible by measurement, to gain the end of functional efficiency. Rational action is related to modern science and scientific method. Empirical evidence is “evidence that one can see, hear, touch, taste, or smell; it is evidence that is susceptible to one’s senses.”36 More importantly, it is repeatable, and can be checked by yourself and others after knowledge claims are made by an individual (Schafersman 1994). In the context of this book, the international standards and rules are based on the concept of formal knowledge and refer to technical specifications drawn up with the cooperation and consensus or general approval of all interests affected by it based on the consolidated results of science, technology, and experience, aimed at the promotion of optimum community benefits and approved by a body recognized on the regional or international level (ISO Guide 2 1980). 35
Freidson (2001) distinguishes other types of knowledge aside from formal knowledge as an important aspect of what he calls “working knowledge” – knowledge and skills used in work. He talks about “practical knowledge” as the knowledge that is largely free of formal concepts and theories, learned by experience and instrumental for performing concrete tasks in concrete settings (Freidson 2001, p. 31). Another type of knowledge is “everyday knowledge.” Everyday knowledge is knowledge that is taught to children in households, communities, and in formal schooling. 36 http://ftk-ftk.blogspot.com/2007/08/micro-vs-macro.html.
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According to Freidson (2001), formal knowledge is institutionalized within disciplines or epistemic communities, which are special groups of intellectual workers that create, preserve, transmit, and debate disciplinary content. It has a high level of validity and should be reproducible by different researchers working within the same professional discipline. Moreover, multidisciplinary approaches across different professions are becoming the norm especially in the context of global problems that manifests not only across countries but also across disciplines. In this regard, the learning and knowledge sharing occur across agents, communities, formal organizations with diverse characteristics in terms of their own knowledge and institutional environment they reside. As we argued before, epistemic communities can be conceived as a system of innovation networks and knowledge clusters that constituted of agglomerations of human, social, intellectual, and financial capital stocks and flows continually coevolving, cospecializing, and coopeting. Within this architecture, across and multidisciplinary knowledge production in areas of global concern can occur and lead to disruption of pre-existing knowledge bases and adoption of the prescribed global norms. Even highly specialized clusters may – at least if they are forced to by the environment – open up for new forms of external knowledge. What enables this strategy is the multidimensionality of human knowledge systems. Humans may embed their various forms of specialized knowledge in layers. These layers may be interrelated through points of dense interactivity, where interactive learning is possible, such as organizations, regional clusters, or single humans. Here, complex processes of interactive translation and communication across different specializations is possible. In this regard, to open or close to external knowledge flows may be seen as optional strategies. The standard argument for closing in is: (1) Reducing external transaction costs. Instead of investing in the transaction costs involved in contacting external sources of knowledge – the system may focus on its own specialization, thus. (2) Avoiding internal complexity. Closing in and specializing may be seen as a strategy to avoid the internal complexity which is necessary to be able to relate to and integrate external knowledge. It is better and more efficient to make it simple, and stay specialized within a narrow niche. (3) Specialization may be profitable. Specialization on the function of the system may prove to be a profitable strategy which is rewarded by the market, as the specialist may avoid price competition from other, less sophisticated competitors. Strategies of closing in have their downsides as well. (1) Exposure to random events. A closed system is a system with no knowledge of its environment. It may be exposed to random and rapid destruction triggered by the market. (2) Loss of “adaptive capacity.” A too narrow specialization may run the risk of turning the system into a unique species – which loose the mating option which may be necessary when the niche is made obsolete.
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In the case of formal knowledge transfer related to promotion of global standards and rules, we argue that the preferred strategy is a “semi-open” system, which combines a border with a horizon. The border is protecting the inner core from the complexities of the environment allowing internal specialization strategies to proceed through establishment of local epistemic communities. But the only way you can create local epistemic communities is by opening up to external knowledge promoted by global epistemic communities. By monitoring the horizon, the system is able to see what is coming, and adjust especially by trying to mitigate the costs resulting from choice of such strategy. As mentioned below, there are costs associated with learning and knowledge transfer processes and derived from an open up strategy of acquiring external knowledge. These costs results from the diverse characteristics of the core elements involved in the learning process. Deconstructing each of the levels of knowledge and institutional learning, we need to look at five elements involved in the life cycle of institutional learning. Evaluation of the benefits of learning and knowledge transfer focus, of course, on impact. But to understand what produces that impact requires identifying agents’ characteristics, content, process, and context. • Agents (those individuals or organizations involved in the learning process). • Content (what is being learned, whether it is a skill, a theory, or a new way of thinking). • Process (the conceptual level of learning, whether it is simply learning new content, learning to learn, or learning to learn-how-to-learn). • Context (the environmental conditions of the learning activity under study: institutional environment, arrangements). • Impact (the change resulting from learning on the organization). In this setting, effective knowledge transfer requires appropriate arrangements and conditions, as well as an understanding of the elements that affect the willingness and ability of institutional units to use that external knowledge. Differences in the characteristics of the agents, varying types of content, differences in the processes, and differences in context characteristics contribute to the occurrence of problems in the knowledge transfer process as mentioned above. For the purpose of this book, we emphasize the distinction can be made between cognitive costs and incentives costs. It is important to note in a perfect world, agents principally must strive to minimize both costs – costs related to understanding each other in transactions (cognitive costs) and costs related to the agents’ behaviors (incentive related costs).37 According to Husman (2001), cognitive costs arise if the firms’ information transfer abilities, that is, their absorptive and transmissive capacities, are low. Cognitive costs occur when the information receiver is unable to understand and
37 Behavior such as opportunism, which basically means that one, or both parties, try to maximize their utility at the expense of the other party’s benefit.
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absorb the transferred information because of predicaments in the information transfer process. This inability eventually leads to a loss of knowledge, as cognitive costs are in effect loss of knowledge – an inability of the parties to understand each other. For instance, cognitive costs may occur if transferred information is not transformed into a sufficiently codified form for the receiver to understand. A good match between the sharing mechanism and the characteristics of the content keeps the cognitive costs down. Since agents differ in the resources and competencies they possess, they are likely to approach their cognitive problems differently (Penrose 1959). For instance, an agent’s approach to reducing cognitive costs may enhance the varieties in the agent’s preferences and priorities. Ultimately this implies varieties in the agent’s intent and incentives of staying in the relationship. Incentive-related costs arise because of determinants in the institutional arrangement and environment, but are also outcomes of firms’ different ways of solving cognitive problems (Husman 2001, p. 1). Living knowledge is embedded in bodies, brains, spaces, institutions, organizations, communities of practice, as well as communities sharing formalized forms of knowledge. This is why, in analyzing the knowledge, we must relate to the deeper layers of institutional arrangements within which knowledge is embedded. As argued by Lam (2000), these forms of institutional embedding of knowledge are crucial in structuring the relations between different forms of knowledge in the processes of interactive learning leading to innovation. For example, incentive-related costs occur if one of the parties misuses the information received. This implies deterioration in the value of the sender’s knowledge stock. In this respect, knowledge exchange bares transaction costs, where co-ordination and motivation problems exist (Williamson 1975; 1985; Milgrom and Roberts 1992). Having said that, it can be argued that agents can affect the determinants of costs in the institutional arrangement, giving them an opportunity to determine whether cognitive and incentive-related information transfer costs arise. However, agents involved in the information transfer process have little influence on the institutional environment (Husman 2001). In concluding this section, we have provided an integrated theoretical framework that defines knowledge and institutional learning as processes of knowledge creation, transfer, absorption and use by primarily collective actors that lead to changes in their conduct, result in changed institutional arrangements, and manifest via strategic knowledge serendipity, arbitrage, coevolution, cospecialization, and coopetition processes. We have further studied and discussed different typologies of knowledge and institutional learning. Then, we linked these notions with the general trend in international policy making that argues that while the world moves toward technocratization and mobilization of expert communities, national policy-making emphasis is on rules and procedures, typically expressed in regularity principles and stable institutional settings. Within this applied context, we argue that one needs to cope with and leverage two mutually reinforcing and complementary trends that characterize
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the institutional learning and formal/specialized knowledge transfer processes aimed to enable adoption of global rules by nations-states: • Top-down – promotion and adoption of global rules is conceived as a one-way linear process by which standards related is transferred from international organizations and its global epistemic communities to a recipient though one or more channels, and that is applied or used by the recipient to achieve compliance with global rules. • Bottom-up – external and specialized knowledge promoted by global experts would be complemented by the creation of local epistemic communities which are the expression of a shared understanding of global rules and how they fit into the local environment and which in turn is devoted to furthering the institutional setting that can sustain such a process in a long term. Core to our argument is the idea of functional convergence – effective transfer of specialized knowledge particularly that relating to international standards and rules, by international organizations and its global expert communities drives national functions of institutional policy-making toward a “common ground” and enable these countries in the long-term to function into the global system according to its rules and norms.
Policy Convergence As we argued previously, much of national policy making moved away from independent decision-making and converges toward a more coordinated (standardized) approach at the international level.38 This linkage can also streamline the various functions of national policy-making institutions and either prevent the repetition of past administrative errors or help correct distorted national policies.39 In this respect,
38 See Mauro F. Guillén, The Limits of Convergence: Globalization and Organizational Change in Argentina, South Korea, and Spain, Princeton University Press, 2001; Daniel W. Drezner, “Globalization and Policy Convergence” International Studies Review, Vol. 3, No. 1 (Spring, 2001), pp. 53–78; Dwyer, Jennifer Holt, Why is Getting Reform Right Taking So Long? Japanese Institutional Stasis and Change in the Era of Global Finance, paper presented at the annual meeting of the International Studies Association, Hilton Hawaiian Village, Honolulu, Hawaii, Mar 05, 2005; Daniel W. Drezner, “Reflection and Reappraisal Globalization and Policy Convergence”, International Studies Review, 2001, vol-3 (1), pp 53–78; and Jacob Park, “Unbundling Globalization: Agent of Policy Convergence”, International Studies Review, 2002, 4 (1), 230–233. 39 It should be noted that the mandate of international advisory processes related to international organization and global governance is not a static variable, which is determined once for all during advisory period. Instead, it is subject to change and fine-tuning over time. The strength of the mandate is a function of the “level of transnational political consensus on the need for and feasibility of meaningful action.” States usually confer authority to international advisory organizations only after their realizations of benefits for underlined course of action. Political consensus on the need for action (however achieved) determines the strength of the state corporation.
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the notion of policy convergence is one of the main consequences of the current development. Is this true? We must first understand what convergence is/what it does in order to answer this question. While there is a general agreement that national institutional forms may differ, there is little disagreement that national policy-making institutional functions of countries participating in the international global system must meet minimally acceptable international standards. Before going further, it is important to note the difference between the functions and the forms of institutions, a distinction often neglected by experts. For example, if we look at the papers by Kaufmann et al. that compile all major “governance” indexes (or the indexes of institutional quality), we find that these indexes often mix up the variables that capture the differences in the forms of institutions (e.g., democracy, independent judiciary, absence of state ownership) and the functions that they perform (e.g., rule of law, respect for private property, enforceability of contracts, maintenance of price stability, the restraint on corruption).40 To avoid this error, our thesis follows Chang identifications, which underline three key functions of institutions: (1) coordination and administration; (2) learning and innovation; and (3) income redistribution and social cohesion.41 In this respect, and throughout this study, the function of institutional policy making refers to the above identifications/characteristics and, in particular, the first function. The justification for focusing on functions rather than forms is based on various theoretical as well as imperial observations that indicating functions of policy-making institution contribute more to dynamic aspect of policy formation. In this respect, this book emphasis is on possible functional convergence through adoption of regulations and standards by national institutional policy-making. In this respect, a basic public goods rationale (for minimum international standards which would benefit both international and individual national systems) has been reintroduced into the global system. At the international level, international standards enhance transparency as well as multilateral surveillance. International standards improve early identification of weaknesses that may contribute to economic and financial vulnerability. Additionally, they cultivate the idea of market efficiency and discipline and ultimately contribute to the production of a global economy. At the national level, international standards provide a benchmark that can help identify vulnerabilities within national economies as well as functional shortfalls of policy-making institutions. In short, the codification of norms and rules was meant to converge expectations – to “convince” participants in the international system to have similar ideas about which rules should govern mutual participation: everyone expects to play by the same rules.
40 Kaufmann, D., Kray, A. and Zoido-Lobaton, P, Governance Matters I, Policy Research Working Paper, WPS 2196, World Bank, Washington DC, 1998; Kaufmann, D., Kray, A. and ZoidoLobaton, P., Governance Matters II, Policy Research Working Paper, WPS 2772, World Bank, Washington DC, 2002; and Kaufmann, D., Kray, A. and Mastruzzi, M., Governance Matters III, Policy Research Working Paper, WPS 3106, World Bank, Washington DC, 2003. 41 Chang, H-J., “Breaking the Mould – An Institutionalist Political Economy Alternative to the Neo-Liberal Theory of the Market and the State”, Cambridge Journal of Economics, 26, 5, 2002.
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In general, convergence is the tendency to grow alike, specifically, by increasing similarity in regulations, structures, processes, and performances.42 Some claim that the replication of policy, such as the removal of trade barriers (that may work in one context and not in another), forces states to roll back long-standing welfare objectives that protect their citizens from outside forces, consequently leading to a “race to the bottom.”43 Others argue that the growth of international governance structures leads to a negotiated convergence of various regulations that eventually jeopardize the sovereignty of nation states.44 However, these arguments are based on a flawed assumption, namely that they assume that convergence to be a condition of making policy alike. However, convergence does not necessarily imply policy similarity. As Bennett explains, policy convergence can mean one of five things. “First, it can signify a convergence of policy goals, a coming together of intent to deal with common policy problems. Secondly, it can refer to policy content, defined as the more formal manifestations of government policy – statutes, administrative rules, regulations, court decision and so on. Thirdly, there may be a convergence of policy instruments, i.e., the institutional tools available to administer policy, whether regulatory, administrative, or judicial. Fourthly, convergence may occur on policy outcomes, impacts, or consequences – the results (positive or negative, effective or ineffective) of implementation. Finally, there may be a convergence of policy style, a more diffuse notion signifying the process by which policy responses are formulated (consensual or conflictual, incremental or rational, anticipatory or reactive, corporatist or pluralist, etc.).”45 These distinctions, as Bennett points out, separate policy-making processes into individual steps. From this perspective, policy-making stages are mutually exclusive
42 Clark. Kerr, The Future of Industrial Societies: Convergence or Continuing Diversity? Cambridge, Mass, Harvard University Press, 1983, p. 3. 43 See Richard Mckenzie and Dwight Lee, Quicksilver Capital: How the rapid Movement of Wealth Has Changed the World, New York, Free Press, 1991. Dani Rodrik, Has Globalization Gone Too Far, Washington DC, Institute for International Economics, 1997, p.36. Moreover, in government regulation, a race to the bottom is a known phenomenon which occurs when competition between nations or states (over investment capital, for example) leads to the progressive dismantling of regulatory standards. See http://en.wikipedia.org/wiki/Race_to_the_bottom. 44 Johnson, Juliet, “Financial Globalization and National Sovereignty”, paper presented at the annual meeting of the American Political Science Association, Boston Marriott Copley Place, Sheraton Boston & Hynes Convention Center, Boston, Massachusetts, Aug 28, 2002; “Globalization and Policy Convergence: Symposium Overview”, Journal of Comparative Policy Analysis, 3 (2), August, 2001; Thierry Balzacq, Sergio Carrera, Security Versus Freedom?: A Challenge for Europe’s Future, Ashgate Publishing, 2006; William Roberts L. Clark , Usha Nair Reichert , Sandra Lynn Lomas and Kevin Parker, “International and Domestic Constraints on Political Business Cycles in OECD Economies”, International Organization, 1998, 52 (1), pp.87–120; David Vogel, Trading Up: Consumer and Environmental Regulation in a Global Economy, Cambridge, Mass, Harvard University Press, 1995; Philip Cerny, “Globalization and Erosion of Democracy,” European Journal of Political Research, 1999 vol.36, no- 1, pp.1–26. 45 Colin J. Benett, “What is Policy Convergence and What Causes it?, British Journal of Political Science, April 1991, vol.21, no.2, pp. 218.
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and do not interact, a feedback process that takes place among different stages.46 These distinctions also neglect institutional differences among countries that may not fit into the conceptual categories outlined above. Legislative and administrative bodies in one country may not be separated, or regulatory governmental agencies may not have complete autonomy from the central government.47 Bennett’s study understands convergence as a process that moves policies from varied positions toward a more common ground. Convergence is seen as a process of becoming rather than being more alike, and hence replication of a policy does not imply policy convergence.48 More importantly, convergence occurs over time as a result of cooperation (and ultimately adaptation) by national policy-making institutions with designated organization members of the global governance. We intend to show that as a result of knowledge transfer, functions of institutional policy-making are moving (converging) toward common functions of global institutions. However, it should be made clear that we are not arguing that such convergence is a result of intended or unintended objective of knowledge transfer. Our core argument in this chapter is that international organizations with its epistemic communities should play an important role by promoting knowledge transfer as the vehicle to enable the functional convergence and enable these countries to function into the global system according to its rules and norms. Hence, enabling convergence through knowledge transfer.
46
Ibid, pp.218. Ronald Brickman, Sheila Jasanoff and Thomas Ilgen, Controlling Chemicals: The Politics of Regulation in Europe and the United Sates, Cornell University Press, Ithaca, New York, 1985, pp.29–33. 48 Bennett 1991. 47
Chapter 5
Case Study: International Financial Architecture and Standards
New International Financial Architecture Considering what has occurred at the global level for the past 20 years, it must be apparent that the time has come for many economies to acknowledge the globalization paradigm and consider economic policies that are suited for the twenty first century global market. Today, virtually all countries are functionally integrated into the prevailing global system and within global framework. As a result of these interlinks, the global economic externalities (positive as well as negative) have direct impact on wider range of countries – for instance, financial crises in an individual country can imperil international financial stability, which, in turn, can hinder the operation of the global exchange, resulting in a real threat to the global system. In fact, over the past two decades, the history of global financial markets has included series of financial crises, which, for their part, have had severe effects on the global economy, demonstrating just how vulnerable international financial systems can be.1 The crisis also demonstrates how desirable financial flows are to the stability of the global financial system. Despite the fact that some observers of financial crises are fond of Tolstoy’s famous remark that “all happy families resemble each other; each unhappy family is unhappy in its own way,” financial crisis prevention has become an important goal for international policy-making organizations.2 As a result, debates over what should be done to prevent these occurrences in the future have emerged.
1
See Jonathan D. Ostry and Jeromin Zettelmeyer, “Strengthening IMF Crisis Prevention”, IMF Working paper no. 206, IMF, Washington DC, 2005; “Crisis Prevention and the IMF”, Remarks by Mr. Takatoshi Kato, Deputy Managing Director International Monetary Fund IMF-Singapore High Level Seminar. Singapore, July 10, 2006; Global Development Finance, The World Bank, Washington DC, 2002; and Charles P Kindleberger, Manias, Panics, and Crashes. A history of Financial Crisis, New York, John Wiley, 1996. 2 See B. G. Ghosh, Global Financial Crises and Reforms: Cases and Caveats, Routledge, 2001. E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0_5, © Springer Science+Business Media, LLC 2012
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In response, financial crisis is among an increasing number of policy issues which not only preoccupy national policy-makers but also cut across territorial jurisdictions and existing global political alignments. However, preventing crises has proven to be a difficult task. One of the most difficult obstacles faced has been that the domain of the problem is incongruent with the jurisdiction. In short, financial crises in the global era have an inherent tendency to spill over national borders, at times exposing the inadequacy with which national governments address them, which consequently expose national government inability to address them accurately. For instance, the flow of international capital over the past three decades has exposed all financial regulation to a lack of transparency, corruption, and irrational competition, subsequently pushing national functions of institutional policy-making toward appropriate standards and regulations. To face these concerns, global organizations and governments have become increasingly outward looking as they seek to pursue cooperative strategies and to construct international regulatory mechanisms to effectively manage the growing diverse cross-border issues, which regularly surface on national agendas. As a result specific objectives (e.g., strengthening of the international financial architecture and providing opportunities for dialogue on national policies, international cooperation, and international financial institutions) have become a priority as indicated by the recent G-20’s gatherings. Eager to defend the importance of mobile financial flows, advanced economies established a series of institutions and network regulations at the global level, including both state and nonstate actors, in the hopes of strengthening the crisisprevention mechanism. This significant manifestation of the Global Governance System is the creation of New International Financial Architecture (Kenen 2001; Roubini and Uzan 2005; Eichengreen 1999). NIFA is defined as the structure design of financial rules and procedures defining the scope and operation of international financial markets to promote international financial stability (Eatwell 2002). The main objective of NIFA is to minimize the incidence of financial crisis (Soederberg 2005). In this respect, accurate information on the economic and financial affairs of governments, financial institutions like banks, and corporations will strengthen market discipline and assist policymakers to identify the need for corrective act. Additionally, NIFA is intended to produce financial-deterrence affects; NIFA helps international institutions and lenders ration credit to borrowers who fail to take the steps needed to maintain their financial stability.3 Although there are many NIFA dimensions one can analyze, there are three main features, namely the Group of 20 (G-20), the Financial Stability Forum (FSF), and the Reports on Observances of Standards and Codes (ROSCs) on which we focus in this case study. While we analyze the ROSCs in detail, I only briefly describe the G-20 and the FSF. The G-20 is a group of finance ministers and central bank governors comprised of the G-7, the EU ,and “systematically important” emerging market economies.4 One of the core actors involved in NIFA is the FSF,5 created in April
3
See Barry J. Eichengreen 1999, pp.10. More information on G20 can be obtain at: www.g7.utoronto.ca/g20/g20whatisit.html. 5 More information on FAF can be obtain at: www.fsforum.org/home/home.html. 4
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1999 to promote international financial stability through international cooperation in financial supervision and surveillance. Its members include the G-7 central banks, plus the central banks of other countries such as Australia, Hong Kong, Netherlands, Singapore, and Switzerland. International financial organizations such as the IMF, World Bank, OECD, European Central Bank (ECB), Bank for International Settlements (BIS), and International standard-setting bodies are also included. The creation of the G-20 and the FSF, on a theoretical level, provides the opportunity to reconsider traditional theoretical notions of international institutions. The severity of recent global financial crises as well as the acute practical consequences of NIFA further contributes to the significant roles that these institutions play in shaping the future of the global system.6 There is a broad-based and continuing agenda aimed at strengthening NIFA. The significant aspects of this agenda, as mentioned above, deal with the vulnerability the international financial system faces in relation to crisis in individual countries. Indeed, because of this vulnerability, there is a consensus among the economic powerhouses of the global economy that the stability of the global financial system rests on the cultivation of robust and stable national systems. As a result, international institutions and organizations have attached significant weight to strengthening the basic infrastructure of the market economy. There is therefore an emphasis on ensuring proper institutional functions, the rule of law, the responsibility of the private sector, and the implementation of social policies that enable countries to harness the benefits and avoid the pitfalls of integration into the international financial system.7 These issues are also critical in maintaining national economic growth, hence contributing greatly to successful economic development and poverty reduction. Thus, the aspects of strengthening international financial architecture that relate to bolstering national economic systems and institutions are of central concern and relevance to the World Bank as a development institution. Therefore, in December 1999, G-20 members began the initiative that intended to “…undertake the completion of Reports on the Observance of Standards and Codes (Transparency Reports) and Financial Sector Assessments within the context of continuing efforts by the IMF and the World Bank to improve these mechanisms.”8 This commitment translated into two Bank-IMF joint initiatives: the Financial Sector Assessment Program (FSAP) and the ROSCs, and a multidonor grant facility, Financial Sector Reform and Strengthening (FIRST) Initiative.
6
A detailed analysis of these institutions can be obtained at: www.g7.utoronto.ca/g20/g20porter/ porter1.html. 7 The reader should note that I chose words like harness or avoid since there are those who believe that NIFA is created in favor of the US government and the US-dominated international financial institutions, and hence the only proposals that found their way to the negotiation table were those that sought to strengthen, as opposed to radically reform, the existing system. Having said that, in this thesis I chose the “positive” approach instead of the “normative” method in my analysis simply because my aim here is more descriptive study of global system and prevailing development. 8 See Ella Kokotsis, G20 Commitments 1999–2005, G8 Research Group at: www.g8.utoronto.ca.
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The FSAP program began on a pilot basis in May 1999, with an emphasis on the prevention and mitigation of crises rather than on crisis resolution. FSAP’s focus is to promote cooperation within the international community to reduce the likelihood and/or severity of financial sector crises.9 The program has been designed to operate for a 1-year period, during which monthly country assessments (totaling 12) are to be carried out to determine the best structure for the program on a permanent basis.10 Through accurate identification of the strengths and vulnerabilities of individual national financial systems, FASP intends to reduce the incidence of crises that could potentially threaten the stability of the international financial system.11 Moreover, FSAP is used as a means to optimize the use of expert resources by reducing duplication of efforts and avoiding conflicting advice on global financial sector networks. It should be noted that participation in the FSAP is voluntary. However, countries which have already experienced economic crises have not been included in the program, as their financial systems’ vulnerabilities are already apparent and programs have, more often than not, already been put in place to deal with them. The standards and codes initiative, “Reports of the Observance of Standards and Codes (ROSC),” was launched in 1999 by the IMF and the World Bank as a prominent component of the International Financial Architecture. The emphasis of the ROSC program is on the development of standards, with the understanding that standards enhance transparency. More specifically, the ROSC indicates the degree to which a national economy observes set of international norms and procedures. Both the World Bank and the IMF are undertaking a large number of summary assessments,12 observing selected standards relevant to private and financial sector development and stability. These assessments are collected as “modules” in country binders constituting the ROSCs. At first, the IMF completed two experimental studies called Transparency Reports. In September 1999, the IMF’s Executive Board requested the preparation of a third round of these studies on members’ observance of international standards. The reports were then renamed “Reports on the Observance of Standards and Codes.” At the international level, these standards foster market efficiency and discipline. At the national level, they provide benchmarks to identify areas of incompatibility with common standard norms, and therefore underline vulnerabilities of national economies and guide policy reform. In short, the ROSC indicate the degree to which a national economy observes international norms and procedures.
9
The World Bank and the International Monetary Fund, Financial Sector Assessment Program— Review, Lessons, and Issues Going Forward, Washington DC, February 24, 2003. 10 DEVELOPMENT COMMITTEE (Joint Ministerial Committee of the Boards of Governors of the Bank and the Fund On the Transfer of Real Resources to Developing Countries), INTERNATIONAL FINANCIAL ARCHITECTURE: An Update on the World Bank Group’s Role, Washington DC, 2000. 11 www.worldbank.org/finance/html/fsap.html. 12 The summary assessments are based on the percentage of benchmarks met for the broad categories of budget formulation, execution, and reporting, and are summarized in scores expressed as: “little upgrading required,” “some upgrading required,” and “substantial upgrading required.” This quote comes from paper filed in current work folder, standard setting, summery assessments – define, page 15.
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The ROSC initiative covers 12 areas and associated standards, which the FSF has recognized as priority implementation. These areas relate to transparency and comparability of financial information (e.g., preparation/disclosure of financial statements), disclosure of central banks monetary and financial policies, disclosure of government’s structure, fiscal policy, public sector accounts, good practices on dissemination of statistical data, corporate governance (rights of shareholders, role of stakeholders, responsibilities of board, disclosure, and transparency) for listed companies, public interest entities, such as financial institutions, and minimum capital adequacy requirements for banks. Under the ROSC modular approach, the IMF takes the lead in preparing modules in the area of data dissemination and fiscal transparency. The World Bank has taken responsibility of three areas, namely (1) corporate governance, (2) accounting and auditing, and (3) insolvency and creditors’ rights. Modules for the financial sector (monetary and financial policy transparency, banking supervision, securities market regulation, payment systems, and deposit insurance) are addressed through a parallel Bank-IMF Financial Sector Assessment Program (FSAP).13 In the Appendix A, a brief description of some ROSC modules is provided. This case study focuses on knowledge aimed at promoting international standards and good practices in policy domain areas that cut across national agendas (e.g., financial instability) and, as such, are addressed through global frameworks and global institutions. More specifically, this study examines the differences in international standards’ adoption by focusing on the ROSC programs.
Emprical Research Results of Knowledge Transfer and Standards Adoption: ROSC Programs Conceptual Model of Knowledge Transfer Used in the Case Study In the previous chapters, we argued that international organizations14 and its global epistemic communities are the core intellectual actors of global governance: identifying and diagnosing problems, developing norms, formulating recommendations and, occasionally, guiding national policies (Thakur and Weiss: 2005). It should be noted that prior to the development of the global governance paradigm, international organizations15 were considered vehicles for promotion of liberalization policies,
13
See the world Bank ROSCs site at: www.worldbank.org/ifa/rosc_more.html. World Bank Group, International Monetary Fund, OECD, as well as bilateral institutions such as the US Agency for International Development (USAID), the Canadian International Development Agency (CIDA), the UK’s Department for International Development (DFID) and the German and Swedish international cooperation agencies. 15 World Bank Group, International Monetary Fund, OECD, as well as bilateral institutions such as the US Agency for International Development (USAID), the Canadian International Development Agency (CIDA), the UK’s Department for International Development (DFID) and the German and Swedish international cooperation agencies. 14
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and the role of these institutions in design and promotion of international policies and rules have widely varied from an informal toward a more formalized involvement.16 Now, the idea of global governance has pushed the international community to play a leading role in mitigating the effects of liberalization and, thus, preventing crisis by promoting better knowledge transfer to anticipate global issues that demand collective action. While the role of such institutions is essential in the design of these standardized policy frameworks, we believe that their primary role should be more on enabling the countries to function within the framework of global institutional structure by having their own global epistemic communities provide the appropriate specialized knowledge. Within this context of prevailing global governance, we argue that knowledge transfer is becoming the means through which state policy-makers are “guided” and national institutions are regulated – reconfiguring the traditional monopoly associated with the practice of national politics. Subsequently, the role of international organizations, such as the World Bank and IMF, and their expert communities to advice national policy makers should be seen as an imperative factor in achieving national developmental objectives. Expertise provided by these expert organizations can help national policy-makers increase their institutional capacity by enabling them to converge onto international regulations and standards in a given issue area, and hence play an active role in the global system. After all, if a national accounting system is not compatible with most auditing practices at the international level, or national corporations do not follow the common international code-of-conducts, participation in the global markets implies only verbal intention, but without substance. A core argument in this book is that this type of knowledge transfer from international organizations and their global epistemic communities creates institutional learning by developing local epistemic communities on technical subjects, which in the long term, will lead to a stronger institutional framework that meets the minimum requirements of harmonization at the global level. Let us explain. As mentioned in previous chapters, we define institutional learning processes to include knowledge creation, transfer, absorption, and use by individual or institutions that lead to changes in their conduct and result in changed institutional arrangements.
16
A more formal role refers to such organizations as the architect of international standards (e.g., forestry), through putting down resources to finance assessments of country compliance (e.g., ROSC) or provide capacity building projects.http://www.accountability.org/images/content/3/2/320/ AccountAbility_Investing%20in%20Standards%20for%20Sustainable%20Developmen.pdf.
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For the purpose of this case study, we have further adapted our definition by looking at the communication theory17 (Shannon and Weaver 1949; Szulanski 1996, 2000; Szulanski and Jensen 2004) as to provide the structure to study the knowledge transfer as a linear process of a message transmission from a source to a receiver. Thus, in this case study, we argue that this relationship between the sender and recipient can be conceptualized as a one-way knowledge transfer process from international organizations and its epistemic communities to countries. As mentioned above, communication theory presents the knowledge transfer process as a linear process and a one-way transfer of information from sender to receiver. The characteristics of the international standards promotion and adoption process justify why we have chosen the communication theory as a main paradigm for my research. Most of these standards are defined by international standardssetting organizations, and they are usually promoted as part of a larger context within the emerging global governance system. These norms and practices are generally packaged as a specific set of regulations and guidelines that are designed and ratified at international level through international exchange and cooperation efforts and ultimately transferred from one party (regulatory setters and/or international organizations) to another party (recipient countries). It is primarily the more advanced economies – with greater complexity in their institutional settings – that contribute to the design of these standards. Thus, the similarities of advanced economies compel the standardization to be unilateral from international organizations to adopting countries. The primary focus is on transfer of specialized and procedural knowledge in development-related technical domains (e.g., accounting procedures, payment systems, corporate governance principles, etc.), and promoting institutional learning at national and local level. In this study, we defined procedural knowledge refers to knowing how to do something through description of a task or procedure’s steps. It results in practice recommendations to assist practitioners to get from current state to future state by advising a specific set of steps and procedures to follow. This type of policy recommendations is similar to guides that are designed to induce appropriate actions
17
However, we should note that communication theory does not include into this process the use of information. Thus, we turned to “accomplished transfer” approach (Darr and Kurtzberg 2000; Davenport and Prusak 1998; von Hippel, 1999; Szulanski 1996, 2000; Szulanski and Jensen 2004; Ko et al. 2005; Inkpen and Dinur 1998; Rogers 1995), where knowledge transfer is made up of information transmission (communication) plus information internalization (understanding, absorption) and information use. Furthermore, we define knowledge transfer process as the transmission action plus absorption and use by the receiver (Zander and Kogut 1995; Darr and Kurtzberg 2000; Davenport and Prusak 1998; von Hippel 1999; Szulanski 1996, 2000; Szulanski and Jensen 2004; Ko et al. 2000; Dinur and Inkpen 1996; Rogers 1983, 1995; George et al. 2001; Sudsawad 2007).
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according to standard norms. These guides contain information on what needs to be done and how, describing the steps that have to be taken. The guides are provided as guidance, rather than instructions or commands. We adapted Rosen and Proctor’s (2003, p. 1) definition of guides to describe this construct: A set of systematically compiled and organized statements of empirically tested knowledge and procedures designed to help practitioners to select and implement interventions that are most effective and appropriate for attaining the desired outcomes.
The specialized characteristic derives from the fact that this type of knowledge is institutionalized within specific disciplines or epistemic communities and is based on the concept of formal knowledge that is defined as “higher knowledge formalized into theories and other abstractions, on efforts at systematic, reasoned explanations, and on justification of the facts and activities believed to constitute the world” (Freidson 1988, p. 3). While some argue that guides are more likely to promote effective intervention, others assert that this type of knowledge advocates standardized recipes that ignore the client needs and characteristics. In the clinical care domain, it has been argued that guides are constraining local flexibility, where those produced by international bodies may curtain local attempts to tailor solutions to local needs and resources. The other perceived problem is related to the fact that these guides are promoted by professional and special interest groups that advocate to increase the resources devoted to certain domains (Haycox et al. 1999). Within the context of international regulations and rule, procedural knowledge transferred consists of various templates (e.g., balance sheet rules, banking regulations, and accounting standards) that are selected by international regulatory and financial organizations as a core policy tool to protect against adverse cross-border developments affecting global financial stability. Most of these standards are defined and formulated by international standards-setting organizations, e.g., International Accounting Standard Board (IASB), and they are usually promoted as part of a larger context within the emerging global governance system. For instance, a country may wishes to member of WTO, and hence the country is asked to integrate its system of national economic account into the standard format by estimating the income and outlay accounts for enterprises, government agencies, and household based on the specific standards. The adoption of such global policies and rules as many actors of as possible is a core element of the entire construct. The only way such a system will ever work is by having the majority of the players adopt the common rules and policies. The development of the conceptual model for transfer of knowledge related to international standards and regulations aims to capture all of the relevant factors that influence the effectiveness of the knowledge transfer process and the resulting adoption of knowledge by the client. An overview on the primary entities and their most relevant determinants identified from the literature on knowledge transfer will be contained in five dimensions that both “enable and restrict” knowledge transfer. The classification of variables resulted in five definable constructs, namely, Sender Characteristics, Receiver Characteristics, Information contents and characteristics,
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Relational Context Characteristics, and External Environment Characteristics. The elements of the knowledge transfer process are defined in order to delineate those activities that occur within an identified knowledge request: • Senders are those individuals or organizations sending the information. • Recipients are those individuals or organizations who must extract information to address a specific need. • Channels: the media (medium) through or by which the information is transferred. • Contents: the information being transferred. • Relational context: relationships between information sender and information receiver. • External context – refers to the broader set of institutions within which people and organizations interact. Transferring such knowledge comes with challenges, and requires certain preexistent conditions to be in place for such transfer to become effective. As discussed in the section on Formal Knowledge Transfer, the strategy of open up to external knowledge asserts that such process is not without its costs, primarily because of differences in the characteristics of the elements involved in the knowledge transfer process. Thus, effective knowledge transfer requires appropriate arrangements and conditions, as well as an understanding of elements involved in the transfer, such as the attributes of senders and receivers, the characteristics of the information being transferred (contents), the media through or by which the information is transferred (channels), the framework of receiver’s and sender’s interaction, and characteristics of the external context of the knowledge transfer process. For example, it should be noted, however, that these modules were met with significant resistance from some members of the IMF’s International Monetary and Finance Committee, particularly those from transitional economies. These members were concerned about the cost of compliance to their respective governments, but not, necessarily, to the overall merits of the ROSCs. For instance, a South African representative also claimed that, “[U]niversal application requires to be implemented with due flexibility. We urge the Fund to take greater cognizance of the different levels of development among members seeking to implement and to comply with the wide new range of elements of strengthened surveillance.”18 Therefore, we argue that this type of procedural knowledge is ultimately only valuable if it is effectively applied by the client. For instance, existence of “absorptive capacity”19 within a recipient country (e.g., established national epistemic community) to understand and use effectively the knowledge transferred, or substantial
18
http://www.imf.org/external/spring/2000/imfc/zaf.htm. Building on the Adler (1965) and Cohen and Levinthal (1990) definitions, we define absorptive capacity for standard’s adoption as the ability of the client to recognize the value of the standardprovided information, assimilate it, and apply it. 19
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resources (e.g., appropriate national institutional environment) are needed to support and implement the right policies. As the Indian representative at IMF pointed out: “……the plethora of these codes, standards and principles are overwhelming and highly demanding of manpower and financial resources. Not only do these involve avoidable micromanage but they also have a potential to become overly intrusive vis-à-vis national authorities.”20 Hegarty et al. (2004) argue that lack of financial resources became a major impediment to the implementation of international standards. In response to these complaints, Stanley Fischer, the IMF’s Deputy Managing Director at the time, stated in June 2000: “There is a concern in some countries that the Fund is pushing too hard for the implementation of these standards. Maybe it is true that we sometimes risk overburdening their absorptive capacity.”21 Nevertheless, opposition to these strategies does not, inherently, invalidate their importance to national economies. When a country intends to join the global financial system, its institutional and legal system and economic structures need to move toward the standard practices that are established within the global system. Effective use of this knowledge is not only dependent on the client’s institutional capacity to implement the policies, but also on the political willingness on part of the client. We are arguing in this book that political willingness of governments is not anymore a major threat in this endeavor. This comes from our belief that countries are now willing to give up parts of their internal sovereignty to be able to participate in the global market. They do not have a choice anymore since the globalized and economic interdependence is the facto way of life and there is no way back. Furthermore, the adoption of international standards requires appropriately qualified individuals who know international and national standards, so they can effectively bridge the gap, hence the need to create and enable local epistemic communities that can perform effectively this role. Thus, an understanding of what these standards are and what is required to adopt them is essential. Many times, clients had a different understanding and interpretation as to the nature of these standards, which led to selective implementations and “gave a false understanding of the actual standards gap and the true implementation challenges they face” (Hegarty et al. 2004, p. 3). Therefore, an important aspect of our book concerns the construct of institutional learning and epistemic communities underlying the knowledge transfer processes that need to be in place. More specifically, we argue that the primary role of international organizations should be in promoting knowledge transfer processes around procedural and technical knowledge aimed at developing local epistemic communities on technical subjects and creating institutional learning that will put the basis for a stronger national institutional framework compliant with the global rules. Additionally, there are factors external to the knowledge transfer process but affect its effectiveness, nonetheless. Factors, such as geographical distance and cultural diversity, have a major impact on the interaction between the sender and the receiver.
20
http://www.imf.org/external/spring/2000/imfc/ind.htm. Stanley Fischer, “The IMF and the Financial Sector.” Speech given at the Seminar on Financial Risks, System Stability, and Economic Globalization, Washington D.C., June 5, 2000. 21
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For example, diversities in national languages can influence the effectiveness of transferred information, both in terms of transformation and/or its utilization.22 Clearly, this type of knowledge is mostly developed in the English language and understanding these standards requires translations of local languages. Many times constructs are very difficult to translate from English because the equivalent terms in the local languages cannot be found (Hegarty et al. 2004). It should be noted that all issues and concerns which were analyzed above have trivial value if institutional settings of both the sender and the receiver are not stable. Instability of an institution implies instability of the relation between partners of exchange. It is important to note that while institutional settings characteristics play a significant role in the effectiveness of knowledge transfer, they are difficult to change. This is mostly due to the nature of these factors and the various elements, such as history and/or socioeconomic development that are involved in creating and shaping their contents. Unfortunately, such instability is more apparent in developing economies than in developed economies, where the state is the absolute state, as in Hobbesian theory, holding the power of ordering and organization. As a result, political change in most developing economies means replacement of the prechange apparatus, redirect previous process, and redirect the past settings. This political eviction seems to be a process that feeds off itself. This turns the national expert groups into frenzy and mistrust, a circumstance that contributes to the explanation for the so many failed developmental projects. Along the same lines, there has been frustration among clients with the Bank’s poor dissemination of knowledge, namely the traditional practice of communicating only with government officials. Thus, FSF Task Force on the Implementation of Standards (FSF 2000) encourages wider dissemination within and outside a country of information related to an economy’s observance of standards. The core argument here is that a large number of market participants, with a collective awareness of international standards, will consider information regarding any given economy’s observance of those standards in order to properly make lending and investment decisions, risk assessments, and allocation decisions. In discussing the “one size fits all” dilemma in relation to international standards and codes, Schneider (2002) emphasizes the importance of standard-setters’ recognition that different countries are at different stages of economic development with varying institutional capacities, and they might follow different paths in corporate governance or finance, depending on what makes sense in regard to their respective circumstances. Thus, those countries that might eventually adopt these international standards and codes must participate in the standards-setting process. Clearly, either being regulatory standards or other policies promoted by external entities to a national government, the issue of “ownership” of proposed reforms in domestic financial architecture is an essential element of the adoption and implementation of these reforms by client governments. 22
It should be noted that knowledge is not only transferred between two entities but is also transformed during that process.
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In line with the literature on the subject and some of the criticisms mentioned above, we recognize that effective transfer of knowledge relating to international standards entails certain conditions such as adequate institutional environments at the national level, and high level of absorptive capacity. However, we argue that the institutional asymmetries that related to difference in language, and culture, of the participants in the process cannot impact the knowledge transfer of international standards in a significant way. One criticism, which is repeatedly mentioned in relation to successful transfer of specialized knowledge, is the fact that these programs do not take the local condition and culture (local knowledge) into their consideration. We reject such a notion on the ground that • First, most harmonization programs are based on procedural knowledge, and are thus designed to conduct a specific task, and hence from the epistemological point of view, are value-free. • Second, the intent of harmonization programs, in general, is to help the local and often not suited standards and rules, e.g., accounting framework, to adjust to the new prevailing economic as well as global financial system. • Third, epistemic communities, which most of these programs are originated from, has it is own culture (epistemic culture). • Fourth, if cultural attributes were an important factor for rejecting these programs, then we should have detected some prevailing trends that convey peculiarity of specific culture among rejected programs. However, the fact is that rejection comes from all corners of the world (so is the acceptance of the programs), and hence cultural attributes could not be the determinant factor. • Fifth, the core idea for global rules to be effective is to become more important that national policy framework and rules. In the following section, we present our analyses and results and conclude with limitations of the case study and perspectives for future research.
Empirical Research Results There are many vehicles through which these standards are promoted; the ROSC program is but one example. While we recognize that the ROSC’s main objective is to examine the selected standards and provide suggestions for improvement, we conceptualize the interaction between the World Bank and IMF and country authorities as a transfer of information from the sender to the receiver. This section below describes the empirical research results for selected case study of the financial international regulatory standards that were being promoted part of the ROSC Program. The results presented in this book are based on empirical data from research study conducted in 2008–2009. For more details of the empirical research see Popescu (2010). In this section, we briefly describe the overall research approach, before presenting and analyzing the results.
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The original research built upon quantitative results supplemented with qualitative research, using ROSC-related documentation substantiated by on-site interviews conducted with ROSC project leaders and subject matter experts in World Bank and IMF to help with the development of the variables, as well as secondary data sources, such as the World Bank and eStandards Forum, and content analysis of ROSC project documents to measure the constructs under study (Operationalization of constructs is described in Appendix 2). We should note that the research is one of the first empirical studies to look at determinants of a country’s adoption of international standards using multiple levels of analysis, and thus, clearly acknowledging that standard’s adoption varies among countries and explore both individual-level variables and country-level variables as predictors of adoption. Multilevel modeling was used to test the overall research model as my data follows a hierarchical two-level structure with individual standards and corresponding ROSC modules at level 1 are nested within countries at level 2 (Hox 2005). In line with this book’s approach to knowledge transfer presented before, international standards promotion was defined as a one-way transfer of standards-related information that is included in a package/document from international organization to recipient countries, and hypotheses about the relationships between knowledge transfer characteristics and information (standard) adoption were developed. The findings corroborate some important core constructs that were prevalent in the literature on the subject and provide some interesting implications to better understanding of the current setting. More importantly, the findings support the theory that the absorptive capacity measure in my case at the macrolevel is of most importance especially in adoption of international standards whose implementation requires a complex setting involving many actors and processes. Consistent with the initial hypothesis, Popescu (2010) found that the overall government’s absorptive capacity is statistically significant in relationship to the standard’s implementation. Since the standards that are the subject of my thesis involve a large range of government institutions, and are highly technical (requiring specialized knowledge), it is essential to note that the overall governmental institution’s skills set and ability to implement policies have a direct impact on their capacity to achieve the full comprehension that is needed for the acceptance of the standard. This prevalence has important implications related to the transfer processes and the creation of national epistemic communities. The promotion of standards from global institutions that have their own epistemic communities is one of the tools that can contribute to increased absorptive capacity by supporting the creation of domestic epistemic communities. The literature and previous empirical findings argue for the vital role that language plays in definitions and transfers of international standards. It was hypothesized that the more a country’s language deviates from English (which is the language in which the standard is defined and promoted), the less likely the country is to adopt the standard, since some of these constructs might be difficult to comprehend by the client. As these standards are mainly defined in English, the transfer of this information can lead to potential misunderstandings and misinterpretations of the regulations, guidelines, and standards. While linguistic distance was not found to be
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statistically significant, we argue that this finding has a significance of its own because it emphasizes once again the prevailing English-based global culture, especially in the technical domains that are subject of this study. Therefore, as we argued before, this findings re-enforces our position that common criticism of international programs that do not take culture (local knowledge) into their consideration is not relevant when applied to the domain of international regulations and standards but what is relevant is the country’s absorptive and institutional capacity. Furthermore, the research results provide strong evidence that individual client’s lack of transparency regarding standard’s compliance do matter for standard’s adoption. As initially hypothesized, the results suggests that clients who are less willing to publish their own standard’s compliance assessments or to allow others to publicly present information that assesses their compliance to a specific standard are less likely to adopt that standard. First, the statistical significance of the country’s lack of transparency regarding the observance of standards implies that many times adoption of these standards is a highly political decision that might outweigh the intended objective of the standards which is to promote accessibility of information regarding a country’s institutions and processes to the outside world. Let us explain. The core emphasis of the ROSC program is on standards that enhance transparency. The core idea here is to provide information on how a national economy observes a specific set of standards that is useful, particularly to a wide range of foreign users, in making economic and investment decisions. Of course, what this degree of observance/compliance actually provides is the underlining of the vulnerabilities of a national economy for global and local market participants, but it also guides the government in conducting proper policy reform. ROSC reports, therefore, are a major source of accurate and transparent information for the external players as well an important tool for establishing internal discipline within the institutional framework. However, it should be noted that there are differences in commitment to the provision and transparency of the standards’ compliance results among nations. Interestingly but not surprising, some of the countries that requested the preparation of such ROSC reports have asked the World Bank or IMF not to publish the results. The explanation for this behavior could be that nations have different commitments because of, among other things, differences in degrees of openness among national governmental agencies, national institutional capacities, political preferences, etc. (Leebron 1996). In this respect, there could be potential conflicts-of-interest among national institutions and global governance institutions. In this case, ROSC reports bear not only technical but also political as well as societal ramifications of accountability (Martin 2004). It was hypothesized based on the policy transfer literature and empirical studies that detailed action plans with step-by-step instructions and sequencing of actions will be positively related to the knowledge transfer effectiveness, e.g., adoption rate of a given standard. The results show that this variable is not statistically significant. As mentioned above, the decision to adopt a standard is highly political and technical implementation considerations might not be as important to the decision to adopt if other factors outweigh it. If the country decides to move forward with the change,
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only then do the detailed action plans have an impact in helping the actual implementation of the policies needed to achieve compliance. Incentives are an important factor in a country’s decision to adopt a standard. To reflect this construct, Popescu (2010) looked at two indicators that were suggested by the literature on this subject and were validated during the pilot study. The first one was the country’s membership in WTO and this was found to have a statistically significant relationship to the adoption rate as hypothesized. As mentioned many times before, one of the primary reasons for the existence of these standards is to encourage accessibility of a country’s settings and institutions to enable global market participants to make adequate decisions when dealing with that country. However, this adoption requires highly intensive resource processes to implement the necessary policies and the country needs to clearly see the direct benefits for doing so. One of the most highly visible incentives is that adoption of a standard might help them to enter international groupings, such as WTO. The potential to become a member of international groupings such as WTO clearly have a direct impact on the decision to adopt, since in this case this membership provides direct benefits to the country that can and should supersede the perceived potential disadvantages. As mentioned, the adoption of international standards is by no means compulsory as it is based on voluntary agreements. Some authors believe that rendering incentives (rewards) for compliance is more useful than meting out punishments for noncompliance, particularly in terms of motivating institutional behavior (see Chapter 3 International Financial Standards and Regulations section). However, when countries decide not to comply, this is not the result of a deliberate decision to violate treaties, but of capacity limitations and ambiguities about the rule. This statement brings in another two important factors that were introduced as potential predictors of the adoption of the standards, namely language and absorptive capacity. The other incentive deals with the definition of the standards and the literature suggests that countries needs to feel that they are an integral part of the processes that are in place for defining these standards that are intended through their implementation. The results of the data analysis found that there is no significant relationship between a country’s membership in the standard-setting agency and implementation of the specific standard. The possible explanation for these findings is that while countries, especially from the developing world, often times specify their interest to participate in the creation of policies and principles that are likely to affect them, their participation in operationalization of such definitions is not a straightforward thing. Active participation in such committees and standard creation requires highly specialized individuals, which developing countries may not have and more importantly requires them to take on responsibilities. If they actively participate, it means that they have made a strong commitment to adopt these principles and there is no way out of it. Another important construct that is very common in knowledge transfer literature is the strength of the relationship between the sender (in our case WB/IMF) and the receiver of information. Popescu (2010) hypothesized that this variable will have a positive significant relationship with the adoption, but my findings suggested otherwise.
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The explanation for this might be related to the way I measured this construct. As suggested by the literature on this subject, the proxy for this relationship strength was given by the length, in years, of the formal relationship between the sender (WB/IMF) and the receiver (client). We should note that this formal relationship occurs between institutions and not individuals and many times, the decision to adopt a standard might be directly related to specific individuals within government institutions. One of the interesting finding in this study was that some of the developed economies, such as Austria and Norway, exhibited the highest level of lack of transparency. There are various reasons for international differences in reporting of compliance ratings and only a thorough in-depth investigation of specific case(s) could determine the causes or propelling factors that contribute to such variation. Nevertheless, the literature on the subject points out to four major factors that may cause such inconsistency: first, external environment such as foreign investments; second, regulatory governance practices; third, institutional structure, such as legal system, capital markets, tax, and finally, cultural elements. Therefore, one should take a holistic approach and look at complexity of all these factors in order to properly understand the differences in reporting of standards’ compliance ratings. Having said that, we attempted to briefly explain why Norway exhibited the highest level of lack of transparency. In the case of Austria, we were not able to find specific reasons that would explain its high level of lack of transparency. We should note that both cases require further in-depth investigation performed by subject-matter experts with knowledge of the financial sector domain. Norway’s economy is build upon its immense oil and gas wealth. The society emphasizes egalitarian values and high standards of social welfare. These goals have enabled the development of a large public sector and social welfare system. In this regard, regulations reforms play an important role in the society and it is aimed at ensuring that the standard of living is broadly the same across the whole country. However, the regulatory governance lacks a dedicated and integrated policy to support effective regulatory reforms. According to OECD (2003, pp. 11), “reforms have tended to be more reactive than proactive, and more ad hoc than systematic.” More importantly, compliance with regulations as well as enforcement is not systematically monitored and it is left to individual ministries (OECD 2003, p. 56). Thus, compliance with regulations is not systematically monitored at national level. And, as a result, we assume that the reason that limited information is publicly available about Norway’s compliance with international standards and regulations is partly due to the lack of a cohesive approach in monitoring of regulations at the national level. The argument we made in this book is that as a result of global governance, specific international organizations (global epistemic communities) are promoting internationally harmonized technical regulations and standards in order to encourage most economies of the world to adopt similar rule of the game. More importantly, our empirical findings reinforced our initial hypothesis that the country asymmetries related to differences in institutional capacity, absorptive capacity, incentives, of the participants in the process can impact the adoption of such standards in a significant way. However, as we hypothesized, institutional asymmetries
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that related to difference in language, and culture, of the participants in the process does not significantly impact the knowledge transfer of international standards. Our explanation relies on the fact that most of the standards are based on procedural and specialized knowledge designed to conduct a specific task, and hence from the epistemological point of view, is value-free. As a developmental tool for international institutions, knowledge transfer processes from international organizations are more relevant to the prevailing globalization process than ever before. All things considered, policymakers’ aim(s) ought to be concentrated on providing (as well as supporting) necessary infrastructures to build the national institutional capability and its national epistemic communities. Furthermore, they should enable national epistemic communities to create institutions that comply with global rules and regulations can control crises. The significant driving force behind this trend is the growing importance of the notions of integration of national economies in shaping international relations in the global system. More importantly, and in complete departure from the last several decades, we argue that knowledge and institutional learning should be perceived as proactive policies that intend not only to empower and converge the functions of national institutions but also to prevent behaviors that destabilize the global system.
A Note on Case Study: Limitations, Challenges, and Opportunities This case study provides a comprehensive examination of the key determinants of a successful transfer of international regulatory standards in the context of international financial architecture, more specifically the ROSC case study. The main research question is how individual-level and country-level determinants interact and affect the information transfer effectiveness reflected in a country adoption of a specific international standard. However, given the complexity of the problem, there are still theoretical and methodological issues that have not been covered by this study. The challenge in linking tangible inputs with tangible outputs remains considerable but it becomes truly intractable when one tries to link intangibles with tangibles, namely the transfer of processes and even more so knowledge and skills with tangibles such as information. Thus, the most effective “lens” for examining and understanding a process dealing with both tangible and intangible inputs and outputs and capturing the value added in the case of intangibles seems to be the case study approach. Therefore, this case study relies most heavily on quantitative results but is supplemented with qualitative research, such as content analysis and unstructured interviews with and subject-matter experts to help with the development of the variables. The secondary data was considered as a source of insight in evaluating the value added of intangibles, such as knowledge transfer.
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In this context, we consider the case study as a “performance metric” in a broad sense – as providing a common context or frame of reference, common enough to make meaningful comparisons as opposed to trying to fit the ambiguity and uncertainty inherent in the intangibles of knowledge transfer in the narrow mould of econometric models. Hence, a case study as a “performance metric” could be a source of insight and information both in depth, as a “well” of knowledge, and in breadth, as part of a “fabric” or number of case studies across which one could pursue emerging recurring patterns. The case study can serve as the conceptual “bridge” between tangible outputs and intangible processes and critical success factors: a combination of qualitative and quantitative measures provides a more comprehensive assessment of not only degree of success but also reasons for success. An important limitation of the case study is that there may not be sufficient information accessible to researchers to create a “picture” comprehensive enough to evaluate knowledge transfer properly. As Penaranda notes: If credible, substantiated cause-effect statistics are to be gathered so appropriate benefits may be attributed to the technology transfer and commercialization processes, every technology transfer event or “hit” must be tracked and documented to its ultimate conclusion… but the sources of the most critical information are often uncooperative. These are the commercial partners themselves…Sometimes the information is impossible to extract from the overall corporate records…Very often, however, there is a general reluctance to share this information with the “feds” for fear of “revenuers” knocking at their doors, literally or figuratively [].23
Therefore, we acknowledge that the constructs chosen to explain the differences in knowledge use (standard’s adoption) are not exhaustive despite the fact that this study includes the most theoretically interesting variables. We should note that due to data-gathering limitations, indirect/imperfect proxies were used to measure the core constructs. While the initial choice was to use scales and questionnaires to measure some of the constructs, it was clear from the pilot study that in order to get objective measures it would be necessary to interview both the senders and the recipients, which was not possible due to the difficulty of finding the appropriate individuals involved in the projects studied. As an alternative, for these variables, the researcher relied on some cases on its own qualitative analyses with scales that were validated by subject-matter and, in other cases, on secondary data sources that were deemed more reliable by subjectmatter experts (such as eStandards Forum) The problem with such an approach is that these secondary sources, such as eStandards Forum, also have issues with proper data gathering as it used only publicly available data to make a qualitative assessment of a standard adoption [see Popescu (2010)]. The ideal situation is to have proper access to a country’s authorities who are responsible for the standards’ implementation. Assuming their political willingness to disclose the data, we would then get an objective assessment of the status of that
23
[] Penaranda (1996).
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country’s compliance with a standard or standards. In conclusion, the selected measurements are admittedly imperfect proxies for the constructs in this study. Finally, another limitation stems from focusing on one aspect of knowledge, namely information and ignoring other important parts of knowledge, such as tacit knowledge. In sum, we considered that such a hybrid approach used in this case study can help better evaluate the knowledge transfer process and its elements and provide for both the transferor and the transferee of knowledge, by means of allowing both tactical and strategic imperatives, short- and long-term criteria to come into play in evaluating the outcomes and reengineering the process of knowledge transfer mechanisms, policies, and practices. The implications and opportunities of the case study’s findings are discussed below. First, a complete theory for explaining a country’s adoption of the standards should have a more objective measurement of the adoption and the other independent variables, which is currently obscured by the lack of transparency on the part of the actors involved. Future research could explore the current factors included in this study within the context of international standards by using matched sender– receiver dyads. For instance, the ability to identify and interview the range of institutions and individuals directly involved in the adoption of a specific standard would provide more objective measurements of the recipient-related variables. Another important factor that we could explore in more detail would be the client’s capacity to implement the information transferred. The implementation of some regulatory reforms requires considerable work and planning from the part of the client. It would be interesting to estimates the resources needed to implement specific actions required by standard compliance in terms of people, costs, and time. Another case study could apply the current research framework to a wider range of standards related to other important global areas such as climate change and trade and migration, which are not addressed here. These, too, need to be studied to obtain a holistic understanding of the role that international standards play within the overall governance system. Moreover, a broader theoretical and research framework that considers the interactions and connections among global governance institutions and the national institutions is important. International standards and regulations are just two of the many tools being used by the current global governance framework to establish objectives. Furthermore, as briefly stated in this book, the contribution of standards to policy convergence is an essential element of the emerging global governance framework. If such analysis is undertaken, it would contribute greatly to the understanding of global governance and its implications. The results show that country’ absorptive capacity is important, especially in the context of understanding external knowledge that is defined outside of local institutions. In this regard, it is essential for international organizations such as the World Bank and the IMF and their own epistemic communities to pay attention to and allocate resources to enhance projects like ROSC. This would involve training sessions, conferences and courses for the recipients’ institutions in order empower them
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to form their own local epistemic communities on technical subjects and standards. More importantly, we believe that ROSC projects could be designed as a more continuous process involving successive interactions with individual government units and relevant stakeholders in the country. This approach implies that the World Bank/ IMF’s own epistemic communities will play a more active role during the design and actual implementation of policies needed for achieving compliance with the international standards. As a result, ROSC projects could effectively contribute to building local epistemic communities and, at the same time, could become a more comprehensive source of accurate information of a country’s compliance with a standard. Institutions like the World Bank should take into consideration and clearly understand the incentives a country has to adopt a specific standard. As stated, receiving the information in an ROSC assessment does not guarantee effective utilization of this information or the adoption of a standard. Thus, it is important that when international institutions are designing programs like ROSC they take a more holistic view of a country’s context, including a clear understanding of the country’s incentives. The World Bank could financially support or provide its knowledge services to complementary programs that would help a country achieve the overall objective that is emerging from its own incentive framework. While such initiatives are being already pursued as a follow-up to ROSC projects, we believe that “operationalization” of such endeavors in a more holistic program would be a necessary next step to build a more effective framework promoting internationally harmonized technical regulations and standards. In sum, initiatives like ROSC are an important element of the prevailing global governance framework and further investments in such programs are strongly needed to support an effective global response to the global crisis.
Chapter 6
Concluding Remarks
Decline of Nation-States Kenneth Waltz’s classic work argues that communities and systems of states are organized around one of two fundamental ideals or in his term continuums: anarchy and hierarchy.1 Anarchy “is taken to mean not just the absent of government but also the presence of disorder and chaos.”2 There is no authority to command, no presumption of obedience, and hence states have no choice but bargain with each other to defend and achieve their objectives and purposes. Hierarchies “are order by social division of labor among units specializing in different tasks, but the resemblance of units does not vanish.”3 More importantly, within states, governments possess legitimate authority and maintain a monopoly power to demand obedience. In either case, Holsti concluded, “War is the ultimate arbiter of conflict of interest, and, in the final analysis, self-help is the only reliable strategy for survival.”4 Nevertheless, the prevailing social, economic, and political circumstances demand a more engaged, a mirror image if you would, explanation to infer the nature of nation-state and the actors who are vital part of its reconstruction. It should also reflect a pale economic system, which is battered by various crises ranging from currency and financial collapses to nations’ bankruptcies, a system that is navigating between storms and utter clam, seeking Tranquility and needing poise. Such account, therefore, should end intellectual window shopping for the emperor’s new clothes and must come to grasp the world we all live in. The prevailing condition of the global system delivers an indispensable service by unveiling the essence of global system. Today, scholars, practitioners, and policy 1
Kenneth Waltz, Theory of International Politics, Waveland Pr Inc; 1 edition, 2010. Ibid., pp. 114. 3 Ibid. 4 K. J. Holsti, “Government: Polyarchy in Nineteen-Century European International Politics” in James N. Rosenau and Ernst-Otto Czempiel, eds, Governance without Government: Order and Change in World Politics Cambridge University Press, 1992, pp. 30. 2
E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0_6, © Springer Science+Business Media, LLC 2012
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makers are increasingly challenged to respond to the rising importance of transnational interventions, which in turn emphasized the global perspective. The prevailing crises among members of club of rich industrialized nations in addition to the prominent status of global financial institutions have changed normative analyses of what traditionally used to called “domestic” or “international” politics to the extent that the notions likes “global” and the “local” can no longer be neatly separated. Financial institutions threaten sovereign nations to run them down to financial liquidation, while national political establishments huff and buff in dismay they are lectured on responsibility, and manage their fiscal expenditures within the instructed framework. These trends clearly illustrates that the prevailing world is making the transitions from a world of principles to a world of rules and standards. The global system will be all the more stable for being more managed by instructions; a system that should be thought of in physical schemata rather than an evolving structure that tends to diverge from stationary state. Respectively, the traditional goal of capturing a hegemonic power is no longer the provocative preoccupation of the economic or political realms. Instead, the primary intend is to organizing compatibility, preparing for convergence, by establishing procedures menu for rules and norms. As the effective power of transnational actors has grown, various notions like “governance without government”5 or “governance beyond the nation-state”6 were introduced which have had a considerable impact on policy making; the relationships between public and private actors (the US supreme court); and the limits of governmental power. Obviously, the latter point compels some theorists to adopt the position that “governments have lost or are losing their power to govern; or – a related point – that they have lost their pre-eminence and are assuming a place within various self-organizing networks.”7 In contrast, some decided to present the issue but using a different angle, and hence place the emphasis on erroneous ground. For instance, Savoie claims that the nation-state “is not about to disappear, and there is little evidence that economic integration at the global or regional levels is promoting new transnational identities. It was, after all, national governments that prevent the collapse of the American and the European banking system in late 2008 and early 2009. In addition, U.S., government so far spent closer to $4 trillion annually, the Canadian government over $200 billion, and the British government 600 billion British pound, which certainly suggesting that they are not about to disappear. The spending power of national governments still matters, constituting an important instrument of political power.”8
5
This term was first coined by Rosenau and Czempiel (see James N. Rosenau and Ernst-Otto Czempiel, eds, Governance without Government: Order and Change in World Politics Cambridge University Press, 1992). 6 See Tanja Bruehl and Volker Rittberger, “From International to Global Governance: Actors, Collective Decision-making, and the United nation in the World of the Twenty-First Century,” in Volker Rittberger, ed, Global Governance and the United Nation System, United Nation Press, 2002, pp. 1–47. See also Volker Rittberger, “Inclusive Institutions for Governance in the Global Political Economy, ACUNS 2007 Annual Meeting on “The Study of International Organizations: Past, Present, Future?” 7 Jim Whitman, The Limits of Global Governance, Routledge, 2005, pp. 18. 8 Donald J. Savoie, Power: Where is it by, Mcgill Queens University Press, 2010, pp. 21.
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The Savoie argument pleads, however, few clarifications. First, the emerging consensus is not about the disappearing of nation-states, but the point of contention is that government does not have control over significant portion of the national economy, e.g., what, where, and how to produce goods and services as a result of internationalization of production cycle and resources. Second, transnational identities are not necessarily related to national identities and it can easily be traced to the origin of many industrial productions, e.g., car, and services, e.g., banking. In this respect, while nations keep their cultural and historical identities, the sources of their economic being, pertaining to the production and use of income, is transnational. Third, although various national governments did prevent the collapse of the global banking system, such prevention occurred as a result of the exercise of power by financial institutions, which preserved the status quo and not the welfare of people in these nations. In another word, popular representation in the bailout was heavily restricted within the circle of policy makers among these nations. For instance, one-third of the money spend in the USA was in the form of tax break, and almost nothing has been done to rescue foreclosed homes, where millions of Americans are in trouble. As Robert Reich recently summed the state of working people: they have lost their jobs, their homes, and their savings to the extend that Bill Moyers, the highly respected longtime PBS commentator and President Lyndon Johnson’s lieutenant in creating Great Society legislation like Medicare and the Voting Rights Act, calls the American political system of today a “plutocracy” – that is, one that is governed by the few and for the few.9 Moreover, a fiscal expansionary (or concretionary) policy like the 2008 bailout program cannot be judged by the pecuniary value but rather by its objectives and intended target, which are linked to overall government agenda setting and policy decisions. Indeed, the 2008 crisis and its subsequent rescue package provide an example that “government” in the global era is only one of many actors that influence the course of events in an economic system. More to the point, government does not have enough power to exert its will on other actors, e.g., financial institutions, since these actors, to a great extent, are ruled by self-interest and shareholders’ interest. In short, they largely rule themselves. In retrospect, Savoie’s argument about nation-states is tainted by relations of power that not only generate an observable clash of interest between actors, but also involve the exertion of power through the control agenda setting and decisions about what gets distributed and what does not. In a broader context, namely, the global system, similar explanation has been applied. For instance, Crawford alluded to the similar observation and claimed, “Power relationships and processes of opinion making and decision making are increasingly located in interdependent and transnational settings, characterized by shifting alliances among international as well as domestic stakeholders.”10 Another significant issue related to inability of nation-states to exercise power over their economic affairs and national interest is the fact that “governance” is not
9
See http://english.aljazeera.net/indepth/opinion/2011/04/20114391843209245.html. Gordon Crawford, “Partnership or Power? Deconstructing the ‘Partnership for Governance Reform’ in Indonesia,” Third World Quarterly, Vol. 24, No. 1 (Feb., 2003), pp. 141. 10
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merely a synonym for management, but also denotes the strategic context in which management takes place.11 In another word, how and who is involved in the management apparatus are integral part of governance. Accordingly, policies that promote international standards and harmonization inevitably lead to creation of knowledgebased managerial technocrats known as an epistemic community. Indeed, a creation of an epistemic community is the major factor in the transformation of a mediocritic bureaucracy to meritocratic (scientific) bureaucracy. Respectively, knowledge transactions (transfers) that take place among epistemic communities and national bureaucratic agencies should be considered as the complementary element to standard setting and harmonization, which help in setting up a new institutional environment. The notion of epistemic community is the subject we address next.
Epistemic Community The global objectives of managed and controlled financial crises through international standards and harmonization are designed to place a policy emphasis on interventions so that the mechanism of exchange and production remains stable. Therefore, these objectives are clear indication that the global economic system is perceived governable.12 However, the notion of governability necessarily entails creation of a legitimate knowledge upon which relevant policy decisions must be based. Subsequently, the importance of epistemic community becomes vital. In Haas’s words, once an epistemic community has established its authority, it “stands to institutionalize its influence and insinuate its views” into vast arena.13 Growing professionalization of bureaucracies through a knowledge-based community, an epistemic community, has led various public agencies to seek autonomy not only from a central government, but also from one another. A variety of strategies can be applied to increase the autonomy of public bureaucracies. However, taken into consideration the content of the present study, the newly emerging notions like “autonomization” and “scientization” bear more relevancy to the structure and rationale of our argument. Autonomization refers to “an administrative reform process whereby sections of the administrative apparatus acquire a legal status that prevent politicians from intervening in how bureaucratic agency in question conducts its business.”14 In this respect, autonomization should be perceived as a depoliticiziation of policy process
11
Jim Whitman 2005, pp. 19. Which according to Webster dictionary means “to exercise continuous sovereign authority over; especially: to control and direct the making and administration of policy in.” 13 Peter M. Haas, “Introduction: Epistemic communities and international policy coordination,” International Organization, vol. 14, no. 1, 1992, pp. 4. 14 Martin Marcussen, “Institutional Transformation? The Scientization of Central Banking as a Case Study,” in Tom Christensen and Peter Laegried, Autonomy and Regulation; Coping with Agencies in the Modern State, Edward Elgar, 2006, pp. 81. 12
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in which bureaucratic agencies are given an opportunity to utilize their capability and competencies free of political interfere or/and special interest groups. However, free of political interference does not mean to suggest that it is possible to take the politics out of decision making; rather, it implies that the politics remains but the domain or procedure through which decisions are made can be altered.15 As Flinder and Buller suggest, “the rational given for creating nationalized industries underpin many of the arguments frequently offered to legitimate the adoption of organizational depoliticiziation tactics today (the need for specialist knowledge … the importance of long-term policy planning beyond the electoral cycle).”16 The notion that a central bank should be independent of a government is another example of depoliticiziation of institutional monetary environment around the world. Accordingly, promotion of international standards and harmonization by global governance should also be seen as an attempt to create an “apolitical” institutional environment in which certain policy issues are decided beyond a national reach. Scientization is another tactic that intends to reform public bureaucracies and “signifies a shift in authoritative status”: “Scientized bureaucratic agencies not only base their legitimacy on delegation, rational–legal or moral authority–scientization also implies that public agencies are endowed with scientifi c authority.”17 Therefore, scientization may imply that governance, as Marcussen argues, is transnationalized, that is, “a movement from territorial governor community to non-territorial knowledge community.”18 The given rationale for such observation is related to the way scientific communities are usually defined according to the rules of the scientific value instead of territorial borders. Like previous notions, the crucial implication of scientization on governance is a likely transformation of political governance to knowledge (epistemic) governance.19 Such transformation is clearly apparent among central banks around the globe. In recent years, there have been signs that “the quiet revolution” using the Blinder’s term has taken place in central banking around the world that represented changes in both procedure and substance,20 more specifically changes in central bank procedures that underlie monetary policy; changes in bureaucratic structure, and in the used of financial data. For instance, by defining transparent conduct as actions that are “easily detected” and “easily understood,” Blinder sketches a series of increasingly stringent transparency standards, such as clarity, substantive content, open to
15
For detailed study of depoliticiziation see Matthew Flinder and Jim Buller, “Depoliticiziation, Democracy and Arena of Shifting,” in Tom Christensen and Peter Laegried, Autonomy and Regulation; Coping with Agencies in the Modern State, Edward Elgar, 2006, pp. 53–80. 16 Ibid, pp. 59. 17 Martin Marcussen 2006, pp. 82. 18 Ibid., pp. 98. 19 Another significant implication of transnationality of knowledge community (epistemic community) is the fact that, and unlike governor community, membership cannot be inherited. For instance, as Marcussen points out, “the German governor will always be part of G10, but the German governor will only be member of the knowledge community if he can contribute to the generation of scientific knowledge.” See Martin Marcussen 2006, pp. 99. 20 Alan S. Blinder, The Quiet Revolution, Yale University Press, 2004.
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public scrutiny, etc. that, in his word, “truly modern central bank might think to meet.” To confirm scientization, and hence depoliticiziation of the central banking institutional environment around the world, Marcussen observed that the consensus is emerging, which compels politicians not to intervene in the conduct of central bankers, “both indirect (that is, simply talking about the conduct of monetary affairs in public) and direct (that is, criticizing the monetary policies conducted by central bankers).”21 It should be noted that even on extreme occasions, like 2008 episode, the major criticisms of Fed policies should not be viewed as political interventions (since there were no alternation of standard monetary policy) but rather consider as a compliance with transparency standards, e.g., open to public scrutiny. The rise of epistemic community means that arithmetic and statistics are now used as interpretive and predictive practice. The world is increasingly comprehended through the numerical average rather than the cultural or moral exemplary; populations not only become known, but are also initially recognized through being numbered.22 The crises, and therefore preemptive actions, are mitigated through probabilistic reasoning.23 At the same time, such mitigation also increases our sense of the world as fortuitous rather than causally coherent, a theme that was also pursued in some detail by Hacking when he argued, “The most decisive conceptual events of twentieth century physic has been the discovery that the world is not deterministic. Causality, long the bastion of metaphysics, was topples, or at least tilted; the past does not determine exactly what happen nest.”24
Conformity The distinction between the age of global economic system and other eras of human civilization is more apprehended when one realizes that in the globalized system we distinguish and separate those who decide what, how, and where to produce from those who encouraged to follow rules; those who part of national legislation bodies from those who choose what need to be done; and so on. In its structural hierarchy, it is necessary to underline the benefits of incorporating interest and institutional conformity (institutional isomorphism). Instead of an autocratic rhetoric in the
21
Martin Marcussen 2006, pp. 103. See, for instance, see also Jacques Donzelot, “The Promotion of the Social,” Economy and Society vol. 17, 1988, pp. 395–427. 23 See, for instance, Zhanbo LEI, Yoshiyasu YAMADA, Jihong HUANG, Youmin XI, “Intelligence Erarly-Warning Support System for Enterprises Financial Crisis Based on Case-Based Reasoning,” Journal of Systems Science and Complexity, 2006, vol. 19, pp. 538–546 and Gordon L. Clark and Roger Urwin, “Making Pension Boards Work: The Critical Role of Leadership,” Rotman International Journal of Pension Management, Vol. 1, issue. 1, Fall 2008, pp. 38–45. 24 A theme also pursued in some detail by Ian Hacking (see Ian Hacking, The Taming of Chance, Cambridge University Press, 1990, pp. 1. 22
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name of masses, it prefers an ever more dissemination of obscure terminologies (information) like “too big to fail,” the object of which is to justify multitude of reactive microdecisions, e.g., bailout, to resolve intrinsic problems. Indeed, that is the main reason why no cultural autonomy is required of these types of decisions, only the assurance that a proper procedure has been set in motion. The polity is a mere game, which has no other object than the preservation of institutional environment, the rule of the game, the only agreed operating standard of a system. “The common good” and “the general welfare,” once keywords of early modern societies, now have arcane ring to them. This is not a value judgment, but rather stating fact. Manage and control are notions in high demand. Nation-states in the globalized system are more and more becoming “surveillance society,”25 preserved from the “clashes of civilizations,” and struggle to sustain a minimum standard of living when the accepted natural rate of unemployment is merging into two-digit percentage. Governance, the regulation of social behavior, implicitly reproduces a mechanistic model of behavior that necessarily entails conformity. In this respect, operation of the governance machine not only becomes smooth, but also does not require philosopher kings, or even enlightened citizens, but standard, identical elements capable of operating with one another in countless combination according to designated rules. In such homogeneous system, information is not – neither should be – particular, but rather standardized, so the actors (under consideration) can be connected to each other like the pieces of Lego. Guehenno puts it best when he compared the today “global society” to a vast brain, “in which the connections between neuroses are made thanks to billions of electric impulses that circulate all the more fluently as long as the neurons bathe in a perfectly homogeneous medium. In a society in which power is a function of the networks, social “conductivity” becomes essential.”26 In turn, conductivity would raise capacity to adapt. Adaptability in fact is an integral part of managerial value in a globalized system to the extent that modern manager
25
Privacy International’s 2007 survey, covering 47 countries, indicated that there had been an increase in surveillance and a decline in the performance of privacy safeguards, compared to the previous year. Balancing these factors, eight countries were rated as being “endemic surveillance societies.” Of these eight, China, Malaysia, and Russia scored the lowest, followed jointly by Singapore and the UK, then jointly by Taiwan, Thailand, and the USA. The best ranking was given to Greece, which was judged to have “adequate safeguards against abuse” (see “The 2007 International Privacy Ranking,” Privacy International, 2007). It should be noted that the UK is seen as a pioneer of mass surveillance. By the end of 2006, the UK was described by the Surveillance Studies Network as being “the most surveilled country” among the industrialized Western states (BBC News – Britain is “surveillance society,” 2 November 2006). On 6 February 2009, a report by the House of Lords Constitution Committee, Surveillance: Citizens and the State, warned that increasing use of surveillance by the government and private companies is a serious threat to freedom and constitutional rights, stating “The expansion in the use of surveillance represents one of the most significant changes in the life of the nation-states since the end of the Second World War.” The report can be accessed at: www.publications.parliament.uk/pa/ld200809/ldselect/ldconst/18/1802.htm. 26 Jean-Marie Guehenno 2000, pp. 79. The emphasis is part of the text.
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is judged by his/her flexibility – forget about “old” way of thinking and you have premises to success. Indeed, in the modern world, we created a category known as “social barometers”27 that were designed to distinguish disequilibrium from equilibrium of norms. Following this train of thoughts, soon we encounter the notion of conformity. Conformity should be examined as a capacity of embracing harmony (or avoiding discord). This view is in direct contrast to the traditional approach that views conformity as subordination to a dominant class, ideology, etc., and hence may provoke descent as a reaction against hegemony (or an ideology that confines liberty of individual, group, or class). Institutional conformity (institutional isomorphism) of global system, therefore, is not threatened by nonconformity in a sense that it does not provoke or encounter resistance since there is no coercion and no arm twisting. This is due mostly to the voluntary nature of global standards and the fact that there is no longer an ideal system that has appeals, no leading opinions worth believing, and no principles worth preserving. There are no ideological magnets that occupy curious minds, but rather the reality of the world, which constantly reminds us the benefits for uniformity. As a result, we conceive conformity, particularly in terms of institutional environment, as the byproduct of globalization of economic system. As Guehenno observed, “conformity is not an accident, … but a necessary condition of [advanced societies] smooth operation.”28
International Standards The goal of industrial production has always been mass production. It has been producing standardized object for mass consumption. Central to industrial standardization, the development of a shared system of measures and models is communicative normalization.29 This makes possible “the institution of the perfect common language of pure communication by an industrial society, a language of precision and certainty, a language without puns, stylistic features or interference.”30 In short, a language of apparent pure reference. In addition, the prevailing advancements in
27
According to Urban dictionary, social promoters means something used to define social norms and gauge appropriate behavior in a social situation. 28 Jean-Marie Guehenno 2000, pp. 81. 29 According to Brenneis, normalization should be perceived as “process-or ‘norming,’ as it is sometimes referred to in in-house dialect.” (See Donald Brenneis, “Discourse and Discipline at the National Research Council: A Bureaucratic Bildungsroman,” Cultural Anthropology, Vol. 9, no. 1, Feb., 1994, pp. 32). In this respect, the principle of normalization is defined as a “normal rhythm of the day,” “a standard behavior.” 30 Francois Ewald, “Norms, Discipline and the Law,” in Robert Post, ed., Law and the Order of Culture. University of California Press, 1991, pp. 151.
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information technology have also affected what is being communicated, as well as how it is communicated. Thus, the question for policy makers and designers has become broader: How should information/knowledge be “packaged” to make communication (transfer) more effective by changing not only the medium, but also attributes of the message itself?31 In parallel, the alternation of the modern nation-states and international standard provides distinct choices to which either states measure up to and conform if they are to fully participate as legitimate members of global economic system or stay away and function as if they are operating in autarkical economic system. On the one hand, the incentive for an economic cooperation, including economic governance, propels any given economy to retain certain disciplines that are compatible to international norms and standards. On the other hand, in an autarkical system, states can do as they please without considering external norms and roles of engagement. For instance, a state can print money to meet its budgetary obligations, without taking into account its currency-relative exchange value. However, once such system is linked to external economic exchange and production, its status would change, and hence its ability to do as it wishes immediately restrained. The rationale for such drastic change is related to the principle of reciprocity or “you get what you give,” which is one of the main key demands of relations among nation-states. Above all, the principle of reciprocity required the organizational compatibility to enter into and uphold mutually binding agreement according to the sets of agreed roles and standards at global level. The principle formulated above can also be expressed in terms of a practical application. The prevalence of market failures in domestic financial markets provides strong motive for governments to step in, as necessary, by establishing financial standards. However, with the globalization of financial markets, market failures have moved to the international level. This means that financial instability in one economy can and will adversely affect many other economies that are tied together in the global economy. However, addressing international market failures is not as straightforward as in the domestic case. International financial intervention, in short, requires international cooperation, one of which is harmonization of financial regulations and standards. In this respect, it must be obvious that the idea of autarkical system is at odd with globalized economic system, and by the same token emerging of terms, such as “good governance,” driven by a core rationale that promotes institutional conformity to international standards. Historically, standards have existed since the beginning of recorded civilization. One of the earliest examples of standardization of information/knowledge is the creation of a calendar. Over 20,000 years ago, our Ice Age ancestors made the first rudimentary attempts to standardized information by keeping track of days by
31
See Dov Te’eni, “Review: A Cognitive-Affective Model of Organizational Communication for Designing IT,” MIS Quarterly Vol. 25, no. 2, June 2001, pp. pp. 252.
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scratching lines in caves and gouging holes in sticks and bones. Or, the Sumerians in the Tigris/Euphrates valley devised a calendar very similar to the one we use today. Five thousand years ago, the Sumerian farmer used a calendar that divided the year into 30-day months. Each day was divided into 12 h and each hour into 30 min.32 Finally, as the first Emperor of China, Qin Shihuang waged wars to conquer more and more territories that eventually formed the present China; he identified one major problem with his archers. Through observing his army, he came to realize that each of his archers made their own bow and arrow, so if an archer dies in a battle, a fellow archer could not grab his arrow and shot at an enemy since the arrow did not fit his bow. So the Emperor ordered that all bows and arrows for his army should be made by single standard. These examples, while are plain and primitive in content, bear a power implication in today’s world. The arguments made above help us to dismiss criticisms and underline the need to redesign knowledge transfer programs, including institutional learning, absorptive capacity, development of epistemic national community (epistemic governance), etc. In sum, the rationale for our argument derives from our belief that countries are now willing to give up parts of their internal sovereignty to be able to participate in the global market. While ideological debates are necessary in any formulation of a developmental program, they should not prevent us from reaching common ground and practical results. For instance, debates on accepting or rejecting globalization are futile because the new paradigm has occurred with or without the consciousness of most developing countries, and hence arguing about its predatory nature or even its exploitive makeup is empty of substance. It must be apparent that the time has come for many nation-states to acknowledge the globalization paradigm and consider economic policies that are suited for the twenty-first century global market. The core issue for nation-states is not whether to embrace global rules or keep the status quo, but rather to analyze their current economic condition, adjusting to the new paradigm. This inclination does implies, however, that we welcome questions that bear substance and intend to contribute to improvement of our understanding of the current state of the world and its intrinsic predicaments. For instance, questions that put forward by Terry Eaglton fall into such category.33 In this book, we argued that transfer of specialized and procedural knowledge in development-related technical domains (e.g., accounting procedures, payment systems, corporate governance principles, etc.) can be conceptualized as one-way knowledge transfer process from international organizations and their global epistemic
32
Excerpted from Through History with Standard, available at: http://www.ansi.org/consumer_ affairs/history_standards.aspx?menuid=5. 33 A questions like: “Why is it that the capitalist West has accumulated more resources than human history has ever witnessed, yet appears powerless to overcome poverty, starvation, exploitation, and inequality?” See Terry Eagleton, “In Praise of Marx,” The Chronicle of Higher Education, April 10, 2011.
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communities to countries. As a developmental tool for international institutions, we argued that knowledge and institutional learning should be perceived as proactive policies that intend not only to empower and converge the functions of national institutions, but also to prevent behaviors that destabilize the global system. More specifically, in the case of transfer of knowledge related to international standards, we argued that adaptation to local circumstances, translatability, local ownership, and cultural sensitivity are not applicable. Instead, the remaining factors in a country noncompliance with global policy frameworks are its capacity (both in terms of financial resource and knowledge and learning) to understand and adopt these standards that is linked to the absence of local epistemic communities. Additionally, at the country level, incentives do affect the country’s adoption of the standard. All in all, better governance, regulation, and guidelines serve as multipliers of development, growth, and prosperity in a globalizing world, whereas their lack or inadequacy increasingly becomes a source of risk, lost opportunities, and development divides. The emerging key lesson learned from our work may well be that the best strategy may be one of minimizing risk and maximizing benefits (a minimax strategy heeding to the insights of the game-theoretic Nash equilibrium concept). Elements of this concept may also be found in the ideas and actions proposed and embraced by Gandhi, Amartya Sen, Yunus, Schumacher, Barerjee, Duflo, Dollar, and others. We end this book by thoughtful comment of Jon Elster who observed, “explanation in the social science should be organized around (partial) mechanisms rather than (general) theories.”34 Elsewhere, Elster clarified his position by stating, “mechanisms are frequently occurring and easily recognizable causal patterns that are triggered under generally unknown conditions or with indeterminate consequences. They allow us to explain, but not to predict.”35 Like most social science debates, various arguments about the declined nationstate rule (or reject such proposition) presented in this book are constructed by passion, by interest, or by impartial reason. These notions are often integral part of language and rationale to prove or refute a hypothesis. David Hume, when addressing the relation between passion and reason, argued that the latter was, and ought only to be, the slave of the former.36 Roughly speaking, Hume indicated that
34
Jon Elster, “Arguing and Bargaining in Two Constituent Assemblies.” Journal of Constitutional Law, March 2000, p. 419 (emphasis in original). Interested reader on the topic can refer to Elster’s classic book, Alchemies of the Mind: Rationality and the Emotions, Cambridge University Press, 1998, pp. 332–402. Emphasis was added to the original text. 35 Jon Elster, Alchemies of the Mind: Rationality and the Emotions, Cambridge University Press, 1998, pp. 1. Emphasis was added to the original text. 36 See David Hume, A Treaties of Human Nature, L.A. Selby-Bigge, ed., 2nd edition, Clarendon Press, 1978, pp. 415.
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there could be no rational deliberation about ends, only about means. Albert Hirschman has considered the changing attitudes toward passions and interests in the eighteenth century, arguing that the dominance of interest over passion in a commercial society constituted “a political argument for capitalism before its triumph.”37 We tried, to the best of our ability, to be faithful to incorporate both passion and reason in this book.
37
Albert O. Hirschman, The Passions and the Interests; Political Argument for Capitalism before it’s Triumph, Princeton University Press, 1977. Hirschman further observed, “to understand the opposition of these two concepts [interest and passion], something must first be said about the various successive (and often simultaneous) meaning of the terms ‘interest’ and ‘interests’ in the course of the evolution of language and ideas.” “Interest” of persons and groups eventually came to be centered on economic advantage as its core meaning, not only in ordinary language but also in such social-science terms as “class interest” and “interest groups.” … When the term “interest” in the sense of concerns, aspirations, and advantage gained currency in Western Europe … its meaning was by no means limited to material aspects of a person’s welfare; rather, it comprised the totality of human aspiration, but denoted an element of reflection and calculation with respect to the manner in which these aspirations were to be pursued (Ibid., pp. 32).
Appendix
Appendix A
International Financial Standards
Overall, there are 12 Key Standards (see Table A.1) highlighted by the FSF as key for sound financial systems and deserving of priority implementation depending on country circumstances. Within the ROSC program, both the World Bank and the IMF are undertaking a large number of summary assessments,1 observing selected standards relevant to private and financial sector development and stability. These assessments are known as “modules” in country binders constituting the ROSCs. Overall, there are 11 modules in the program: (1) Data Dissemination; (2) Fiscal Transparency; (3) Transparency in Monetary and Financial Policies; (4) Banking Supervision; (5) Securities Regulation; (6) Insurance Supervision; (7) Payments and Settlements; (8) Corporate Governance; (9) Accounting and Auditing; (10) Insolvency and Creditors’ Rights; and (11) Anti-Money Laundering and Combating the Financing of Terrorism. Below, we will describe briefly the contents of three of the above standards.
1
The summary assessments are based on the percentage of benchmarks met for specific standards and are summarized in scores expressed as follows: “little upgrading required,” “some upgrading required,” and “substantial upgrading required”. E.G. Carayannis et al., Institutional Learning and Knowledge Transfer Across Epistemic Communities, Innovation, Technology, and Knowledge Management 13, DOI 10.1007/978-1-4614-1551-0, © Springer Science+Business Media, LLC 2012
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Table A.1 Description of the 12 key standards Area Standard name Macroeconomic policy and data transparency Monetary and financial Code of Good Practices policy transparency on Transparency in Monetary and Financial Policies Fiscal policy Code of Good Practices transparency on Fiscal Transparency Data dissemination Special Data Dissemination Standard/General Data Dissemination System
Issuing body ROSC module IMF
IMF IMF
Institutional and market infrastructure Insolvency
World Bank
Corporate governance
Principles of Corporate Governance
OECD
Accounting
International Accounting Standards (IAS)
IASB
Auditing
International Standards on Auditing (ISA)
IFAC
Payment and settlement Core Principles for CPSS Systemically Important Payment Systems Recommendations for Securities Settlement Systems Market integrity The Forty FATF Recommendations of the Financial Action Task Force/9 Special Recommendations Against Terrorist Financing Financial regulation and supervision Banking supervision Core Principles for Effective Banking Supervision
BCBS
Securities regulation
Objectives and Principles of Securities Regulation
IOSCO
Insurance supervision
Insurance Core Principles
IAIS
Part of WB and IMF Financial System Stability Assessment (after 2000) IMF Fiscal Transparency ROSC Module IMF Data Dissemination ROSC Module
World Bank Insolvency and Creditor Rights ROSC Module World Bank Corporate governance ROSC Module World Bank Accounting and Auditing ROSC Module World Bank Accounting and Auditing ROSC Module Part of WB and IMF Financial System Stability Assessment (after 2000)
World Bank Anti-Money Laundering and Combating the Financing of Terrorism ROSC Module
Part of WB and IMF Financial System Stability Assessment (after 2000) Part of WB and IMF Financial System Stability Assessment (after 2000) Part of WB and IMF Financial System Stability Assessment
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Corporate Governance2 The importance of corporate governance in a market-based economy stems back to the nineteenth century, where state corporation law in the United States enhanced the rights of corporate boards to govern without the unanimous consent of shareholders in exchange for statutory benefits to make corporate governance more efficient.3 In the twentieth century, and after the 1929 Crash, legal scholars such as Adolf Augustus Berle, Edwin Dodd, and Gardiner C. Means introduced the new role of the modern corporation in society. For instance, Berle and Means monograph, “The Modern Corporation and Private Property,” continues to have a profound influence on the conception of corporate governance.4 In 1937, Ronald Coase, from the Chicago
2
It should be noted that there are many different models of corporate governance around the world. These models are different according to the variety of capitalism in which they are embedded. The market-oriented system is called capitalism because it is an economic system organized around the production and allocation of capital. The savings of individuals are the basis of all capital. Yet, the way in which economies accumulate and allocate capital are quite different in different countries, and seem closely related to how each country handles corporate governance issues. The corporate governance model adopted by international agencies, e.g., the World Bank, is based on Anglo-American model (AA). However, and in contrast to AA model, family-owned companies are dominant models in East Asian Countries. A study by Claessens et al. (2000) investigated the top 15 families in East Asian countries and found that they dominated listed corporate assets. In countries such as Pakistan, Indonesia, and the Philippines, the top 15 families controlled over 50% of publicly owned corporations through a system of family cross-holdings, thus dominating the capital markets. Family-owned companies also dominate the Latin model of corporate governance, that is, companies in Mexico, Italy, Spain, France (to a certain extent), Brazil, Argentina, and other countries in South America. 3 For detailed analysis of history of state corporate law see James Willard Hurst, The Legitimacy of the Business Corporation in the Law of the United States, 1780–1970, Charlottesville, University of Virginia Press, 1970. Having said that, one can also define corporate governance in a way that looks to the economic functions of the firm rather than to any particular set of national corporate laws. Firms exhibit good corporate governance when they both maximize the firm’s residuals – the wealth generated by real operations of the firm – and, in the case of investor-owned firms, distribute the wealth so generated to shareholders in a pro rata fashion. Bad corporate governance is just the failure of a firm to meet one or both of these conditions. Whether managers operate their firms in ways that meet these conditions depends on the structure of constraints and incentives in which they operate, a structure that depends in part, but only in part, on the prevailing legal system. 4 Adolf, Berle, and Gardiner C. Means, The Modern Corporation and Private Property, Macmillan, New York, 1933. The initial section of the book documents the extent, as of 1930, to which economic power had become concentrated in large corporations, and how ownership and control of these same corporations had become separated. Berle and Means then summarize concisely the legal history of the relationship between corporations, their shareholders and managers, and the state. They go on to suggest the implications of these developments: managers, largely free from shareholder control, have a natural tendency both to enrich themselves and to fritter away the firm’s assets in unproductive endeavors and inattentiveness, at the expense of the owners. Berle and Means credit Adam Smith for the first questioning remarks about stock companies, presumably based on the sometimes erratic performance of the first great modern corporation, the East India Company: “negligence and profusion must always prevail, more or less, in the management
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School of Economics, wrote the “Nature of Organization,” which introduced the notion of transaction costs into the understanding of why organizations are founded and how they continue to behave. The concept of transaction cost provides an easy way to understand the nature of organization boundaries in a developed competitive economy. As transaction cost economists envision the world, a country’s productive economic activities consist of a set of transactions – potentially value-enhancing reallocations of goods and services – that occur between two or more parties. Every transaction that is not simultaneous and unambiguous in its implications for each party requires some kind of mechanism to govern the actions of the parties over time. In the simplest model, there are only two possible mechanisms, both easily enforceable contracts that specify each possible future state of nature and what each party must do (referred to as a “well-specified contract”). With an organization, one party owns all the assets related to making the transaction value-enhancing. The owner enters into an agreement with another party in which the owner promises compensation and the other party promises in return to do whatever, within a specified range of activities, the organization owner commands the party to do. The period following World War II witnessed the emergence of multinational corporations and the establishment of the managerial class, or the managerialist corporation.5 In the following years, Harvard Business School management professors published influential monographs studying the prominence of multinational corporations: Myles Mace (entrepreneurship), Alfred D. Chandler, Jr. (business history), Jay Lorsch (organizational behavior), and Elizabeth MacIver (organizational behavior). Then, in the early 1980s, Eugene Fama and Michael Jensen introduced agency theory6 as a way of understanding corporate governance. Fama and Jensen
of the affairs of such a company.” The substantial bulk of academic research since Berle and Means supports this proposition: separation of ownership and control does adversely affect the performance of the firm. However, interestingly, they then asked, “given the size and complexities of modern business, what reasonable alternative organizational arrangements could be devised?” The authors assert that “by surrendering control and responsibility, [passive property owners] have surrendered the right that the corporation should be operated in their sole interest.” From this it follows that shareholders are not entitled to the full profits of their capital. The way is thus cleared for the modern corporation to serve “all society … on the basis of public policy rather than private cupidity.” Here is the intellectual foundation for a massive expansion of governmental oversight which the authors helped bring about through the establishment of the Securities and Exchange Commission and the confused, harmful concept that the corporation has many “stakeholders” – with shareholders typically at the end of the list. 5 See Berle, Adolph, Jr., and Gardiner C. Means, The Modern Corporation and Private Property, New York, MacMillan, 1932. 6 The reader should note that while agency theory can be viewed as an empirical theory of the corporation, it can equally be considered a prescriptive theory, that is, not an explanation of what is but a vision of what could or should be.
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described the organization as a series of contracts.7 By the end of the 1980s, agency theory’s dominance was well established.8 The debates on the importance of corporate governance are varied. It is frequently argued that by maintaining control over enterprise decision-making, politicians can use enterprises to pursue so-called higher national goals. For instance, some argue that politicians use enterprises to correct market failures such as natural monopolies and externalities.9 Some scholars suggest that politicians use enterprises to accelerate capital formation and technology transfer,10 reduce income inequality,11 and increase macroeconomic stability.12 Others defend politicians’ participation in enterprise decision making on the grounds of the possible presence of information asymmetry between producers and politicians and/or incomplete contracts.13 Putting aside the important question of whether politicians should use enterprises to improve social welfare, the enterprises that politicians do use to pursue social goals are forced to abandon profit maximization in favor of social-welfare maximization, which is likely to result in less-favorable corporate performance. The prevailing view assumes that politicians act according to their own interests. Shapiro and Willig suggest that a politician’s objective function is a weighted average of social welfare and his/her personal goals and that the relative weight placed on these two kinds of goals depends on the efficiency of the political market.14
7
Eugene Fama and Michael Jensen, “The Separation of Ownership and Control,” Journal of Law and Economics, Vol. 1, 1983, 301–25. 8 See Kathleen M. Eisenhardt, “Agency Theory: An Assessment and Review,” The Academy of Management Review, Vol. 14, No. 1 (Jan., 1989), pp. 57–74. 9 Vickers John and George Yarrow. “Privatization: An Economic Analysis.” Cambridge, MIT University Press, 1989; Andrei, Shleifer and Robert W Vishny. “Politicians and Firms.” Quarterly Journal of Economics 109 (1994), 737–783; and Andrei Shleifer, “State versus Private Ownership.” Journal of Economic Perspective 12 (1998), 133–151. 10 For example see Emilio Sacristan, “Some Considerations on the Role of Public Enterprise,” in Public and Private Enterprise in a Mixed Economy: Proceedings of a Conference held by the International Economic Association. Baumol, William, eds. New York: St Martin’s Press (1980), 44–56; and Armando Labra, “Public Enterprise in an Underdeveloped Economy.” In Public and Private Enterprise in a Mixed Economy, Proceedings of a Conference held by the International Economic Association. Baumol, William, eds. New York: St Martin’s Press (1980), 36–43. 11 Johan Willner, “Social Objectives, Market Rule and Public Policy.” In Competitiveness, Subsidiarity and Industrial Policy. Devine, Pat; Katsoulacas, Yannis and Roger Sudgen eds. New York: Routledge (1996), 12–41. 12 Millward, R. “Price Restraint, Anti-Inflation Policy and Public and Private Industry in the United Kingdom 1949–1973.” Economic Journal, 86 (1976), 226–242. 13 See David E Sappington and Joseph E. Stiglitz. “Privatization, Information, and Incentives.” Journal of Policy Analysis & Management, 6 (1987), 567–581; Andrei Shleifer and Robert W Vishny. “The Grabbing Hand: Government Pathologies and Their Cures.” Cambridge, MA: Harvard University Press (1998). 14 Carl Shapiro and Robert D. Willig. “Economic Rationales for Privatization in Industrial and Developing Countries.” In The Political Economy of Public-Sector Reform and Privatization. Suleiman eds, Boulder: Westview Press (1990), 22–54.
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Boycko, Shleifer, and Vishny examine the way politicians use enterprises to provide employment to obtain more political support.15 Krueger suggests that politicians tend to hire politically connected individuals rather than qualified individuals.16 Jones describes numerous cases in which politicians in various countries use stateowned enterprises (SOEs) as vehicles to transfer wealth and favor from one group to another.17 However, corporate governance research during the 1990s expanded from a narrow focus on large corporations to a broader concern with issues of political economy and the global system.18 The transition of state socialist societies to market economies, and the spread of financial markets to emerging economies around the globe, infused the puzzle of managerialism with enormous policy relevance. As a result of several sequential events, corporate governance has been added as another important pillar of the International Financial Architecture. The East Asian Financial Crisis of 1997 saw the economies of Thailand, Indonesia, South Korea, Malaysia, and the Philippines severely affected by the exit of foreign capital after property assets collapsed. The lack of corporate governance mechanisms in these countries highlighted the weaknesses of the institutions in their economies. The East Asian Financial Crisis was followed by the Russian Financial Meltdown of 1998, whose primary cause was not the fall of oil prices directly, but rather the non-payment of taxes by the energy and manufacturing industries. As a result of these crises, the leaders of the G7 announced a new focus on corporate behavior and incentives.19 By mid-1999, the Organization for Economic Cooperation and Development (OECD) adopted a set of basic principles. The international financial institutions (IFIs) all view improved governance practices as a key to spurring prosperity and jobs by strengthening corporations’ ability to compete for global capital.20 In response, many World Bank client countries have initiated legal, regulatory, and institutional corporate governance reform projects. The general consensus is that better corporate frameworks benefit organizations through greater access to financing, lower cost of capital, better organization performance, and more favorable treatment of all stakeholders.
15
Boycko, Maxim, Andrei Shleifer, and Robert W. Vishny. “A Theory of Privatisation.” Economic Journal, 106 (1996), 309–319 16 Krueger, Anne O. “Government Failures in Development.” Journal of Economic Perspectives, 4(1990), 9–23. 17 Jones, Lerory P. “Public Enterprise for Whom: Perverse Distributional Consequences of Public Operational Decisions.” Economic Development and Cultural Change, 33 (1985), 333–348. 18 See Gerald F. Davis and Michael Useem, “Top Management, Company Directors, and Corporate Control,” in Andrew Pettigrew, Howard Thomas, and Richard Whittington, edited, Handbook of Strategy and Management, Sage Publications, 2001. 19 Ironically, at the beginning of twenty-first century, the trend of corporate crisis continues in US, in which two big corporations, namely, Enron and WorldCom, crumpled and the ensuing scandals and collapses in other organizations such as Arthur Andersen, Global Crossing and Tyco. 20 See http://www.worldbank.org/ifa/rosc_cgoverview.html.
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Given the importance of corporate governance to the development of the private sector, the World Bank, under the ROSC programs, has committed to carry out assessments of corporate governance in client economies. Officially, these assessments fall under the responsibility of the Asian Development Bank (ADB), as well as the OECD and, implicitly, the US-based credit-rating agency, Standard & Poor’s (S&P). The methodology used to assess a country’s corporate governance system began with the identification of a benchmark. Consequently, the OECD’s Principles of Corporate Governance was adopted. As the selected benchmark, “the OECD Principles represent the minimum standard that countries with different traditions could agree upon, without being unduly prescriptive”.21 The Principles are applicable to countries with civil or common law traditions, different levels of ownership concentration and various models of board representation. The assessment practices in a country measure the legal and regulatory framework, as well as the practices and compliance level of the listed organizations against the OECD’s Principles of Corporate Governance.22 The Financial Stability Forum has also adopted these principles as one of the twelve standards of the Core Standards for Sound Financial Systems. Accordingly, OECD principles form the basis of the corporate governance template developed by the World Bank and the IMF to conduct the corporate governance assessments under the ROSC and FSAP programs. The general framework of the Bank’s assessment of corporate governance practices in a given country follows these steps23: 1. Measuring the legal and regulatory frameworks (benchmarking the country’s corporate governance framework) as well as the practices and the compliance of listed organizations against the OECD Principles of Corporate Governance; 2. Assisting the country in developing and implementing a country action plan for improving institutional capacity in respect to the country’s corporate governance framework; and 3. Raising awareness of good corporate governance practices among the country’s public- and private-sector stakeholders. The assessment process began when the World Bank commissioned a local consultant to complete a “template” (questionnaire) designed to capture a country’s corporate governance legal and regulatory framework as well as information on its corporate governance practices.24 The Bank’s experts then visited a country to meet with government officials, market participants, investors, and credit issuers and draft an assessment report. The assessment was divided into four parts: (1) executive
21
World Bank, “An Assessment of Corporate Governance in the Slovak Republic,” World Bank, Washington DC, 2003. 22 OECD, OECD Principles of Corporate Governance, Paris, 1999. 23 http://www.worldbank.org/ifa/rosc_cgoverview.html. 24 http://www.worldbank.org/ifa/rosc_cgoverview.html.
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summary; (2) capital market overview and institutional framework; (3) principle by principle review, including policy recommendations; and (4) a summary of recommendations highlighting areas for legislative reform, institutional strengthening, and voluntary/private initiatives. The assessments attempt to decipher the actual practices of market participants and see how these differ from compliance with the legal and regulatory. They include a chapter on institutional strengthening, as well. Each OECD Corporate Governance Principle is evaluated according to quantitative and qualitative standards. It should be noted that the OECD Principles are non-binding. They provide a framework for dialog on country experience and identification of policy reform “without prejudice to the prerogative of each nation to find its own path to better corporate governance.” The Principles aim to develop a common framework under which good practices can develop, in consistency with national regulations and traditions.25 Moreover, compliance to these principles “will not eradicate criminal activity,” but such compliance would make these types of activities more difficult as rules and regulations are adopted in accordance with the Principles.26
Accounting and Auditing As part of the ROSC plan, the World Bank has also initiated a program to assist its member countries in implementing international accounting and auditing standards in order to strengthen the financial reporting regime.27 The objectives of this program are twofold: 1. Assess the comparability of national accounting and auditing standards with International Accounting Standards (IAS) and International Standards on Auditing (ISA),28 respectively and the degree to which corporate entities comply with established accounting and auditing standards in the country.29 Analysis of comparability of national accounting and auditing standards with international 25
See “OECD Principles of Corporate Governance,” OECD, Paris, 2004, pp. 4. It should be noted that the OECD went out of its way not only to invite the usual government officials, international policy makers, and international financial groups but also to consult trade unions and non-governmental organizations, in order to adequately represent the creation of the “holistic principles” governing corporate governance. 26 Ibid. 27 See http://www.worldbank.org/ifa/rosc_aa.html. 28 Within this document, IAS refers to all standards and related interpretations issued by the former International Accounting Standards Committee (IASC) and the International Financial Reporting Standards (IFRS) and related interpretations issued by IASC’s successor body, International Accounting Standards Board (IASB). The ISA is promulgated by the International Federation of Accountants (IFAC). 29 The World Bank, Overview of the ROSC Accounting and Auditing Program, Washington DC, 2004, pp. 2.
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standards determine the degree to which applicable accounting and auditing standards are complied, and assess strengths and weaknesses of the institutional framework in supporting high-quality financial reporting.30 2. Assist the country in developing and implementing a country action plan for improving institutional capacity with a view to strengthening the country’s corporate financial reporting regime.31 It should be noted that within this document, the term “accounting” refers both to accounting and financial reporting.32 Comparability of national and international standards (IAS and ISA) and compliance proceed as the ROSC Accounting and Auditing Module (hereafter AAM) review entails an evaluation exercise that (1) assesses the strengths and weaknesses of existing institutional frameworks that underpin financial accounting and auditing practices; (2) determines the comparability of national accounting and auditing standards with internationally recognized standards (IAS and ISA); and (3) examines the degree of compliance with national accounting and auditing standards and evaluates the effectiveness of enforcement mechanisms for ensuring compliance with existing national standards, rules, and regulations.33 With regard to the second objective for assisting the country in bolstering the corporate financial reporting regime, the AAM also identifies areas for improvement that help policymakers and other country stakeholders develop an action plan for enhancing accounting and auditing standards and practices in the country. It should be noted that the AAM examines financial reporting by public interest entities. Public interest entities are defined as entities that play a significant role in public life, because of their business, their size, their number of employees, or because their corporate status is such that they have a wide range of stakeholders. Examples of such entities might include credit institutions, insurance companies, investment organizations, pension organizations, and listed companies. The AAM does not address financial reporting by small- and medium-size entities. The AAM advocates for a strong participatory approach with the robust involvement of policymakers and other country stakeholders.34 The World Bank has developed a complementary diagnostic tool that captures a comprehensive review
30
See http://www.worldbank.org/ifa/rosc_aa.html. Ibid. 32 Overview of the ROSC Accounting and Auditing Program, 2004, pp. 2. 33 For detailed analysis of comparability of national and international standards and compliance see Overview of the ROSC Accounting and Auditing Program. 34 At the inception of an AAM review in a given country, the country authorities (policymakers) identify the country stakeholders who have an interest in accounting and auditing matters. These stakeholders may include representatives from the Ministry of Finance, securities market regulator, banking regulator, insurance companies and other non-banking financial institutions regulator, higher education institutions, professional accounting and auditing bodies, auditing firms, and institutional investors. These representatives are typically grouped in a National Steering Committee (NSC) established for the purpose of the AAM (The involvement of country stakeholders may be organized in different ways. For example, some countries may prefer to use an existing structure rather than establishing an NSC). Past experience has demonstrated that the chairmanship of 31
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of accounting and auditing standards and practices in a country.35 Once the participatory structure is in place, the diagnostic tool is used to conduct the assessment. The diagnostic tool is comprised of four parts: Part 1, Assessment of the accounting and auditing environment; data regarding the accounting and auditing environment is collected. This provides an overview of the institutional framework in the country. The input of relevant members of the National Steering Committee is instrumental for the identification of the strengths and weaknesses of the accounting and auditing environment. Part 2, Comparison of national accounting standards to International Accounting Standards and International Financial Reporting Standards (IAS/IFRS). Part 2 of the review uncover available information on the gaps existing between national accounting standards and IAS/IFRS. Those conducting Part 2 will interview national experts, such as individuals who work in organizations with jurisdiction for setting national accounting standards, in order to _____________________. Part 3, Assessment of actual accounting practices in which a sample of publicly available financial statements of public interest entities is reviewed. The review assesses the compliance of these entities with existing national accounting standards. Part 3 of the assessment requires the involvement of independent reviewers with appropriate technical knowledge. Part 4, National auditing standards and practices and their implementation are assessed. The ten largest auditing organizations in the country are asked to complete the questionnaire within this part. The input of relevant members of the National Steering Committee (which might include the securities market regulator, any statutory body responsible for regulating the auditing profession, and/or? academic researchers) is instrumental for the assessment of the robustness of national auditing standards and practices. Upon completion of the assessment, the AAM team36 conducts a due diligence37 review on the basis of the data collected by the World Bank staff, the consultant, and the NSC is critical for the success of the program. A government official of high rank, such as from the Ministry of Finance or the Ministry responsible for capital market development/supervision, typically chairs the NSC. Generally, the NSC provides inputs on key factors during the AAM process, including the strengths and weaknesses of the existing institutional framework that underpins accounting and auditing practices, the extent of compliance of national accounting and auditing standards in practice, and the effectiveness of enforcement mechanisms. The NSC also assists in identifying areas for improvements in the accounting and auditing standards and practices. The NSC acts as counterpart to the World Bank in the preparation of the AAM report and country action plan. The NSC acts as an intermediary with the Government in getting approval for publication of the final report. Finally, it oversees the implementation of the country action plan. 35 The diagnostic tool is available at http://www.worldbank.org/ifa/rosc_aa.html. 36 ROSC AAM team members are comprised of World Bank financial management specialists with specific country/regional expertise and other experienced Bank staff who have conducted ROSC AAM reviews in several countries. 37 That is “a reasonable investigation conducted by the parties involved in preparing a disclosure document to form a basis for believing that the statements contained therein are true and that no material facts are omitted.”
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the National Steering Committee. This exercise involves a detailed review of the findings from the diagnostic tools and from meetings with policymakers, the National Steering Committee and other country stakeholders. Finally, the AAM team prepares a report presenting the factual findings arising from the review and makes policy recommendations to help the country enhance its accounting and auditing standards and practices. The NSC reviews the draft report prepared by the AAM team.38 The final draft report is prepared taking into account comments received from the NSC and is then submitted to the country authorities for comments, approval, and permission to publish. Once the final report is completed, country stakeholders and World Bank staff co-develop a country action plan based on the findings. The country action plan is then implemented.39
Insolvency40 and Creditor Rights41 In the context of the joint World Bank (Bank) and International Monetary Fund (Fund) Initiative on Standards and Codes, insolvency and creditor rights (“ICR”) constitute one of the 11 areas for which assessments are to be undertaken.
38
The AAM team may also organize a workshop where various national stakeholders, including members of the National Steering Committee would discuss findings of the review and policy recommendations. 39 Development of a Country Action Plan – After approval of the final report by the country authorities, the National Steering Committee meets and prepares a country action plan. If requested by the country authorities, the World Bank would assist in developing the country action plan. The country action plan should address the most significant areas for improvement. With a focus on specific, realistic, and achievable objectives, the action plan derives success from country ownership. The NSC may oversee its implementation. 40 Insolvency is a financial condition experienced by a person or business entity when their assets no longer exceed their liabilities, commonly referred to as “balance-sheet” insolvency, or when the person or entity can no longer meet its debt obligations when they come due, commonly referred to as “cash-flow” insolvency. 41 The importance of creditor rights stems from the intrinsic inability of lending institutions to establish with certainty the quality of borrowers’ assets in the future. Less predictable future quality of assets necessitates more intensive screening and monitoring of borrowers and increases the likelihood of default, inflating the costs associated with screening, monitoring, and repossession. Thus a less-risky macroeconomic environment is likely to contribute significantly to development of deeper financial markets. In this respect, lending institutions are more willing to extend credit to borrowers when they have appropriate mechanisms to enforce the repayment of loans (see Aghion, Philippe, and Patrick Bolton, 1992, “An Incomplete Contracts Approach to Corporate Bankruptcy,” Review of Economic Studies, Vol. 59, pp. 473–94; or Townsend, Robert M., 1979, “Optimal Contracts and Competitive Markets with Costly State Verification,” Journal of Economic Theory, Vol. 21, pp. 265–9). Appropriate regulation and institutional arrangements can also facilitate monitoring of the quality of borrower’s assets by lending institutions. Since the relationship between the borrower and the lending institution is typically a complex dynamic one, lending institutions need to be able to establish the current value of borrower’s assets, ability of borrowers to repay and viability of borrower’s projects at a given point in time. This information helps the lending institutions
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Work towards defining principles and guidelines for sound ICR systems has been undertaken by the Bank and the United Nations Commission on International Trade Law (UNCITRAL). The World Bank’s Principles and Guidelines for Effective Insolvency and Creditor Rights Systems (“Principles”) cover a range of commercial laws relating to ICR, including institutional and regulatory aspects of ICR legal regimes, and set out fundamental principles intended to have a flexible application in diverse country systems.42 The UNCITRAL’s Legislative Guide on Insolvency Law (“Legislative Guide”) focuses more detail on the key elements of an effective insolvency law and presents a detailed series of Legislative Recommendations (“Recommendations”) that provide specific guidance on the content of an insolvency law, with an extensive discussion of various options and approaches.43
Appendix B Operationalization of Constructs Used in the Case Study The data used in the case study analysis come from a variety of secondary sources. Data for the dependent variable was inferred from the eStandardsForum qualitative assessment of standard adoption. The other independent variables have been drawn from ROSC reports, World Bank publications and statistics, and other sources, such as eStandardsForum, West and Graham (2004), and Kaufmann et al. (2008).
make a decision regarding provision of extra financing that would enable a country, a firm or an individual to overcome temporary difficulties versus insisting on immediate repayment of all obligations due to poor prospects of improvement in the future. Finally, efficient exchange of information can reduce the costs of initial screening of borrowers. This can be achieved, for example, with the help of independent credit agencies collecting information on credit history or worthiness of a borrower. The role of information in credit market development was first emphasized by Jaffe and Russell (Jaffe, Dwight M., and Thomas Russell, 1976, “Imperfect Information, Uncertainty and Credit Rationing,” Quarterly Journal of Economics, Vol. 90, pp. 651–66) and Stiglitz and Weiss (Stiglitz, Joseph, and Andrew Weiss, 1981, “Credit Rationing in Market with Imperfect Information,” American Economic Review, Vol. 71, pp. 393–410). 42 The recently revised text of the Principles is available at http://www.worldbank.org/gild. 43 The text of the Legislative Guide is available at: http://www.uncitral.org/uncitral/en/uncitral_ texts/insolvency/2004Guide.html.
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Construct definition
Information transfer effectiveness
This construct attempts Standard’s to assess the level adoption of adoption or non-adoption of a standard’s core principles against which the country is assessed in the ROSC report (Larsen 1982; Sundararajan et al. 2001)
The index measures the progress made by each country in adopting a specific standard’s principles, several years after ROSC assessment
The adaptation of the standard being transferred refers to differences introduced between the original practice and template and the replica (Szulanski and Jensen 2004) Good-quality content with well-defined data gathering methods, clear findings and recommendations for action (Florio and DeMartini 1993)
Standard’s adaptation
Dummy variable whose value is 1 when the country has adopted the standard and 0 when the standard has been implemented “as-is” with no changes
Standard/ eStandardsROSC Forum ROSC report
Descriptive/ templates Descriptive/ results Action
Standard instrument to assess the type of information used by the source (templates, compliance findings, policy actions) in the ROSC report – scored as a dummy variable (e.g. “1” if standardized templates were used for data gathering, and 0 otherwise)
Standard/ ROSC ROSC report
Client’s lack of transparency refers to a client’s unwillingness to publish the results of ROSC assessments or any private or selfassessments of a country’s compliance with a standard
Lack of transparency
Measured by the ratio of the number of a standard’s principles for which the available public sources do not directly address that country’s compliance with each principle, to the total number of principles
Standard/ eStandardsROSC Forum and World Bank/IMF publications
Adaptation
Information type quality
Lack of transparency
Measures
Measures definition
Unit of analysis
Construct
Source
Standard/ eStandardsROSC Forum
Rate of implementation (ij44) = (FI + PI45)/ (total number of principles – II46)
(continued)
44
where i = country, j = specific standard. A standard’s principles fully implemented (FI) and partially implemented (PI). 46 A standard’s principles for which there is insufficient information. 45
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Appendix
Construct
Construct definition
Measures
Measures definition
Linguistic distance
Linguistic distance refers to the degree of non-overlap between linguistic resources of English and the language of the client/receiver (West and Graham 2004)
Linguistic distance
Relationship strength
The strength of the relationship between the sender and the recipient is defined by frequent interaction (frequency) and intimacy (closeness) between the between sender and recipient. (Hansen 1999; Szulanski 1996)
Relationship strength
The linguistic distance index for a language is calculated by its measure of distance from English by counting the number of branches on the language tree used to connect it to English (for example, Mandarin = 6, Spanish = 3, Swedish = 2 and German = 1) Length, in years, of the relationship between the sender and the receiver (Uchida et al. 2006)
Absorptive capacity
Absorptive capacity Government is defined as the ability effectiveness for a recipient to absorb and utilize external information (Adler 1965; Cohen and Levinthal 1990) Regulatory quality index
Incentives
The adoption of international financial standards depends on the incentives structure for the countries to adopt and implement them (Schneider 2002)
Unit of analysis
Source
Country
West and Graham (2004)
Country
World Bank publications
Quality of the Country government systems and its qualified staff personnel needed to effectively manage its resources and implement sound policies. (−2.5, 2.5) Ability of the government to formulate and implement sound policies and regulations that permit and promote private sector development. (−2.5, 2.5)
Kaufmann et al. (2008)
Absorptive Average of regulatory capacity index quality and Government effectiveness indexes WTO For participation in Country membership standard-setting bodies, Participation 1 means that the in standardrecipient was a member setting bodies of the bodies that defined the specific standard assessed by the ROSC project Recipients’ membership in international groupings was assessed by a proxy variable, namely the membership of the country in the WTO
WTO and standardsetting agencies
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Index
A Absorptive capacity, 3, 141, 159, 160, 162, 163, 165, 180, 196 Access to knowledge, 126 Access to learning opportunities, 128 Accountability, 40–42, 44, 46, 49, 71, 72, 98, 100–102, 114–116, 125, 135, 156, 164 Accounting practices, 37, 192 Accounting procedures, 3, 157, 180 Accounting standards, 4, 45, 79, 113, 115, 116, 135, 158, 184, 190, 192 Ahistorical process, 17
B Bretton Woods Institutions, 16 Bureaucratic structures, 128
C Cognitive costs, 145, 146 Collaborative learning, 128 Collective action, 117, 118, 156 Communication theory, 114, 157 Communities of practice, 146 Corporate accounting, 37 Corporate governance, 3, 115, 124, 155, 157, 161, 180, 183–190 Cross-border transactions, 16, 21
D Decision-making process, 13, 17, 20, 50, 83, 118, 128, 129 Deregulation, 16, 23, 35, 36, 50, 54, 109 Derivative instruments, 22, 55
Derivative markets, 23 Derivative securities, 23 Dynamic capabilities, 138
E Economic convergence, 17 Economic integration, 1, 122, 123, 172 Economic interdependence, 1, 16, 18, 21, 69, 72, 76, 81, 94, 95, 123, 160 Epistemic community(ies), 2, 3, 5, 65, 82, 111, 123–150, 155–160, 162, 163, 166, 167, 169, 170, 173–176, 180 Exercise of power, 17, 35, 45–66, 173 Explicit knowledge, 112, 140 External knowledge, 141, 144, 145, 159, 169
F Financial accounting standards, 4, 116, 135 Financial crisis(es), 14, 23, 32, 34, 38, 40, 41, 43, 47, 51, 53, 56, 57, 61, 64, 68, 88, 100, 111, 130, 151–153, 174, 176, 188 Financial deregulation, 36, 54 Financial innovation(s), 22, 24 Financial Institutions, 2, 13, 16, 18–68, 102, 105, 106, 152, 153, 155, 172, 173 Financial regulations, 5, 108, 128, 152, 179, 184 Financial reporting, 4, 113, 190, 192 Financial Sector, 1, 33–35, 38, 48–52, 62, 64, 70, 153–155, 160, 166 Financial System, 21, 23, 25, 38, 41, 47, 48, 52–54, 56, 57, 62, 64, 87, 113, 151, 153, 154, 160, 162, 184, 189 Formal knowledge, 142–147, 158, 159
219
220 Formal learning, 128 Functional convergence, 147, 148, 150
G Global capital flows, 18 Global economic system (GES), 1, 16, 18, 19, 22, 27, 28, 32, 33, 52, 54, 55, 62, 79, 81, 84–88, 91, 174, 176, 179 Global economy, 17, 19, 62, 84–87, 91, 94, 98, 99, 101, 127, 148, 149, 151, 153, 179 Global finance, 33, 52, 147 Global financial market, 2, 34, 151 Global financial system, 38, 54, 56, 62, 64, 113, 151, 153, 160 Global governance, 2–5, 7–96, 100, 102, 107, 108, 111, 115, 117, 122–124, 131, 134, 137, 138, 147, 150, 152, 155–158, 164, 166, 169, 170, 172, 175 Globalism, 5, 7–18, 75, 77 Globalization, 1, 4, 7–96, 102, 108, 125, 135, 147, 149, 151, 160, 167, 178–180 Global knowledge, 131 Global market(s), 4, 12, 18, 21, 25, 33, 34, 71, 81, 97, 111, 125, 128, 151, 156, 160, 165, 180 Global marketplace, 18, 21 Global neighborhood, 68–74 Global norms, 2, 136, 144 Global norms and rules, 5, 101, 103, 109, 112–114, 117, 119, 121, 122 Global production, 5, 18, 33, 81–96 Global rules, 2, 3, 5, 97–122, 135, 147, 160, 162, 167, 180 Global standards, 2, 85, 142–147, 178 Global standards and rules, 2, 145 Good governance, 5, 97–122, 179 Governance Institutions, 3, 97–122, 164, 169 Governance structures, 82, 135, 149 Governance system, 17, 72, 108, 152, 157, 158, 169, 189 Government regulation, 136, 149
I Imagined community, 8 Incentive costs, 145 Information asymmetry, 21, 129, 187 Information transfer, 141, 145, 146, 167, 169, 195 Information transmission, 157 Innovation networks, 132, 144 Institutional arrangements, 68, 69, 101, 123, 133, 138, 146, 156, 193
Index Institutional capability, 167 Institutional capacity, 80, 99, 109, 112, 128, 130, 156, 160, 164, 166, 189, 191 Institutional conformity, 176, 178, 179 Institutional environment, 2, 3, 5, 98, 103–108, 114, 144–146, 160, 162, 174–176, 178 Institutional forms, 73, 148 Institutional framework, 5, 125, 126, 156, 160, 164, 190–192 Institutional infrastructure, 18 Institutional isomorphism, 107, 108, 176, 178 Institutionalization, 1, 39, 68, 106, 142 Institutional learning, 3, 5, 123–150, 156, 157, 160, 167, 180 Institutional quality, 148 Institutional reform, 128 Institutional setting, 13, 18, 79, 86, 116, 123, 137, 146, 147, 157, 161 Institutional structure, 156, 166 Institutions, 2, 9, 97–123, 152, 172 Intellectual assets, 136 Intellectual capital, 136, 137 Interactive learning, 142, 144, 146 Interest groups, 64, 128, 133, 158, 175, 182 International bodies, 158 International capital, 16, 152 International community, 74, 122, 154, 156 International cooperation, 2, 26, 118, 152, 155, 179 International exchange, 157 International Financial Architecture, 2, 73, 102, 151–170, 188 International Financial Institutions, 2, 152, 153 International financial markets, 152 International financial standards, 108–122, 183 International Financial Standards and Regulations, 108–122 International financial system, 151, 153, 154 International Institutions, 2, 74, 79, 98, 111, 119, 152, 153, 167, 170, 181 Internationalization, 1, 4, 67, 81, 90, 92, 95, 123–130, 135, 173 Internationalization of production, 4, 67, 81, 92, 173 International Monetary Fund, 2, 16, 33, 63, 65, 99, 151, 154, 155, 193 International norms, 80, 109, 112, 121, 154, 179 International organization(s), 1–4, 16, 17, 31, 34, 52, 70, 76, 77, 94, 95, 99–101, 109, 111, 113, 115, 117–120, 122, 124, 127, 129–131, 134, 137, 147, 149, 150, 155–157, 160, 163, 166, 167, 169, 172, 174, 180
Index International policy(ies), 25, 146, 151, 156 International standards, 3, 4, 108, 143, 147, 148, 153–158, 160–163, 165–167, 169, 174, 175, 178–181, 184, 190, 191
K Knowledge acquisition, 140 Knowledge arbitrage, 139 Knowledge assets, 132, 139 Knowledge-based economy, 137 Knowledge clusters, 132, 144 Knowledge coevolution, 139 Knowledge communities, 2, 3, 5, 123–150, 155–163, 167, 169, 170, 175, 180 Knowledge coopetition, 139 Knowledge cospecialization, 139 Knowledge creation, 128, 138, 143, 146, 156 Knowledge distribution, 124 Knowledge economy, 85, 86, 137, 138 Knowledge exchange, 146 Knowledge management, 45, 83, 112, 126–128, 131, 136, 137, 141, 142, 174 Knowledge networks, 124, 125 Knowledge production, 132, 134, 144 Knowledge receiver, 141, 145, 157–162, 165, 166, 169 Knowledge sender, 146, 157–160, 165, 166, 168, 169 Knowledge serendipity, 139, 142, 146 Knowledge sharing, 144 Knowledge society, 82–84, 126, 128, 136, 166, 178 Knowledge stock(s), 132, 146 Knowledge system(s), 144 Knowledge transfer, 3, 5, 114, 122–150, 155–165, 167–169, 180 Knowledge use, 132, 141, 168 Knowledge workers, 137
L Local epistemic communities, 3, 123, 142, 145, 147, 156, 160, 170, 180 Local Institutions, 169
M Managerial technocrats, 174 Mode of global production, 85 Multilateral agencies, 134 Multilateral organizations, 134
221 Multilateral system, 17 Multinational corporations, 124, 131, 134, 135, 186
N National economies, 18, 30, 31, 66, 76, 87, 94, 95, 97, 131, 134, 148, 154, 160, 164, 167, 172 National governments, 30, 65, 76, 93, 114, 125, 127, 135, 137, 152, 161, 164, 172 National institutional frameworks, 126, 160 National interests, 4, 67, 73–75, 79, 125, 130, 135, 173 Nationalism, 7–11, 75, 81, 94, 96 National policies, 2, 28, 92, 126, 130, 147, 152, 155 Nation-states, 2–5, 7–96, 100, 102, 124, 125, 129, 171–173, 177, 179, 180 Networks, 5, 11, 101, 124, 152, 172 New International Financial Architecture, 151–155
O Organizational cognition, 140 Organizational knowledge, 137, 140 Organizational learning, 140
P Policy making, 3, 5, 53, 65, 79, 109, 112, 113, 121, 123–135, 141, 146–152, 172 Policy networks, 124, 131–134 Post-industrial society, 81–84 Power, 2, 13, 97, 127, 161, 171 Procedural knowledge, 2, 3, 124, 130, 157–159, 162, 180 Public accountability, 41, 71, 72 Public goods, 49, 99, 117, 118, 148
R Regional clusters, 144 Regulation(s), 2, 13, 100, 124, 152, 177 Regulatory mechanisms, 2, 109, 111, 115, 152 Regulatory policies, 54 Regulatory standards, 5, 161, 162, 167 Reports for Observance of Standards and Codes (ROSC), 5, 154–167, 169, 170, 183, 184, 189–192, 194–196 initiative, 155 modules, 184 program, 154, 162, 164, 183
222 ROSC.See Reports for Observance of Standards and Codes (ROSC) Rule of law, 40, 42–44, 69, 81, 86, 148, 153 Rules of the game, 13, 99, 103–108, 133
S Scientific knowledge, 19, 136, 143, 175 Scientific management, 126, 127 Specialized knowledge, 3, 4, 128, 129, 143, 144, 147, 156, 162, 163, 167 Standards adoption, 155–167 Standard setting, 108, 110, 116, 153, 154, 165, 174, 196 Structure of global production, 5, 18, 81–96
T Tacit knowledge, 139, 140, 169 Technical assistance, 3 Technical expertise, 81, 128, 129, 134 Technical experts, 3, 83 Technical knowledge, 129, 134, 143, 160, 192
Index Technocracy, 4, 126–128, 134 Technocrat(s), 3, 123–130, 135, 146, 174 Technocratization, 123–130, 135, 146 Techno-determinism, 19 Technological change(s), 19, 20, 23 Technological innovation(s), 20, 21, 24, 47 Transaction costs, 21, 144, 146, 186 Transparency, 40–42, 44, 46, 98, 99, 102, 111, 113–115, 118, 119, 122, 123, 127, 135, 148, 152–155, 164, 166, 169, 175, 183, 184, 195
U United Nations, 69, 124, 194 Universality, 11, 12
W World Bank, 1, 16–18, 25, 54, 62, 64, 79, 81, 82, 84–86, 97–100, 102, 111, 115, 120, 121, 134, 135, 138, 153–156, 162–164, 169, 170, 183–185, 188–196
