The activities of financial asset-holders as a structural constraint on national macroeconomic policy-making.

Abstract

This study examines the causes and political consequences of financial liberalization in the advanced industrial states. Tracing the interaction between domestic political choices and the structure of the international financial regime, the argument is that the ability of financial asset-holders to hedge political risk through portfolio diversification systematically constrains state behavior by rewarding some actions and punishing others. Therefore, what is commonly referred to as structural phenomena are the activities of non-state actors who operate transnationally. In addressing the political capability and influence of financial asset-holders, this study challenges traditional state-centric explanations for policy choice. States have contradictory preferences, desiring to control financial flows while at the same time desiring to attract finance for policy purposes. According to the hegemonic stability theory, a dominant state is needed to create and maintain an international regime to solve the collective action problem. However, the collective action problem for international finance is different from that of international trade. A free trade regime is an outcome that states must collaborate on in order to achieve. International capital mobility, by contrast, has been an outcome that states needed to coordinate their policies on in order to avoid. Following the Second World War, industrialized states were united in their desire to stabilize financial markets. Internally, all states adopted variants of the Keynesian interventionist model, with finance under strict supervision. The collective action problem in international finance is one of how to facilitate coordination, in which some states win more than others, in order to control finance. This problem of coordination existed as financial asset-holders shifted from habitual to adaptive behavior. As real rates of return on assets shrank with higher inflation in the 1960s, financial asset-holders innovated through the use of new financial instruments. The rise of the Eurocurrency markets arose as the contradictory preferences of states met with the desire of financial asset-holders for greater freedom. Eventually, states dismantled the capital control regime of Bretton Woods in an effort to maintain the state policymaking autonomy that the controls were originally put in place to protect. While states gained the ability to procrastinate on making needed economic adjustments, they could not permanently postpone adjustments. Financial asset-holders have emerged as the new disciplinarians of state policymaking. Transnational financial flows and interest rate fluctuations, far from representing destabilizing speculation, have become indicators of the soundness of state policymaking.