Constructivism and the politics of international money and finance

Constructivists have also turned their attention to the politics of international money and finance — and, as was the case for international trade, their work has contributed to knowledge by identifying and explaining empirical puzzles that were difficult to understand through the material- rationalist lens (or were altogether oft the material—rationalist radar).

One of the central themes in the IRE of money is the rise of a massive and highly mobile global pool of capital. The international market for capital and financial assets began to dramatically swell in the early 1960s, starting with the development of a large “offshore” pool of money lying beyond the reach of any country’s regulatory authorities (the so-called Eurodollar market, housed in the financial hub of London but largely unregulated by the British (or any other) government) (Helleiner 1995). International economist Robert Mundell soon noted that in a world of global capital mobility governments had to navigate a new kind of macroeconomic policy tradeoff. If they hewed to fixed exchange rates and relinquished tight exchange controls sealing off their national financial system from the emerging global market, they had to ensure that their national interest rates did not deviate too far from the rates set by central banks in the financial centers in the international economy (namely, the U.S., UK, and Japan). If they did, the currency traders and international investors operating out of the Eurodollar market would move against them, putting either upward or downward pressure on the exchange rate. Faced with this tradeoff — currency stability at the cost of monetary policy independence — many states simply decided it was better to give up fixed exchange rates and to let the value of their currencies be set by market forces.

Scholars operating in the OEP/HIM mode invoked domestic interests to explain the politics of the tradeoff generated by large and unrestrained global capital flows. In Frieden’s (1991) seminal contribution, domestic groups van,' in their exposure to international market forces and in the degree to which the assets they hold are specific to their current uses — and it is these features that predict groups’ preferences over the tradeoff in a world of unrestricted capital mobility. Others, like Verdier (1999), focus attention on different distributional fault lines in countries grappling with the consequences of international capital flows. One recent contribution, using survey experiments with a sample of ordinary Americans, suggests that self- interested preferences over the exchange rate stability versus monetary policy autonomy tradeoff can be induced by giving people relatively small amounts of contextual information, which helps average people connect the policy choice to their own personal financial circumstances (Bearce and Tuxhorn 2017). Regardless of how groups’ and individuals’ interests are characterized, all of this work depicts a structural feature of actors’ material environments (the degree of capital mobility) as the determining factor in the construction of their policy preferences.

Kathleen McNamara (1998) directly targeted that assumption in her path-breaking constructivist work on the politics of European monetary cooperation in a post-global capital mobility world. Her case studies of episodes of policy coordination showed that fluctuations in European countries’ positions on the tradeoff generated by capital mobility were not products of interest group politics. The world of capital mobility was not, contra the OEP view, one in which cleaner price signals and more intense competitive pressures clarified groups’ self-interests; rather, firms and other organized groups were grappling with pervasive uncertainty, and “uncertainty creates highly fluid conceptions of interest” (McNamara 1998: 7).4 Policymakers’ shared beliefs, not societal groups’ material interests, underpinned European governments’ willingness to forego monetary policy autonomy in exchange for currency stability: the rise of the “neoliberal policy consensus that elevated the pursuit ot low inflation over growth or employment,” in McNamara’s argument, turned high-level policymakers’ preferences strongly toward a common European exchange rate system and, eventually, toward monetary unification on the continent (McNamara 1998: 3).

Other work in the constructivist mold questions the assumption that global capital mobility imposes, in law-like fashion, the strict policy choices identified by Mundell in the first place. Where OEP and other perspectives that take the tradeoff as a brute material fact of life in a world ot capital mobility go wrong, some constructivists hold, is by assuming that capital mobility

is a non-social machine that creates invariant and irresistible pressures for liberalization____

In this [constructivist] view, the effect of rising ICM [international capital mobility] may be mediated by intersubjective beliefs about ‘appropriate policy’; that is, its impact on actor preferences for greater openness (or closure) may be conditional on variation in social facts.

(Chwieroth and Sinclair 2013: 472)

Shared beliefs about what constitutes appropriate or acceptable deviations from disciplined (which is to say, austere) monetary and fiscal policy agendas provide the interpretive frames through which market players and policymakers understand the choices they face (Kirshner 2003: 14-15; Widmaier 2010).

Along these same lines, constructivists have provided rich empirical studies of the involvement ot lOs in the production and dissemination ot the “stigma” targeting capital controls (regulatory policies that restrict cross-border flows of money and financial assets) — a policy stigma that emerged and hardened in the 1980s and 1990s and has only eased in the wake ot the 2008 financial crisis. Abdelal and Meunier (2010), for example, trace elite French policymakers’ central roles in promoting regional and global rules that prohibited the use of capital controls. Chwieroth (2010) focuses on how a cohort of economic officials hewing to “neoliberal” economic beliefs promoted the norm ot capital openness within the IMF.

One of the consequences ot the drive toward capital decontrol and the unshackling of capital from within national borders is an increase in the proportion of countries experiencing serious financial crises (Reinhart and Rogoft 2009). In the OEP/HIM tradition financial crises have typically been treated as exogenous shocks that yield distributional effects or, in a move that partially endogenizes the conditions that give birth to financial market crises, as the suboptimal outcome of rational but myopic market players and market-captured regulators responding to incentives and seeking to maximize their short-term returns, with collectively disastrous results. Even before the 2008 eruption of the largest financial crisis in 70 years constructivists in IPE added a distinctive perspective on the nature of crises. Rather than assuming that crises bring with them self-evident features that do not require any kind ot mediating interpretive framework, understanding how a particular crisis comes to be understood as type “X” rather than types “Y” or “Z” require understanding, first, that because crises are moments ot radical uncertainty distributional consequences are unlikely to be clear and knowable, and, second, that vying epistemic communities composed of policy advocates are always involved in struggles over how to define and respond to a crisis (Farrell and Quiggin 2017; Widmaier, Blyth, and Seabrooke 2007).

Given that constructivists already had a keen interest in crisis episodes it is not surprising that the 2008 Global Financial Crisis (GFC) touched oft a flurry' of constructivist-influenced work in IPE. One theme loomed large in many of the discussions ot the meaning and lessons of the 2008 crisis for the field of IPE: the failure of economists to recognize a looming crisis on the horizon and, once it had arrived, to say much of anything useful about it reflected the jettisoning of Knightian uncertainty from the analysis in favor of the assumption of a risk-only' world, and IPE scholarship would do well not to make the same mistake as macroeconomists (Nelson and Katzenstein 2014). Some of the most prominent features ot the 2008 GFC were difficult to understand without bringing in a role for radical uncertainty (see Box 12.1) and the social conventions that people rely upon to stabilize their expectations in the face of uncertainty. Why, for example, did well-informed market players with large stakes have such confidence in securitized assets that, in retrospect, were flimsily' constructed? And why did confidence in the valuations of those assets erode so quickly'?

The constructivist lens brought uncertainty into the center of the analysis of the run-up to the financial crisis of 2008 and its aftermath.5 In this view, important decisions in and around financial markets are undertaken without precise knowledge about the probabilities of payoffs and the size of those pay'offs. We simply don’t know enough about the underlying process to reliably forecast future returns from past events.6 Nonetheless, financial market actors still have to make choices — and they need to be confident that their decisions are the right ones; otherwise, they would be paralyzed by indecision. If financial markets resembled actuarial models of life and property' insurance (where, thanks to good information and relatively stable parameters, risks can be reliably' quantified), confidence would simply mirror past and current objective economic conditions (Skidelsky 2009: 41). The economic landscape, however, is more treacherous for investors in asset markets than insurance companies: financial market actors can win or lose big as massive, unpredicted swings in market sentiment render prior probability' distributions poor guides to decision. Traders can sample the past to predict returns with some accuracy for some time, until catastrophic events that lurk in the far tails ot the distribution “radically alter the distribution in ways that agents cannot calculate before the fact, irrespective ot how much information they have” (Bly'th 2006: 496). Crises occur with alarming frequency, and their causes are very difficult to diagnose, even years after they have passed.

Constructivist approaches informed by economic sociology' recognize that financial markets are complex, deeply' interdependent patterns of economic and social activity. Market actors, and the policymakers that observe and regulate financial markets, adopt social conventions to impose a sense of order and stability' in their worlds, thereby' allowing “exchange to take place according to expectations which define efficiency” (Storper and Salais 1997: 16). Conventions are not explicit agreements or formal institutions; rather, they are templates for understanding how to operate in contexts that are experienced as shared and common (Wagner 1994: 174). Conventions vary' in their degree of materiality. They' can take the form ot public discourses and mental models, such as the “new era stories” that encouraged people to treat homes as assets that could not lose value, which anchored agents’ expectations in uncertain environments (Akerlof and Shiller 2009). Conventions in financial markets also take material forms, such as risk management technologies (Biggart and Beamish 2003: 452—3). Social conventions can stabilize actors’ expectations, but not permanently; Keynes, after all, argued that conventional expectations resting on a “flimsy foundation” are inherently unstable (Skidelsky 2009: 93). The conventions that inform market expectations do not mirror underlying economic fundamentals; rather, the partial and distorted views that market participants impose on the world shape the markets. And these views often evolve in a social environment in which “rumors, norms, and other features of social life are part of their understanding of finance” (Sinclair 2009: 451). In “reflexive feedback loops” these conventional views drive markets, which then subsequently shape beliefs and thus can generate far-from-equilibrium situations.

A distinctive contribution of constructivists studying the politics of finance has been to identify and investigate the purveyors of market-stabilizing conventions. By acknowledging the crucial role of uncertainty in finance and by looking tor the conventions that become part of the deep structure of financial markets, constructivists were well placed to answer two fundamentally political questions: who governs, and how do they govern? An important governor in the realm of global finance has been the credit rating agencies (CRAs). The credit rating industry

— with Moody’s, S&P, and Fitch as the three largest firms — is indispensable for contemporary finance (Sinclair 2005). The CRAs’ main purpose is to (illusorily) transform uncertainty into quantifiable risk (Abdelal and Blyth 2015; Carruthers 2013). The CRAs do this work by producing conventional judgments about borrowers’ creditworthiness — judgments that are legible to participants in the markets. As Abdelal and Blyth observe, “contrary to what one would expect, rather than revealing new information, CRAs oftentimes codify what the market already knows: they become a part of the governance of markets by establishing ‘the conventional judgment’ regarding a borrower’s creditworthiness” (2015: 40). Because they help establish market conventions (by codifying and signifying market sentiments ratings help drive upswings and downswings in asset prices), the CRAs’ model-based judgments powerfully discipline many of their subjects; when they downgrade a sovereign state, tor example, the CRAs reinforce what the market players already suspect (that the state is a high credit risk), and when the markets react accordingly, the subject of the rating starts to look more like it is indeed not creditworthy (Abdelal and Blyth 2015). And by describing “reality” through the use of ratings, the agencies’ rating “makes that reality correspond more closely to the description” (Rona-Tas and Hiss 2010: 141).

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