The Theory of Hegemonic Stability
According to 'the theory of hegemonic stability', as I am using it in this article, the creation and maintenance of an open and liberal world economy such as the one that has characterised most of the world economy since the end of World War II requires a powerful leader. This leader uses its power and influence to promote trade liberalisation and a stable international monetary system primarily in order to advance its own political and economic interests. The leader, however, can seldom coerce reluctant states to obey the rules of a liberal international economic order and must seek their co-operation. These other states co-operate with the hegemon because it is in their own economic and security interests to do so. For example, although the American hegemon played a crucial role in establishing and managing the world economy following World War H, it did so with the strong co-operation of its Cold War allies.
The original idea that a liberal international economy requires strong political leadership by the dominant economic power was initially set forth by Charles Kindleberger in his book The World in Depression, 1929-1939 (1973). 1 The existence of a liberal international economy, Kindleberger argued, required a political leader that could and would use its influence to create the international economic system and subsequently to perform a number of necessary economic functions to keep the system working efficiently. In The World in Depression and other writings, Kindleberger identified and discussed at length the tasks that the leader of the world economy must carry out. These tasks of the hegemon that include the creation and maintenance of a liberal trade regime, the establishment of the international monetary system, and playing the role of 'lender of last resort' to prevent financial crises.
A corollary of Kindleberger's hypothesis is that the relative economic decline of the leader leads to a weakening of the regimes governing a liberal world economy. The declining ability and willingness of the leader to enforce the rules of a liberal world economy results in increasing trade protectionism and violations of the regimes governing trade, monetary, and other forms of international commerce In the 1990s, an extremely important manifestation of the relative economic decline of American economic power has been the growing tendency for the world economy to fragment into regional blocs centred on the major economic powers. The dynamics of the rise and then of the steady erosion of a liberal world economy can be demonstrated by an examination of the British and American eras of international leadership.
Kindleberger's basic ideas on the importance of a political leader for international economic affairs were appropriated (with proper acknowledgments) by American political scientists including me. However, we made several modifications that placed his basic insight in a realist or state-centric intellectual framework of political analysis and thereby fashioned a realist version of the theory of hegemonic stability. In the first place, we substituted the Greek word 'hegemon' for 'leader' to reflect the fact that the leader had to exercise power to achieve its objective; more specifically, a hegemon is the leader of an alliance such as the one organised by Sparta to defeat the Persians in the fifth century B.C. In addition, whereas Kindleberger argued that the leader created a liberal international economy for cosmopolitan economic reasons, political scientists argued that the hegemon created a liberal international economy to promote its own interests. Finally, in contrast to Kindleberger's assumption that the interests of the leader were primarily economic, political scientists argued that these interests were not only economic but also political. Despite these differences between Kindleberger's liberal version of the theory and the political scientist version, both versions state that the provision of international collective (public) goods such as free trade and monetary stability requires a dominant power with an interest in a liberal world economy and a willingness to expend economic and political resources to achieve and maintain this goal.
The world has known only two eras of economic liberalism based on a hegemonic power. From the late nineteenth century to the outbreak of World War I, Great Britain led the efforts for trade liberalisation and monetary stability. Similarly, the United States led the world economy following World War II. However, it should be noted that there were several fundamental differences between the two periods. In the first place, the liberal world economy in the late nineteenth century was truly global and was characterised by non-discrimination in trade, unrestrained capital movements, and a stable monetary system based on the gold standard; the American system comprised only the 'Free World' and has been characterised by trade discrimination, capital controls until the mid-l970s, and monetary instability after 1971. Whereas the British promoted and inspired free trade through a series of bilateral agreements, the United States championed trade liberalisation through multilateral negotiations in the GATT. International security considerations, that is, the forging of the Western alliance against the Soviet Union, played a crucial role in America's promotion of free trade. Although the Bank of England played a central role in the management of the gold standard, the nineteenth century monetary system was largely denationalised. The post World War II system was based on the dollar and was subject to American influence.
British economic decline began in the late nineteenth century as other countries, especially Germany and the United States, industrialised. Britain responded to new developments with a gradual retrenchment of its global position and initiation of numerous measures to strengthen its security. Although Great Britain modified a number of its economic policies, its huge dependence on trade forestalled a retreat into protectionism. British leadership in trade liberalisation slackened, and by the 1930s Britain bad retreated to a system of imperial preferences. As early as the mid-1970s, concerns over the relative decline of the American economy and the damaging effects of international competition on American industry were expressed by American political leaders, business interests, and scholars. These changes produced the New Protectionism; as formal tariffs were reduced through trade negotiations, the United States erected such non-tariff barriers as those embedded in the Multi-Fiber Agreement, in which many nations were assigned quotas, and imposed 'voluntary' export restraints on Japanese automobiles. In response to the ballooning American trade deficit intensifying fears of deindustrialisation, and rising protectionist pressures, the Reagan Administration in the mid-1980s significantly modified America's postwar commitment to multilateralism. The Administration began to pursue a multitrack trade policy that has not only de-emphasized multilateral negotiations, but also increased unilateralism and bilateralism (especially 'managed trade' with Japan) and economic regionalism as well (in the North American Free Trade Agreement with Canada and Mexico). My concern in this article, however, is the rise of American hegemony following World War II and its implications for the world economy.
The American System
The United States emerged from World War I with a clear vision of the new international order that it wished to create. The so-called Rooseveltian vision, named after President Franklin Delano Roosevelt, had several elements. The United Nations and particularly the Security Council (including the five permanent members) would be responsible for guaranteeing the peace. In addition, the Bretton Woods conference (1944) proposed that a constellation of novel economic institutions, which were to include the International Monetary Fund (IMF), the International Bank for Reconstruction and Development (World Bank), and the International Trade Organisation, should be responsible for promotion and administration of an open and multilateral world economy; with the eventual defeat of the International Trade Organisation by the United States Congress, the United States and its economic partners established the General Agreement on Tariff and Trade (GATT) as a negotiating forum although not as a full-fledged international organisation. The postwar international order was to be based on the Atlantic Charter and its Four Freedoms (today's 'human rights') in whose name the United States and its allies had fought the war. Within this structure, the victors would build the peaceful, prosperous, and humane world that had eluded mankind after World War I. As we know at the turn of the century, not all of these worthy objectives would be achieved.
Within a brief period, the Rooseveltian concept of 'one world' was shattered. The Soviet-American confrontation over the territorial settlement in Central and Eastern Europe destroyed the wartime spirit of Allied collaboration. The ideal of a reunited world economy collided with the realities of the economic devastation wrought by World War II and the ensuing Cold War; the world economy soon was ideologically driven into what Stalin called the two antagonistic 'systems' of capitalism and socialism. Responding to this situation, the United States and its allies assumed the task of fashioning economic, political, and security arrangements that would restore the shattered economies of Japan and Western Europe and provide for their common security. The American System emerged from this joint effort of the United States and its allies.
At the core of the American System, including its associated military alliances, was a shared perception of the overriding danger of the Soviet threat. In the interest of political unity, the United States and its allies tacitly agreed to subordinate their short-term economic and other differences to the long-term political priority of containing Soviet power. The Soviet danger provided the political glue that helped hold together the postwar international economy and facilitated compromise solutions to a number of serious economic problems throughout the postwar period. Although the economic and political structure created by the United States and its allies between 1946 and 1950 still stands, the tensions within the System have become increasingly pronounced with the end of the Soviet military threat.
The American System has included both the American relationship with Western
Europe and the American relationship with Japan. Although these two principal
components of the American system have certain common features, these relationships
are fundamentally different regarding a number of economic, political, and security
matters; these differences have become increasingly important in determining
the economic and political relations between the United States and its two major
allies. My principal concern here, however, is with the differences in the economic
relations between America and its principal allies.
The American-West European Component of the System
As relations with the Soviet Union deteriorated after 1945, the United States realised that there were urgent fundamental problems related to the security of Western Europe. The most pressing need was to assist in the revival of the West European economy while also finding a way to guarantee the military security of the West Europeans against the threat from the Soviet Union. To achieve an American commitment to the pursuit of these goals, the American people had to be linked psychologically to Western Europe. It was vital to prevent a retreat into isolationism like that which had followed World War I and contributed to the outbreak of World War II. With the strong cooperation of its Western European allies, the United States undertook several initiatives.
The first important initiative was the launching in 1947 of what became known as the Marshall Plan. The Marshall Plan transferred huge capital resources from the United States to Western Europe, while basing American financial assistance on the premise of intra-European cooperation. By one estimate, the cost of Marshall Plan to the United States was approximately $13 billion over four years or approximately about 1.5 per cent of the American Gross National Product. In 1994 dollars, this amount would be $100 billion. The United States was able to finance the system because, at the end of World War II, it was the world's major creditor. Like Great Britain in the late nineteenth century and like Japan in the late twentieth century, the United States used its accumulated wealth to help create a world that American leadership believed would serve both American economic and political interests.
Another major initiative strongly supported by the United States was the formation of what would become the European Common Market or European Economic Community (EEC). While the primary responsibility for this truly extraordinary initiative lay with the West Europeans themselves, the United States gave the project its complete backing. Although the political goal of reconciling France and Germany was the principal purpose of the EEC, its proponents believed that the creation of a huge market in Western Europe would give the West Europeans the economic strength to resist their domestic Communist Parties and the blandishments of the Soviet Union. In addition, the European Economic Community was conceived as a means to anchor West Germany firmly to the West despite the fact that historically the industrial Ruhr and other areas of West Germany had looked eastward for their export markets. These markets were now in Communist hands and alternative markets had to be found to decrease the feared West German temptation to strike an independent deal with the Soviets.
Although the Common Market represented a violation of the American ideal of a multilateral world and entailed European discrimination against American exports, American policymakers accepted these economic costs as necessary for security reasons. The United States could tolerate European protectionism because of its immense economic superiority over the Europeans and other countries. However, the United States assumed that the Common Market with its external tariff and protective Common Agricultural Policy would be a short-term expedient and that it would, over the longer term, become a stepping-stone to a multilateral system. American officials believed that, when Western Europe had regained its economic strength and self-confidence, the West Europeans would lower their external barriers and participate in the open world economy envisioned by the United States at Bretton Woods.
American officials, however, did demand an economic quid pro quo from the West Europeans that would become of considerable importance in defining the long-term economic relationship between the United States and Western Europe. As a precondition for supporting the movement toward European economic unification, the West Europeans agreed to treat American multinational corporations as if they were European corporations and to avoid discriminating against them in their policies. Or, in more technical language, the West Europeans extended the principle of 'national treatment' to American firms, While the United States did demand access to the Common Market for American corporations, it tolerated what it assumed would be the temporary discrimination against American agricultural and other exports in order to rebuild Western Europe and thwart Soviet expansionist designs.
The other important American initiative was the 1949 creation of the North Atlantic Treaty Organisation (NATO) to link the two sides of the Atlantic militarily. In effect, the United States brought Western Europe under the American nuclear umbrella through the strategy of extended deterrence and thereby communicated to the Soviet Union that an attack on Western Europe would be tantamount to an attack on the United States itself. The stationing of American troops on European soil became a visible sign of this commitment. The NATO Treaty identified and legitimated for Americans and West Europeans alike the linking of their security. In short, economic and security ties have been closely linked in defining the relationship of the United States and its West European allies since shortly after the end of World War II
The American-Japanese Component
In Asia the United States also found itself facing a serious political, economic, and strategic challenge. World War II and its aftermath had strengthened the position of the Soviet Union in East Asia, while China and North Korea had become communist countries and political allies of the Soviet Union. These important traditional Japanese markets were now in hostile hands. Similarly to West Germany, intense concern existed that the forces of economic gravity would pull Japan toward the Soviet Union and its Chinese ally. Moreover, the Japanese economy was a shambles; it had been much more devastated by the War than had initially been appreciated. Although in retrospect, it is difficult to understand, American officials truly despaired over the problem of ensuring Japanese economic survival.
In addition to guaranteeing Japanese security through the formation of the American-Japanese Mutual Security Treaty (MST), the United States wanted to integrate Japan into a larger framework of economic relationships and thereby remove the attractiveness of the communist-dominated Asian market. However, unlike West Germany, there were no large neighbouring non-communist economies to which the Japanese economy could be anchored. To overcome this problem of an isolated and vulnerable Japan, the United States took several initiatives. One was to expedite the decolonisation of southeast Asia (it should be remembered that one cause of the Pacific War was that European colonizers had largely closed these economies to Japanese exports). The United States also sponsored Japanese membership in the 'Western Club'. Despite strong West European resistance based on intense fear of Japanese economic competition, the United States eventually secured Japanese participation in the IMF, the World Bank, and other international organisations. In addition, the United States gave Japan relatively free access to the American market and to American technology. Furthermore, the United States used its vast financial resources to assist in the rebuilding of the Japanese economy, but it did not demand access to the Japanese economy for its multinational corporations. Instead, the quid pro quo for American economic concessions to Japan was Japanese permission to use their air and naval bases in order to deter the perceived threat of Chinese and Soviet expansion.
In order to guarantee Japanese security, the United States also spread its nuclear umbrella over Japan. The MST, however, differs fundamentally from the NATO alliance. Under the NATO treaty an external attack on any member obliges the other members to consider measures of mutual defense. In the MST, the United States agrees to defend Japan if Japan is attacked, but the Japanese are not obligated to defend the United States. Also, whereas the NATO agreement applies only to the territory of its members, the MST refers to the outbreak of hostilities in the entire Pacific region. Through this agreement the United States obtained the right to use air and naval bases in Japan to defend and secure its position in the Western Pacific. The Japanese were given access to the American market in exchange for the right to anchor on Japan the American strategic position in East Asia.
In these ways, the United States became the fulcrum of the American system; the American-West European and the American-Japanese components of the system had little to do with one another. Lines of cooperation, however, did and do run through Washington. Although Japan and Western Europe would become equal participants in the annual 'Western' summits, Japanese-West European diplomatic relations were primarily a function of their ties to the United States. In the economic arena, Japanese-West European commerce was and still is relatively minor compared to the commerce of each with the United States. With respect to security, no military connections exist between Western Europe and Japan. In economic, diplomatic, and security affairs, the American system has, for nearly half a century, tested squarely on American leadership.
The American system of alliances across the Atlantic and the Pacific provided the political framework within which American political and economic influence expanded around the globe until the expansionism was brought to an end at least temporarily in the jungles of Vietnam. Although both the United States and the Soviet Union sought to expand their domain, the United States was the most successful expansionist power in the postwar era. In response to its intense fear of communism and in pursuit of its policy of containment of the Soviet Union, the United States, like other great powers before it, became the most expansive power in the international system. American influence expanded rapidly in Europe, Asia, and the Middle East. Thus, in its effort to contain Soviet expansion, the United States itself became a highly successful expansionist power.
The Liberal World Economy
The institutional framework of the postwar world economy was constructed at the Bretton Woods conference in 1944. Eventually known as the Bretton Woods System (BWS), this essentially American-British achievement reflected the thinking of Harry Dexter White and John Maynard Keynes. (In retrospect, the small number of principal players involved in formulating the agreement accounts in large part for the extraordinary success of the conference and is in marked contrast to subsequent efforts to agree on rules to govern the world economy.) Although a number of disagreements divided the American and British negotiators, the conference succeeded in reconciling its two major objectives. The first goal of the conference was to formulate unifying principles that would be embodied in the institutions to comprise the BWS: the International Monetary Fund (IMF), the World Bank, and what would become the General Agreement on Tariffs and Trade (GATT). These guidelines included (1) a commitment to trade liberalisation via multilateral negotiations and the principle of nondiscrimination, (2) agreements that current account transactions should be freed from controls, but that capital controls were permissible, and (3) agreement that exchange rates should be fixed or pegged and that their adjustment was of concern to all. The second goal of the conference was to leave mom within the BWS for governments to pursue Keynesian stabilisation and social welfare policies; individual nations would be free (within prescribed limits) to pursue economic growth and full employment policies. These fundamental principles and the international institutions embodying them created the framework within which the postwar international economy has flourished.
In subsequent years the original Bretton Woods System has been significantly modified in response to economic and political realities beginning immediately after the end of World War II. The prostrate European and Japanese economies, the problem of the 'dollar shortage', and especially the exigencies of the Cold War brought about major changes in the original system. In the interest of forging an alliance system against the Soviet Union, the United States reversed its prior positions on a number of international economic issues and took a decisive leadership role in the creation of the postwar world economy. The emergence of the postwar international economic order cannot be understood without recognising the need for allied co-operation against the Soviet Union.
The world's foremost creditor nation, the United States, used its financial
reserves, primarily through the Marshall Plan, to facilitate the rebuilding
of the West European economies as a buffer against Soviet expansionism. Despite
its historic aversion to trading blocs, the United States pressured the West
Europeans to pursue European integration. As a pre-condition for receiving American
assistance, West European governments were required to remove intra-European
trade barriers and to co-operate and co-ordinate their economic plans through
the Organisation for European Economic Cooperation (OEEC); the West Europeans
were also encouraged to carry out domestic economic ref orms, including the
adoption of America's more productive manufacturing and management
techniques. In order to promote European integration, the United States even tolerated European discrimination against American agricultural and manufactured exports. In a less dramatic but equally important way, the United States also used its financial and other resources to help rebuild the Japanese economy and integrate it into the Western system. Thus, during the Cold War, the postwar international economic order and the international security order became intimately joined to one another.
The core of the modified Bretton Woods System was composed of two international regimes with important roles in the early success of the international economy. The first regime was the international monetary system based on fixed but adjustable exchange rates, rates for which the International Monetary Fund (IMF) was given formal responsibility in reality, the United States used its economic resources and political influence to assure the early success of that monetary system. The second important regime was the international trading system based on the GATT; responsibility the the trading regime was diffused among a number of nations and, as this number increased during the postwar years, the trading regime became more and more unwieldy. There were plans for a third regime (based perhaps on the World Bank) to be responsible for promoting the economic development of the less developed countries. This regime never materialised, largely because of the strong opposition of the industrial economies; even at the end of the twentieth century, no full-fledged development regime or agreed-upon principles regarding economic development yet exists.
International Monetary System of Fixed Rates
Experts from many countries holding common views on the technical issues needing resolution played significant roles in the creation of the international monetary regime. The system had to provide monetary reserves and reserve credits in sufficient amounts to enable member governments to keep their exchange rates fixed or pegged to one another. (This is called the 'liquidity problem'.) The IMF would solve this problem by offering reserve credits to deficit states using contributions from member countries. Second, the system also bad to solve the so-called Nth problem. (This is called the 'adjustnent problem'.) In a monetary system based on fixed exchange rates covering N countries, if policy conflict is to be avoided, only N-I countries can, at any particular time, pursue independent exchange rate policies, i.e., the currency of at least one country must stay stable while others are free to vary the value of their own currencies. The requirement that countries had to obtain IMP approval to alter their exchange rate was designed to solve the Nth country problem. Third, the monetary system had to anchor its members' monetary policies to some objective standard in order to prevent global inflation or devaluation. (This is the 'confidence problem'.) Stabilisation of a monetary system can be achieved in one of three ways: by (1) tying every currency to a 'non-monetary' asset, gold being the asset of choice; (2) adopting a policy rule to co-ordinate national monetary policies, or (3) following a leader whose revealed policy preferences promise to provide the desired degree of economic stability. Although all three methods were in fact employed in the early postwar years, the monetary policies of member states were 'anchored' by tying every currency to gold and the major powers coordinated (informally at least) their national economic policies.
The postwar international monetary system, which lasted until 1973, was extraordinarily successful. The system was designed to provide both domestic policy autonomy and international monetary stability; in effect, the system provided a compromise between the rigid gold standard of the late nineteenth century under which governments had very little ability to manage their own economies and the monetary anarchy of the 1930s when governments had too much license to engage in competitive devaluations and other destructive practices. In order to achieve both autonomy and stability, the system was based on the following principles: (1) fixed or pegged exchange rates, but with sufficient flexibility to enable individual states to deal with extraordinary situations including the pursuit of full employment; (2) the establishment of a reliable source of reserve credit in the event of an international payments problem; (3) an agreement among member countries to peg their currencies to gold at $ 35/oz. or to the dollar; (4) IMF approval of exchange rates and of adjustments in the event of a 'fundamental disequilibrium' in a nation's balance of payments; (5) monetary reserves provided by an IMF endowment to create a pool of national currencies or county quotas which could be made available to deficit countries. These principles would govern the system until its breakdown in the early 1970s.
The ways in which the system actually functioned in practice did not fulfill the intentions and expectations of its founders. Firstly, although the IMF was made responsible for maintaining liquidity, in practice the primary solution was the build-up of the dollar reserves of member governments due to continuing American balance of payment deficits, especially after 1959. In this way the American dollar became the foundation-stone of the international monetary system. Secondly, although the adjustment or Nth country problem was to be solved by requiring counties in 'fundamental disequilibrium' to obtain IMF approval before changing exchange rates, in practice, the problem was solved politically through co-operation among the United States and its allies and by the passive US attitude toward the exchange rate of the dollar up to the 1971 Nixon shock. The confidence problem was solved as the members followed US policy preferences which, in the early postwar era, promised to provide stability to the system. However, the essential requirement that the United States as the N-I country, pursue a policy of price stability failed eventually with the escalation of the Vietnam War in the late 1960s; the ensuing inflation leading to the abandonment of the fixed rate system by the Nixon Administration in the early 1970s because the system no longer suited American interests. Nevertheless, the United States and the dollar have continued to be the foundation of the system.
The key role of the dollar in the international monetary system held the American alliance system and the world economy together, and the international role of the dollar as both a reserve and transaction currency actually became a cornerstone of America's global economic and political position. Because America's major allies and economic partners were willing to hold dollars for political as well as for economic reasons, the international role of the dollar conferred on the United States the right of 'seigneurage'; this term refers to privileges associated with being the provider of the currency for an economy, in this case the international economy. As President Charles de Gaulle of France bitterly complained in the 1960s, the 'hegemony of the dollar' conferred 'extravagant privileges' on the United States, because it alone could simply print dollars to fight foreign wars, buy up French and other businesses, and go deeply into national debt with no fear for the consequences.
As Robert Triffin warned in the early 1960s, there was a fundamental contradiction at the heart of this dollar-based system. While the huge outflow of American dollars to finance the re-building of Western Europe and Japan and the American military build-up during both the Korean and Vietnam Wars helped to solve the liquidity problem, this outflow or overhang of dollars meant that the United States would one day be unable to redeem in gold those dollars held by private investors and foreign governments at the agreed price. Triffin predicted that confidence in the dollar would be undermined as the American balance of payments shifted from a surplus to a deficit. As this deficit grew in the late 1950s and the 1960s, the conflict between the monetary system's mechanism of liquidity creation and the solution of the confidence problem became increasingly severe. The problem became even more acute in the 1960s when the escalation of the Vietnam War and its inflationary consequences caused a deterioration of international confidence in the value of the dollar. As confidence in the dollar declined, the foundations of the Bretton Woods system of fixed rates began to erode.
Decreasing confidence in the dollar led to intensifying speculation in gold, and this was followed by attempts to find solutions to the confidence problem; the most important of these efforts was the creation in the late 1960s of Special Drawing Rights (SDRs) as a new reserve asset to complement the dollar. However, the 'solution' reached was essentially political. America's Cold War allies, fearing that a collapse of the dollar would force the United States to withdraw its forces from overseas and to retreat into political isolation, agreed to hold over-valued dollars to prevent the monetary system from breaking down. In essence, the confidence problem was solved by the political necessity to maintain the anti-Sot alliance. Another factor in the allied support of the overvalued dollar, however, was that the American market was lucrative for such export-oriented economies as West Germany and, later, Japan.
At any particular time during the postwar era, the United States has had one primary partner in defending the dollar and hence its international position. In the early postwar period, the American position in the world and support for the dollar were based on co-operation with the British this 'special relationship', begun between World Wars I and II, had been solidified by the wartime experience. The Anglo-Saxon powers worked together to frame the Bretton Woods System and re-establish the liberal international economy. By 1967, however, the relative decline of the British economy forced Great Britain to devalue its currency and pull away from its close partnership with the United States. West Germany then replaced Great Britain as the US's foremost economic partner and supporter of the dollar, Throughout the Vietnam War and into the 1970s, the Germans supported American hegemony by holding dollars and buying American government securities. The inflationary and other consequences of this new special relationship weakened the American-West German relationship in the mid-1970s and eventually led to its fracture in 1979; the Germans refused to support what they considered to be President Carter's inflationary economic policies and, with their joint sponsorship with the French of the European Monetary System in the late 1970s, began to isolate the mark from the wild fluctuations of the dollar. During the Volcker Recession in the late 1970s and early 1980s, Germans were replaced by the Japanese who 'provided the financial backing for President Reagan's economic and military policies. In the 1990s, in the guise of the G-7, the international role of the dollar has been maintained primarily through the informal co-operation of the American, German, and Japanese central banks. This co-operation continues largely out of fear of what would happen to the international economic and political system if the monetary system were to break down.
The Trade Regime
The trade regime was born in conflict between the American and British negotiators at Bretton Woods. Reflecting American industrial supremacy, the American negotiators' goal was to achieve free trade and to open foreign markets. Although the British were also committed to the principle of flee trade, they were extremely concerned over the 'dollar shortage', the possible loss of domestic economic autonomy to pursue full employment, and a number of related issues. However, the eventual British-American compromise and agreement to create the International Trade Organisation (ITO) to complement the IMF and the World Bank, proved futile. The American Administration itself rejected the ITO because it believed that the ITO would meddle in domestic economic affairs, resulting in the American government failure to ratify the agreement.
As an interim measure until a replacement for the defunct ITO could be found, the United States and its principal economic partners created the GATT in 1948. The purpose of the GATT (like the moribund ITO) was to promote 'freer and fairer' trade, primarily through the negotiated reduction of formal tariffs. Although the GATT was remarkably successful in fostering trade liberalisation and providing a framework for trade discussions, its authority and the scope of its responsibilities were severely limited and applied primarily to manufactured goods. The GATT did not have authority to deal with agriculture, services, intellectual property rights, or foreign direct investment; nor did the GATT have authority with respect to customs unions and other preferential trading arrangements. Successive American administrations and other governments became increasingly cognizant of these inherent limitations and, following the completion of the Uruguay Round in the 1980s, replaced the GATT with the World Trade Organisation (WTO) whose responsibilities are much broader and which, unlike the GATT, is a full-fledged international organisation rather than merely an international secretariat.
Despite the limitations of its mandate and organisational structure, however, the GATT for many years played an important role in reducing barriers to international trade. Embodying the neo-classical economic commitment to free trade, the GATT provided a rule-based regime of trade liberalisation founded on the principles of non-discrimination and Most-favoured-Nation treatment (MFN), unconditional reciprocity, and transparency (for example, the use of formal tariffs and the publication of trade regulations); in effect, the members of GATT agreed to establish regulations lowering trade barriers and to let markets determine trade patterns. Under GATT, markets were opened and new rules established by mutual agreements and negotiations carried out under its auspices; agreement was based on balanced compromise or unconditional reciprocity rather than on unilateral actions by the strong and the type of 'specific reciprocity' that; in the final decades of the twentieth century, became increasingly characteristic of international trade. The goal of the GATT was an open multilateralism, that is, the agreement provided for the extension of negotiated trade rules without discrimination to all members of the international system; however, candidates for membership had to meet certain criteria and agree to obey the rules. The founders of the GATT wanted a steady progression toward an open world economy with no return to the cycle of retaliation and counter-retaliation that had characterised the 1930s.
Although the early postwar period witnessed a number of agreements to lower tariff barriers, a significant shift in trade negotiations took place with the Kennedy Round (1967), initiated by the United States in response to a growing concern over the trade diversion effects of the European Economic Community. As a consequence of American pressures, the Kennedy Round resulted in an approximate 35 per cent reduction of trade barriers on nonagricultural imports and led to a number of basic reforms such as the regulation of anti-dumping practices and the substitution of across-the-board tariff cuts (or the principle of 'general' reciprocity) on industrial products for the earlier emphasis on bilateral negotiations and the 'multilateralising' of tariff reductions on individual products (or 'specific' reciprocity). Subsequent rounds of GATT negotiations cut tariffs by more than 75 per cent. These tariff reductions have had a profound impact on international trade in manufactured goods, but trade liberalisation in agricultural products has developed much more slowly. With the reduction of trade bathers, international trade grew at an annual rate of 7 per cent between 1948-1973.
In 1971 the industrial countries committed themselves in the Smithsonian Agreement to reduce tariff and other trade barriers even more. The agenda of the subsequent Tokyo Round, far more comprehensive than previous meetings, included tariff cuts, liberalisation of agricultural trade, and elimination of non-tariff bathers. In addition, the industrial countries pledged to pay greater attention to the demands of the LDCs for special treatment of their exports. However, the most important task of the Tokyo Round was fashioning codes of conduct dealing with unfair trade practices. The results of the Round, completed in 1979 following nearly a decade of bickering, were substantial. For example, tariffs on manufactured goods were lowered by about an additional 34 per cent and the negotiations resulted in a number of codes of conduct such as the prohibition of export subsidies and the elimination of some discrimination in public procurement. However, the Round failed to resolve the American-European dispute over agriculture and neither satisfies the LDCs nor prevented the noxious proliferation of non-tariff barriers that had been occurring throughout the 1970s.
With these trade-liberalising agreements, international trade throughout the postwar era grew one or two percentage points more rapidly than did the Gross World Product. This substantial expansion of trade meant that imports penetrated deeply into domestic economies and exports became a much more important aspect of national economies. In fact, for some EEC countries, exports have reached as high as 50 per cent. Even the domestic markets of the United States and Japan were internationalised. Between 1970 and 1989, American imports increased from 4,1 per cent to about 18.1 per cent of GNP. For Japan, the increase was from 10 per cent to 13 per cent of GNP. It is particularly significant that Japanese imports have included a growing percentage of manufactured goods. Meanwhile, GATT membership greatly expanded over the years until it included 125 members in 1995, while growing trade flows created a highly interdependent international economy despite the slowdown in the 1970s with the onset of global stagflation.
Limitations of the Bretton Woods System
The Bretton Woods System had several inherent limitations that would in time weaken the foundations of the postwar economy. Many issues and topics of potential importance were left vague or simply not covered by the rules of the Bretton Woods system. On the trade issue, the fundamental purpose of the GATT was to govern the exchanges of products and commodities, and at the insistence of the United States, agriculture was excluded from GATT rules. Services, foreign direct investment and intellectual property rights, issues which were quite unimportant at the time of the founding of the Bretton Woods institutions and were not included in GATT rules, would become major components of international commerce only in the 1970s. Certain monetary issues were never satisfactorily resolved, i.e. the problem of adjustments in payments imbalances and determination of the responsibility of deficit and/or surplus countries to correct imbalances. The role of international financial flows, which would transform the global economy in the 1970s, was unanticipated and no rules were developed to govern such matters. Finally, the increasing importance of the multinational corporation (MNC) and foreign direct investment (FDI) in the postwar era profoundly transformed the international economy, especially as trade and investment became linked to one another. Initially, MNCs were mostly American corporations that began a rapid overseas expansion in the 1950s as a response to the creation of the European Common Market, but subsequently, the firms of all the industrial and some industrialising countries would join the growing ranks of the multinationals. Indeed, many of the economic activities and economic problems that would become extremely important in the 1980s and 1990s were not covered by the original GATI' framework. Despite these limitations, the Bretton Woods system and the hegemony of the United States on which it rested provided a solid foundation for the success of the world economy following World War II.
1 Kindleberger, C., The World in Depression, 1929-1939 (London, 1973).