The Emerging Financial Architecture: A New Take on Decoupling

Think back to the good old days just before the world financial system exploded. Remember all the talk then of “decoupling”? What advocates of the decoupling thesis had in mind was very simple: the world economy had changed in such a way that the growth trajectory (and business cycles) of developing countries had separated from the economic fortunes of the U.S. The strong performance of rapidly growing developing countries, not least the BRICs (Brazil, Russia, India and China), was seen as evidence that substantial parts of the global economy had broken free of the U.S. iceberg and were now floating in distinct economic currents. Decoupling advocates cited much evidence to support their claims—most importantly, they focused on the fact that export and GDP growth in large developing countries was smartly outpacing that of the U.S.

Then came the global economic crisis of 2008-?, which did serious damage to the decoupling thesis, as Chandrasekhar and others have pointed out. The contraction of remittances, exports and global credit hit developing countries hard. On the European periphery the continued unfolding of crises and the contraction of output were also damaging to the thesis. That decoupling is a myth should not be surprising: after all, in a globally integrated economy it is impossible to insulate economies from one another. That the BRICs are performing well these days does not salvage the decoupling thesis: just like crises themselves, recoveries are always geographically and temporally uneven.

That said, a different sort of decoupling is now underway, and it may prove to be very significant in the coming years. This decoupling has two dimensions–policy and architectural.

Policy and Regulatory Decoupling

Instead of the customary convergence to the norms of U.S. economic policy and regulation, policymakers in some developing countries are moving in directions that are decidedly at odds with the path of the U.S. As is well known, monetary policy in the country continues to be highly expansionary. Moreover, the financial reform bill was a disappointment to progressives since it does very little to curtail the power of the country’s financial sector.

In much of the developing world, monetary and financial policies are trending in a decidedly different direction. Not only have central banks in rapidly growing developing countries been tightening monetary policy and taking other steps to reduce credit growth, they are also implementing restrictions on outsized activities of the shadow financial sector, and imposing a variety of controls on capital flows. In most cases they are now restricting capital inflows, though in some cases controls on outflows have been implemented as well. These measures have been driven by the challenges confronted by these rapidly growing economies—namely, high levels of foreign investment are fueling asset and price inflation, and are also placing currencies under pressure to appreciate.

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To be sure, these measures reflect “fundamental” economic challenges. But they also reflect a very different set of political forces: in the developing world, policy is turning in the direction of managing finance in the interests of the broader economy. In the rich countries, no such political realignment has taken place.

Architectural Decoupling

To date there is little evidence that the IMF has been demoted from its perch as the critical institution of financial management. Indeed, the IMF has been the big winner from the crisis: the institution has discovered new vitality as a first-responder to economic distress, and its funding has been increased significantly by the G-20. The newly revitalized Fund is playing its familiar damaging role of promoting pro-cyclical macroeconomic policies in those countries to which it has provided assistance.

But, as I argue in a recent paper, today the geography of IMF influence is significantly curtailed as a consequence of the rise of relatively autonomous states in the developing world (some of which have even emerged as lenders to the institution) and the emergence of new financial architectures. The Fund now faces competition from other national, multilateral, and regional and sub-regional financial institutions that are beginning to play a greater role in the area of crisis management and project lending. These include the Inter-American, Asian and African Development banks, Brazil’s BNDES, the Latin American Reserve Fund, Chiang Mai Initiative Multilateralisation, Argentina and Brazil’s Agreement on Reciprocal Payments and Credits, and the Andean Development Corporation. The Bank of the South and the Bolivarian Alliance for the Americas (ALBA) are newer initiatives that may hold promise in the future, though each is still in its infancy.

At this point it remains unclear just how significant these architectural changes will prove to be as competitors to the IMF. However, it is clear that we are witnessing a slow process of structural transformation in the global financial architecture, a development that appears to be leading to a more decentralized, pluralistic, and heterogeneous financial architecture. We may well find that this more heterogeneous architecture is one that provides more policy space for development. Let’s face it: it could hardly do worse in this regard.