Friday, July 31, 2009

2008- Year of the Power Shift?

WILL the financial and economic crisis that enveloped the global economy in 2008 have irreversible geopolitical consequences, finally pushing the much anticipated power shift from the West to East?1 There is no doubt that global economic crises have geopolitical consequences, but one must recognize that these are not necessarily enduring or irreversible. The implications of a ‘big bang’ economic phenomenon may unfold over a longer period of time or may be quite dramatic. Much will depend on a complex range of both domestic and external political and social factors.

Further, the past need not always be a guide to the future, given the complexity of change that has already occurred or is underway, across different parts of the world.

Given these caveats, it would be foolish to rush to judgment on the geopolitical consequences of the current global financial and economic crisis. The United States may yet bounce back or may slip into terminal decline. China may find itself more powerful, or more vulnerable. Nothing is inevitable. Much depends on the quality of political leadership, the ‘learning by doing’ effects, and the management of expectations. The challenge for policy-makers is to anticipate events, learn from experience and shape expectations.

But if the anticipated power shift were indeed to come to fruition in the years ahead, 2008 would be marked out as the year the scales finally tipped. The ‘unipolar’ phase of US dominance will be replaced by a ‘multipolar’ phase in which the US will continue to remain the ‘predominant’ power, with China rising as a new global power. Analysts are already speculating whether a new ‘G-2’ (US and China) will come to ‘manage’ the world.2 A G-20 has been put together, but at its core remain the G-5 – US, European Union, Russia, China and Japan – Henry Kissinger’s chosen five major powers, with India still a Kissingerian ‘probable’.3 Some now add Saudi Arabia to this list, partly because of its cash reserves and partly because of its influence in the Islamic world.

There is no doubt that economics alone will not determine the balance of global power, but there is no doubt either that economics has come to matter for more.

The management of the economy, and of the treasury, has been a vital aspect of statecraft from time immemorial. Kautilya’s Arthashastra says, ‘From the strength of the treasury the army is born. …men without wealth do not attain their objectives even after hundreds of trials… Only through wealth can material gains be acquired, as elephants (wild) can be captured only by elephants (tamed)… A state with depleted resources, even if acquired, becomes only a liability.’4 Hence, economic policies and performance do have strategic consequences.5

In the modern era, the idea that strong economic performance is the foundation of power was argued most persuasively by historian Paul Kennedy. ‘Victory (in war),’ Kennedy claimed, ‘has repeatedly gone to the side with more flourishing productive base.’6 Drawing attention to the interrelationships between economic wealth, technological innovation, and the ability of states to efficiently mobilize economic and technological resources for power projection and national defence, Kennedy argued that nations that were able to better combine military and economic strength scored over others.

‘The fact remains,’ Kennedy argued, ‘that all of the major shifts in the world’s military-power balance have followed alterations in the productive balances; and further, that the rising and falling of the various empires and states in the international system has been confirmed by the outcomes of the major Great Power wars, where victory has always gone to the side with the greatest material resources.’7

In Kennedy’s view the geopolitical consequences of an economic crisis or even decline would be transmitted through a nation’s inability to find adequate financial resources to simultaneously sustain economic growth and military power – the classic ‘guns vs butter’ dilemma.

Apart from such fiscal disempowerment of the state, economic under-performance would also reduce a nation’s attraction as a market, a source of capital and technology, and as a ‘knowledge power’. As power shifted from Europe to America, so did the knowledge base of the global economy. As China’s power rises, so does its profile as a ‘knowledge economy’.

Impressed by such arguments the China Academy of Social Sciences developed the concept of Comprehensive National Power (CNP) to get China’s political and military leadership to focus more clearly on economic and technological performance than on military power alone in its quest for Great Power status.8

While China’s impressive economic performance and the consequent rise in China’s global profile has forced strategic analysts to acknowledge this link, the recovery of the US economy in the 1990s had reduced the appeal of the Kennedy thesis in Washington DC. We must expect a revival of interest in Kennedy’s arguments in the current context.

A historian of power who took Kennedy seriously, Niall Ferguson, has helped keep the focus on the geopolitical implications of economic performance. In his masterly survey of the role of finance in the projection of state power, Ferguson defines the ‘square of power’ as the tax bureaucracy, the parliament, the national debt and the central bank. These four institutions of ‘fiscal empowerment’ of the state enable nations to project power by mobilizing and deploying financial resources to that end.9

Ferguson shows how vital sound economic management is to strategic policy and national power. More recently, Ferguson has been drawing a parallel between the role of debt and financial crises in the decline of the Ottoman and Soviet empires and that of the United States of America. In an early comment on the present financial crisis, Ferguson wrote:

‘We are indeed living through a global shift in the balance of power very similar to that which occurred in the 1870s. This is the story of how an over-extended empire sought to cope with an external debt crisis by selling off revenue streams to foreign investors. The empire that suffered these setbacks in the 1870s was the Ottoman empire. Today it is the US… It remains to be seen how quickly today’s financial shift will be followed by a comparable geopolitical shift in favour of the new export and energy empires of the east. Suffice to say that the historical analogy does not bode well for America’s quasi-imperial network of bases and allies across the Middle East and Asia. Debtor empires sooner or later have to do more than just sell shares to satisfy their creditors. …as in the 1870s the balance of financial power is shifting. Then, the move was from the ancient Oriental empires (not only the Ottoman but also the Persian and Chinese) to Western Europe. Today the shift is from the US – and other western financial centres – to the autocracies of the Middle East and East Asia.’10

An economic or financial crisis may not trigger the decline of an empire. It can certainly speed up a process already underway. In the case of the Soviet Union the financial crunch caused by the Afghan war came on top of years of economic under-performance and the loss of political legitimacy of the Soviet state. In a democratic society like the United States the political legitimacy of the state is constantly renewed through periodic elections. Thus, the election of Barack Obama may serve to renew the legitimacy of the state and by doing so enable the state to undertake measures that restore health to the economy. This the Soviet state was unable to do under Gorbachev even though he repudiated the Brezhnev legacy and distanced himself from it.

Hence, one must not become an economic determinist and historic parallels need not always be relevant. Politics can intervene and offer solutions. Political economy and politics, in the form of Keynesian economics and the ‘New Deal’, did intervene to influence the geopolitical implications of the Great Depression. Whether they will do so once again in today’s America remains to be seen.

Consider a recent example – the Asian financial crisis of the late 1990s. There is no disputing the fact that the crisis had geopolitical consequences. It altered the balance of power in Asia in China’s favour. China gained economically and geopolitically vis-à-vis Japan. It was not so clear at the time that it had also done so vis-à-vis the United States, because China chose to work with the US, with Japan consigned to the sidelines, rather than against the US.

Commenting on the geopolitical implications of the Asian financial crisis, I had at that time argued along the following lines:

‘The new modus vivendi between China and the US has also weakened Japan’s influence in the region as well as any resistance to US policy intervention in the cleaning up of the financial crisis. Thus, far from being part of the solution through the instrumentality of the Asian Monetary Fund (a Japanese proposal that has been rejected by the US), Japan is now increasingly viewed as part of the problem. Even in the Korean peninsula, US policy towards North Korea has put South Korea on a tight leash. The ouster of Indonesia’s Suharto and the problems enveloping Malaysia’s Mahathir, both directly linked to the social and political fallout of the financial and economic crisis, have also increased US influence in the region.’11

It can be argued that the crisis also weakened the ‘Korean state’ by postponing the prospect of Korean unification. The two Koreas were preparing for unification after 1990, but the 1997 crisis made the cost of unification prohibitive for the prosperous South. But the geopolitical implications for Asia have not been along predicted lines. The US in fact came out weaker after the crisis, mainly because it did not step in to help Asian economies in distress. China emerged stronger in the pre-crisis period through the pursuit of ‘beggar-thy-neighbour’ exchange rate and trade policies that contributed to a shift of labour-intensive export industries from Southeast Asia to China, and in the post-crisis period by stepping in to help neighbours in distress.

Conspiracy theorists could well argue that with the collapse of the Soviet Union in 1990, the United States chose to ‘team up’ with China during the Clinton era. The US ‘allowed’ China to emerge stronger from the Asian financial crisis at the expense of its own traditional allies – Japan, South Korea and ASEAN economies. This was the period, mid-1990s, in which the US also ‘facilitated’ China’s entry into the World Trade Organization and gave China a bigger voice in the affairs of the International Monetary Fund and the Asian Development Bank. The Bush Administration sought to reverse some of this, but with little success.

A decisive geopolitical shift had taken place in the Eurasian land mass in favour of China after the collapse of the Soviet Union and the Asian financial crisis. The geopolitical consequences of the economic under-performance of the Soviet Union and the financial crisis in Asia are there for all to see. There has been some ‘resurgence of Russian power’ in recent years based almost entirely on trends in the global energy market. Whether Russia will be able to sustain this and recover its lost geopolitical space remains to be seen. But one must not exaggerate Russia’s inherent capacity to regain the power that the erstwhile Soviet Empire commanded mainly because Russia has not been able to find an economic route back to power. Nor has Russia regained its position as a ‘knowledge power’. Its industrial and technological capability may well be falling behind China’s in many respects. Energy alone cannot sustain Russia as a great power.

Given these trends in the past two decades, it does not require too much prescience to suggest that the recent financial crisis will have the effect of weakening US power and enhancing China’s. Where it will leave Russia, Japan and Western Europe is still not clear. China’s massive ‘bailout offer’ of close to US$ 600 billion, twice the size of India’s total foreign exchange reserves, is a pointer to the change underway. China’s response to the trans-Atlantic financial crisis is similar to its response to the Asian financial crisis. It would like to be seen as being part of the ‘solution’ by the rest of the world, not as a part of the problem. Just as the Asian financial crisis enhanced China’s profile in Asia, its response to the present crisis will enhance its global profile.12

While it is easy enough to forecast a decline in US power and an increase in China’s, one should not rush to the conclusion that America is in terminal decline. The United States has shown remarkable ability to renew itself as an economy and as a technological and military power. Its openness and pluralism have been great assets. Under Barack Obama’s leadership America can renew itself and re-emerge as a global power with global influence. In doing so the US may well reach out to other economies and peoples, especially in Europe, Asia and Latin America. This can only enhance US power and profile, not diminish it. If China has to compete with the US for global influence it will have to imitate the US and become a more open economy and open society. It remains to be seen if China can make that transition.

Therefore, to appreciate the geopolitical implications of the current financial crisis one must wait and see how the respective political leaderships of the US, Europe and Asia respond to the challenge at hand. If Obama provides new leadership and renews global confidence in America’s ability to lead, he could avert a decline in US influence and power.

What is however clear is that reform of global governance is long overdue. The International Monetary Fund has failed in disciplining developed economies when they falter on fiscal and financial policies. The global regulatory and supervisory regime requires improvement, with countries like India and China given a role commensurate with their size, experience and record in economic management. India’s recent record of sound management of its financial sector and its record over the past two decades in external economic liberalization and management, deserve to be commended.

India may now well be entering a more difficult era of geopolitics and globalization after a benign decade. The 1990s was a decade of difficulty for India because they began with the collapse of the Soviet Union and a massive balance of payments crisis, and ended with the fallout of nuclear tests and renewed tension with Pakistan. The 21st century began on a more hopeful note. Not only did the Indian economy perform relatively well, but the global political and economic environment too was benign.

As Prime Minister Manmohan Singh has said on many an occasion, ‘The world wants India to do well, our challenges are at home.’ The conclusion of the civil nuclear cooperation agreement with the United States and the 45-member Nuclear Suppliers Group was the high point of this benign phase. The support and friendship extended to India by President George Bush, especially in his second term, went a long way in strengthening India’s hand globally, even if it upset a few Islamic countries.

A benign global environment and a robust performance of the domestic economy, with savings and investment rates reaching record highs, of over 35% of GDP, and ever burgeoning foreign exchange reserves, enabled India to adopt a more generous profile within its own neighbourhood. The ‘asymmetric trade liberalization’ Manmohan Singh offered all Least Developed Countries (LDCs) was one manifestation of this. India’s willingness to walk the extra mile with Southeast Asian nations and conclude a free trade agreement with ASEAN was another manifestation.

However, if the Indian economy comes under renewed pressure, if the US is unable or unwilling to be as supportive as it was during Bush II, and if China becomes more assertive, especially with India, while being more accommodative of the US and its other neighbours, the global environment for India could easily deteriorate. Such a deterioration of the external environment could encourage elements in India to adopt more assertive and less accommodative postures on national security issues. This would complicate relations with major powers and neighbours, slowing down the process of change in the subcontinent, with attendant consequences.

Hence, to prevent any negative geopolitical fallout of the present crisis, India must remain focused on the economy and ensure sustained economic growth in the medium term. If the Indian economy can sustain an average of eight per cent growth over the next decade, it would have finally succeeded in altering geopolitical equations within the region. China may continue to outperform India, but a strong economic performance can enhance India’s strategic autonomy and enable it to deal with immediate challenges closer home. India must remain actively engaged with all its immediate and wider Asian neighbours, in South, Southeast and West Asia. India must remain engaged with all major powers, especially the United States.

India must work on the assumption that China will continue to perform well and will use its economic prowess to strategic advantage. China’s influence is on the rise within Asia and globally. If the US and Europe remain preoccupied with domestic economic issues and the management of the global economy, China will increase its global influence both by continuing to perform well on the economic front and by working with the major powers in the management of the global economic and political order.

India’s options stand out. Continued focus on the economy. Making the growth process inclusive and more efficient. Increased public investment in infrastructure, in education and skill-building. Financial stability and prudent fiscal management, exchange rate stability and sustainability of the external account. In short, sustaining India’s growth process is the only insurance India can take against any adverse geopolitical fallout of the global financial crisis.

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