Università Degli Studi Di Milano

UNIVERSITÀ DEGLI STUDI DI MILANO GRADUATE SCHOOL IN SOCIAL AND POLITICAL SCIENCES Dipartimento di Science Sociali e Politiche Doctoral Program in Political Studies, XXVII cycle The Political Economy of Monetary Followership in Surplus Countries. The divide between Small and Middle Powers SPS/04 – Political Science Doctoral Research Dissertation by Nicolò Raico Supervisor: Prof. Alessandro Colombo Director of Doctoral Program: Prof. Francesco Zucchini Committee Members: Prof. Filippo Andreatta (Università di Bologna) Prof. Manuela Moschella (Scuola Normale Superiore) Prof. Corrado Stefanachi (Università degli Studi di Milano) Academic year 2014/2015 Contents Introduction CHAPTER I: Small and Middle Powers in the International Monetary System. A Critical Assessment of the Literature…………………………………………………….....………………………………….....1 1.1 Challenges and opportunities of ‘smallness’ in International Relations 1.2 Small states in the international economic system 1.3 ‘Size-optimism’ in international economy. Explaining the economic successes of small states 1.4 Middle powers in International Relations: the system’s responsible stakeholders 1.5 The hierarchy of power in the international monetary systems. Rethinking Cohen’s ‘Monetary Power’ 1.6 Small and Middle Powers in International Monetary Relations 1.7 The two typologies of deficit countries 1.8 The characteristics of major and minor holders and the literature gap on surplus countries 1.9 Literature gaps and research design CHAPTER II: The Power of Currency. Macroeconomic Policy Autonomy and Power Relations in the International System………………………………………………………………………………………..………25 2.1 The role of economic relations and the ‘struggle for autonomy’. A review of state’s priorities in a realist framework 2.2 Autonomous from what? ‘Iron and Steel’ versus purchasing power in the approach of realist IPE 2.3 Beyond great powers and security: policy autonomy as a fundamental good of anarchical systems 2.4 Monetary policy, payment imbalances and policy autonomy in asymmetrical monetary systems 2.5 Monetary policy adjustments: Cooperation or Coordination? 2.6 The economics of Monetary Policy Coordination: a brief overview 2.7 Monetary Policy Coordination and the Compensation Rule CHAPTER III: Leadership and Followership in International Monetary Relations...................53 3.1 Leadership and Hegemony in International Relations: a brief overview 3.2 Hegemony and Leadership in the Monetary System: the early debate 3.3 Capital mobility and ‘passive leadership’: the second generation of theories on asymmetrical monetary regimes 3.4 Monetary Leadership as control over macroeconomic adjustments 3.5 Between Neutrality and Followership: small and middle powers vis à vis dominant currencies 3.6 Targeting the leader’s money: currency warfare and monetary coercion 3.7 Monetary Neutrality though structural accumulation of current account surplus 3.8 Monetary Neutrality though Investment Attractiveness 3.9 Three typologies of Monetary Followership between exchange rates and domestic policies CHAPTER IV: The causes of Monetary Followership and the ‘puzzle’ of Surplus Countries.........................…..................................................................................................82 4.1 Why do states follow in monetary affairs? Theories and hypotheses on monetary followership 4.2 Constructivist approach: cognitive and cultural variables 4.3 Comparative approach: domestic institutions, economic systems and interest groups 4.4 The limits of the Comparative approach against surplus countries and systemic outcomes 4.5 International-structural approach: economic relations, security issues and monetary followership 4.6 Polarity, capital mobility and asymmetries in monetary power 4.7 The accumulation of foreign assets and the entrapment hypothesis 4.8 ‘Bretton Woods II’. The Neo-Mercantilist explanations of currency followership in surplus economies 4.9 ‘Precautionary’ foreign exchange accumulation: surplus countries’ followership after a currency crisis 4.10 Money and security. Military alliances, alignments and the conflict on macroeconomic adjustments CHAPTER V: The divide between Small and Middle Powers in the Monetary System. Implications for Autonomy and Followership of Small Holders………………………....……………118 5.1 The major-holder bias of the literature and the followership of small holders 5.2 Modelling the baseline scenario of intra-follower relations 5.3 Joint Goods and Issue Linkages: the causes of monetary followership in small holders 5.4 Systemic stakeholders or regional leaders? Major holders as mediators between monetary leaders and small countries CHAPTER V: The Arab monarchies and the 2008 financial crisis in the Persian Gulf: the autonomy of small states and the role of Saudi Arabia….………………………………………..……….136 6.1 Case selection and methodology 6.2 Background of the crisis: macroeconomic imbalances, the subprime mortgage bubble and the repercussions on the GCC countries 6.3 The domestic political economy of the exchange-rate regime in GCC countries 6.4 International economic relations and the dollar peg 6.5 International political relations and the dollar peg 6.6 The international political economy of the dollar peg in small holders 6.7 Monetary policy, reserves and sovereign wealth funds. Opportunistic followership in small holders 6.8 Conclusions Conclusions List of Figures Figure 1 Norway current account balance to GDP (annual 1995-2014) 75 Figure 2 Currency composition of foreign assets at the Government Pension Fund of Norway, in % 76 Figure 3 Norges Bank’s discount rate against ECB main policy rate (2000- 2014; in % monthly) 77 Figure 4 Sweden nominal effective exchange rate (NEER, 2002=100) and Current Account Balance (yearly, in million S$) 79 Figure 5 Accumulation of official reserves assets in autocracies and liberal democracies 97 Figure 6 SNB holdings of foreign assets (in billions francs) and franc/eur exchange rate 108 Figure 7 Convergence of policy interest rates of European Central Bank and the Sveriges Riksbank (in %) 108 Figure 8 Official foreign exchange reserves – world total (yearly data 1990-2013), in billion US dollars 110 Figure 9 Central Bank policy interest rate in GCC countries (except UAE) plus US Fed, in % (monthly data) 149 Figure 10 GDP deflator index in GCC countries(2010=100) 150 Figure 11 Index of financial market development in GCC countries (average 2007-2009) 155 Figure 12 Volume of Imports and Exports on GDP in GCC states (average 2007-2009) 155 Figure 13 Main export destination of GCC countries in 2007 159 Figure 14 Share of imports from non-dollar related countries on total GCC imports 159 Figure 15 Monthly Ryial/US$ Exchange Rate (right scale) and price of Oil (left scale, monthly average current US$) 161 Figure 16 Foreign exchange reserves in Saudi Arabia, in million US$ 163 Figure 17 Official Reserves/GDP ratio in GCC countries (yearly data, % on GDP at current US$) 171 Figure 18 Currency composition of SWFs in GCC minor monarchies (2007, in billion $) 171 Acknowledgements The success of this research is not exclusively a merit of my effort and commitment, many people has made it possible through their direct or indirect contribution. The first mention, as obvious, goes to my family, comprising my father, my mother and my sister, who have always allowed me to follow my professional objectives with a constant support and a concrete help in the most difficult moments. Likewise, I thank all my friends and my cousin Diego. The leisure time I spend with all of you every weekend relaxes by brain and makes possible a good restart every Monday. Secondly, I want to thank the team of professors who followed my work during the PhD in Milan and Toronto. First, my supervisor Alessandro Colombo, who first suggested me to explore the world of International Political Economy, and provided his fundamental mentoring during the most delicate stages of this research. Second, Professor Eugenia Baroncelli, who accepted to follow my work ‘from behind’ and provided myself with the most precious suggestions about IPE during my initial approach to the subject. Third, I thank Professor Carla Norrlof for her mentorship during the four months I spent as visiting student at the University of Toronto, Canada. Her insightful comments to the early versions of my work have incommensurably improved my arguments and hypotheses. Finally, the third mention goes to all my friends and colleagues of the Department, for the great time we have together in these three and a half years. Especially I thank all my colleagues of the 27° Cycle, especially the ‘Pols people’ Carlo, Marcello and Matteo, as well as Manu, Vale, Moi, Anna and Alberto for the unforgettable moments we had together. I thank Giulia (Julie) for her warm friendship and all the opportunities we have for exchanging views, as well as Chiara for her wonderful dinners and Francesca Pasquali for her nice friendship. I thank Fedra, who never said ‘no’ when I needed help on statistical stuff. Last, but to the least, I thank my ‘IR’ friend Simone for his constant encouragement, and Francesca Cerutti (Franci), for all the time she spent trying to understand something of this research and improve it. To conclude, I thank all the people I cannot mentions in one page, and Professor Francesco Zucchini for his indispensable help in all the administrative passages of my PhD period. Introduction This research is about the impact of states’ financial size on their choices in the field of monetary and exchange rate policy. The main argument

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