REVITALIZING THE SPIRIT OF BRETTON WOODS 50 PERSPECTIVES ON THE FUTURE OF THE GLOBAL ECONOMIC SYSTEM

The Bretton Woods Committee Conference delegates register at the Mt. Washington Hotel on July 2, 1944

Source: Bettman/Getty Images MULTILATERAL COOPERATION AND SYSTEMS CHANGE

REVITALIZING THE SPIRIT OF BRETTON WOODS | 47 TRANS-SOVEREIGN NETWORKS ’s Role in the New Global Order

KEYU JIN Associate Professor of Economics, School of Economics and Political Science

The world is increasingly characterized Competition and substitution, by networks: technologies, firms, banks, emphasized in traditional economic global supply chains, even the English thinking, are gradually giving way to language. It is impossible to under- notions of complementarity, connec- stand the workings of the modern-day tivity, and cooperation. With greater economy without grappling with the interdependence comes the need for a intricacies of how shocks propagate rethinking of the international politico-­ through networks, how firms conduct economic architecture that takes into business via networks, how infrastruc- account networks of a transnational ture connects countries into networks, nature. There is also a series of questions and how productivity gains are accrued to ponder: Will networks supersede from networks. The world as a whole sovereign relations? Will they render also works as a network. Whether it is the concept of hegemons obsolete, or the Red Cross, an agreement to tackle at least less relevant? Will networks of global climate change, or international the transnational sort need fostering, or financial systems and global supply will they just emerge without design? chains, these efforts are of a transnational If they do need shepherding, who will nature. Even looming challenges such as play that leadership role? technology displacing jobs or AI out- This century and the subsequent smarting humans are issues not between ones are likely to be centuries of states but across them. expanding networks, but the current

92 | REVITALIZING THE SPIRIT OF BRETTON WOODS era is also one in which China will rise China has defied conventional wisdom and assert itself as a global leader. What on its path to prosperity; it has achieved will be the defining characteristics of economic growth not by sheer forces its leadership? This will likely be a key of the market but instead with signifi- question of our time. Seventy-five years cant state intervention. It is on its way ago, China was one of the 44 allied to becoming the largest economy in nations to have participated in the the world, yet it is still a developing founding of the Bretton Woods system. country, marked by backward financial Ever since, it has transformed itself development and ailed by a myriad of from an economic backwater to one deep-seated economic distortions. It of the most connected components in has cutting-edge technological capacity the global economy. China has experi- despite its low income levels. It’s seen an enced seismic changes, in the same way income growth of more than 15 times that the global economy has radically since 1990, and this was all achieved transformed itself by weaving a web without being a Western-style democ- of interconnected, interrelated com- racy and arguably even without a proper ponents. But what hasn’t changed at a set of incentives-enabling institutions. similar pace is the design and thinking But there seems to be a “silver bullet” on international economic and finan- absent from the conventional set of cial architecture. explanations for China’s success. Yes— The main argument of this essay is factor accumulation has been important, that in a world of global economic net- and reforms that have removed distor- works, new economic relationships and tions have so far led to efficiency gains. linkages warrant a new type of economic But China’s ability to transform itself leadership, one that supplants traditional rapidly from an economic backwa- notions of power and hegemony. China, ter to one of the world’s most vibrant by living through its own experience economies in a matter of three decades of building networks that succeeded seems to hinge on something else. Forty in jump-starting development, is poised years ago, China was a centrally planned to become a global network leader. In economy, absent a properly functioning that role, the most central and connected marketplace. The state set production nation enables and propels the networks; targets and prices, with virtually all it does not seek to dominate the system daily necessities and many other con- but instead strives to ensure the smooth sumer goods rationed. But over a short functioning of the networks, as well as period of time, the government was their safety and sustainability. able to coordinate the various elements China, the second-largest economy in the nation and set development in today, doesn’t easily fit into a category motion. The country leveraged its ability of historical and nascent superpowers. to accumulate resources and mobilize

REVITALIZING THE SPIRIT OF BRETTON WOODS | 93 them—rapidly building infrastructure machines, a trained workforce, techni- that connected its various regions, cal expertise, security, business licenses, people, and complementary inputs. It transportation networks, electricity, worked as a network, with firms and and so on. Problems with any input can industries enabling other firms and other substantially reduce the overall output. industries, and productivity gains were What China has managed to achieve is maximized as the networks were built to build up the business and transpor- and expanded. tation networks that have connected The idea of building linkages to these inputs fairly rapidly—further foster economic development goes back increasing the value of the inputs and, to Hirschman.29 By building forward in turn, the incentive to produce them. and backward linkages, development Whereas it took the West a hundred can be self-reinforcing, propelling a vir- years to create and link markets, China tuous cycle. A straightforward example did it in a matter of two decades. illustrates that this mechanism extends beyond simple scale economies: if, for example, the transportation sector is NETWORK EFFECTS ON inadequate, then output in many other A GLOBAL SCALE activities, including truck manufac- The same idea of network effects and turing and highway construction, will self-reinforcing linkages carries over to be hampered, in turn further reducing the global economy. There is substantial output in the transportation sector and evidence, first, that inputs across coun- in the rest of the economy. This vicious tries have become complementary. For cycle engenders a multiplicative effect. example, Japanese earthquakes in 2011 The same goes for a virtuous cycle, in are shown to have caused substantial dis- the opposite direction. ruptions for parts of the US economy.30 If intermediate goods are comple- Moreover, switching costs in global sup- mentary in nature, then forging and ply chains tend to be high.31 In the world strengthening these linkages is ever of financial networks, interdependen- more important. For instance, tex- cies among governments, central banks, tile producers require raw materials, investment banks, and firms, through

29 Albert Hirschman, The Strategy of Economic Development (New Haven, CT: Press, 1958). 30 Christoph Boehm, Aaron Flaaen, and Nitya Pandalai Nayar, “Input Linkages and the Transmission of Shocks: Firm-Level Evidence from the 2011 Tōhoku Earthquake” (Unpublished working paper, University of Michigan, Department of Economics, Ann Arbor, MI, 2014); Vasco M. Carvalho, Makoto Nirei, and Yukiko Saito, “Supply Chain Disruptions: Evidence from the Great East Japan Earthquake” (RIETI Discussion Paper Series No. 14035, Research Institute of Economy, Trade and Industry, Tokyo, 2014). 31 Jean-Noël Barrot and Julien Sauvagnat, “Input Specificity and the Propagation of Idiosyncratic Shocks in Production Networks,” Quarterly Journal of Economics 131, no. 3 (2014): 1543–92.

94 | REVITALIZING THE SPIRIT OF BRETTON WOODS cross-border exposures in bonds, equi- arrangements—but that is where the ties, housing, and capital flows, can lead current international economic policies to cascading defaults and failures. and thinking lie. Technology has precipitated more Brexit is a major disruption in intense specializations around the networks. The calculable cost is still world. Examples abound in which spe- unknown. And the UK’s rupture with cific countries’ resources and inputs can the EU is mainly regulatory rather than realize their full value only in a world physical. The chaos we have already with linkages: cheap labor in devel- witnessed at the border points between oping countries became an important the UK and France indicates that in the asset when technology advanced and present-day world, the networking in trade costs fell; oil from Middle Eastern terms of policy, regulation, and other countries was useless 150 years ago but nonphysical issues is no less crucial than is a critical input to the world’s output the tangible and visible connectivity. today; rhodium and lithium are now Whether it is a hard Brexit, a soft Brexit, valuable only because the world needs or a blind Brexit, Britain’s tendon, deep batteries to produce electric cars. The under the skin, is snapped, and all of networks and linkages make country-­ the unprepared-for consequences are all specific inputs and products more of a sudden apparent to the naked eye. valuable, which in turn makes the net- Already, the English Channel looks like works and linkages more valuable, and an artery clogged up by cholesterol. It so on and so forth. is reported that trucks now back up This cycle makes the importance of for miles outside the tunnel’s entrance connectivity, both physical and digi- and passengers have to wait for board- tal, ever more crucial in this modern ing Eurostar trains. Slow and longer day and age. Ideas feature economies processes in clearing trucks, cars, and of scale. Physical infrastructure makes passengers at ports, train stations, and markets larger; digital infrastructure the tunnel linking Britain with France and technology makes ideas display and the rest of Europe is expected to be greater economies of scale. And because routine. Even though both the UK and ideas are now of more value than ever France have substantially increased cus- before, infrastructure serves an even toms officers, security staff, and other greater purpose in connectivity. The employees, things will get worse yet connectivity makes the inputs more after Brexit. Breaking connectivity and important, in turn heightening the networking, physical or nonphysical, benefits of connectivity. As crucial as is no joke. these notions may seem, they are not If linkages are crucial, will every described nor fully captured by simple nation do its part to build these measures of cross-border goods and linkages and internalize its own exter- financial flows, bilateral or multilateral nalities on the network? Take again

REVITALIZING THE SPIRIT OF BRETTON WOODS | 95 the example of infrastructure, which countries, there is not only an issue of connects countries via roads, railways, willingness but also one of capacity. power transmission lines, and gas pipe- After all, building links across nations lines. It may well be that China would is more difficult than building them like to build connections of its hith- within nations. Cross-border frictions erto isolated hinterlands to Europe. and distortions abound—be they politi- But if neighboring countries such as cal, regulatory, informational, or due to Kyrgyzstan or Tajikistan cannot build unaligned incentives. In this instance, railways and highways that link them should there be a supranational actor, with their surrounding nations, then or a lead sovereign actor, that plays the the transport linkages that China builds role of coordinating nations and miti- with this purpose in mind are of no gating these frictions? If the traditional substantive value. Similarly, Kenyan hegemon was a great power strong ports are modern and efficient, but in enough to force the other countries to the absence of a railway link that con- follow the rules it had created, the new nects Angola to the coastal areas, these power of a network leader should be ports fall short of achieving their poten- that of a connected and central partic- tial, and Angola’s precious resources ipant that initiates, creates, and expands remain beneath the earth. networks. The concept behind such a The more connected the entire leader should be different from that of network is, the more valuable is each a hegemon, and so should its behavior. link. Only when the global network of But who will play this new role, and infrastructure is constructed with rela- how much should each nation contrib- tive completeness is its externality the ute? The question of burden sharing greatest, are its productivity gains the among states in the global provision largest, and does each segment of the of public goods is a time-dated con- infrastructure linkage reach its great- troversy. It goes back to the classic est value. In this sense, the actions of problem of how much rich countries each sovereign nation have considerable such as the United States should con- externalities at a global level. tribute to NATO spending. Olsen and Zeckhauser provided a theory as to why it makes sense for large, rich CHINA: AN ENABLER? countries to shoulder a disproportion- If governments do not fully internalize ate amount of defense spending while these externalities, efforts to build and allowing smaller and poorer allies to maintain networks will be subopti- enjoy a free ride.32 In 1980, the United mal. Moreover, when it comes to small States’ contribution to NATO was

32 Mancur Olson Jr. and Richard Zeckhauser, “An Economic Theory of Alliances,” Review of Economics and Statistics 48, no. 3 (1966): 266–79.

96 | REVITALIZING THE SPIRIT OF BRETTON WOODS around a 75 percent share (68 percent Challenger broke apart 73 seconds into in 2016), larger than what is required its flight in 1986, it was the failure of a for its relative GDP size and larger than single inexpensive rubber seal (O-ring) the estimated relative benefits it derives that killed the entire crew. (around 35 percent).33 The flip side of China’s Belt and Road Initiative, the this argument is that by getting other grand plan to connect Asia, Africa, and countries to contribute to some of the Europe, aims to connect and build net- defense spending, the United States can works. In infrastructure networks, there avoid paying for 100 percent of it. are some “critical nodes”—occupied by Global networks and public goods countries in important geographic and share some similarities but are still dis- strategic locations. But some of these tinct concepts and require different countries may be too small and too thinking on international cooperation. poor to build cross-border infrastruc- Building linkages to form a network is ture. Moreover, they may not be able different from contributing to public to handle the range of risks that infra- goods. Efforts in the latter are often structure entails—uncertainty associated more substitutable, while those in with the long gestation period, regula- the former are more complementary. tory changes, disruptions in financing, If countries spend less on building operational glitches, and the like. In this military alliances or supporting inter- case, the active participation of a larger national organizations, other countries nation with capacity and scale, capable of can compensate by spending more. But mitigating or absorbing such risks, may in the case of many networks, reduced be critical. But why is China the large efforts in one country can substan- nation incentivized to bear the brunt of tially affect the entire network. In the the burden on this project? Arguably it extreme case, in which each country’s can derive more private benefits from inputs are “critical,” then the failure this particular network than can, say, of one nation’s contributions to the other large economies. It occupies a network will lead to the collapse of more central position geographically, the entire system. In this scenario, the and it also relies more on trade with network is only as strong as its weak- other countries and is more dependent est link.34 When the space shuttle on resources in Africa.

33 Todd Sandler and Keith Hartley, “Economic of Alliances: The Lessons for Collective Action,” Journal of Economic Literature 39, no. 3 (2001): 869–96. 34 Michael Kremer, “The O-Ring Theory of Economic Development,” Quarterly Journal of Economics 108, no. 4 (1993): 551–76; Charles I. Jones, “Intermediate Goods and Weak Links in the Theory of Economic Development,” American Economic Journal: Macroeconomics, 3, no. 2 (2011): 1–28.

REVITALIZING THE SPIRIT OF BRETTON WOODS | 97 CHINA: A GLOBAL Perhaps no country understands the NETWORKER power of networks better than China. Guanxi, or “connections,” has been a In today’s world, being at the center of linchpin of socioeconomic and political a network and becoming its most con- life for centuries, and all the way up to nected component has some substantial the present day. The rise through the privileges. The power derived from ranks of the political hierarchy relies on such positions in networks is nowhere guanxi; conducting business and under- better illustrated than in the histori- taking projects requires connections to cal example of the rise of the Medici the local party cadres; even finding the family in 15th-century Florence. At right doctor requires guanxi. the outset, the Medicis were not the Even from a historical point of view, wealthiest family, nor did they have China has been a purveyor of networks. the most political clout. The Strozzi The ancient Silk Road, begun in the family was more financially powerful second century BC, aimed to connect and had more seats in the legislature. Asia and Europe. It stretched about But by marriage, the Medici family 7,000 kilometers from Chang’an, the was the most connected component ancient capital in China, to Athens and of a network of intermarried families, Constantinople. The lasting legacy of economic relationships, and political the Silk Road is as much about bridg- patronages. Cosimo de’ Medici consol- ing cultures and people as about trade. idated political and economic power by Merchants learned the languages and leveraging the family’s central position, customs of countries to which they allowing the Medicis to become the traveled, and the knowledge helped “godfathers of the Renaissance.” with negotiation and commerce. The China is currently fashioning itself process of making paper was propa- into a successful global networker. gated worldwide via the Silk Road By participating in various areas of network, and the same is true of the global effort—whether it is building printing press technology. truly international institutions with sound corporate governance, coordi- nating global infrastructure projects, A LEADER IN THE AGE OF or building relationships with devel- NETWORKS oping and emerging economies—it is turning itself into the central and The growing connectedness of the most connected component in them.35 world is a key fact of our economic and

35 According to the American Institute, some US$340 billion will be spent on infrastructure as part of the Belt and Road Initiative. In 2018, during the Summit of the Forum on China- Africa Cooperation, Chinese leaders pledged about US$60 billion in financial assistance to African nations, and the country’s aid reached US$3 billion in 2018.

98 | REVITALIZING THE SPIRIT OF BRETTON WOODS political life, but if the field of vision suit work well as network builders, in is confined to the traditional economic terms of policy coordination and coop- lens, the world will still be viewed as a eration in addressing debt problems and collection of discrete and separate enti- financial crises, as well as cofinancing for ties. Developing intellectual frameworks physical infrastructure projects. that capture a global web in which ele- Forums such as Asia-Pacific Econ­ ments are connected, overlapping, and omic Cooperation (APEC) and the enmeshed has become imperative. So G20 have been playing a big role in have policy prescriptions that reflect international cooperation. China sets such global realities. More work needs great store by getting involved in these to be done on measuring the intercon- multilateral networks in a proactive nectedness of nations, the structure of way. Some China watchers in the West various networks, and the propagation seem to be concerned, even with a bit of shocks across these networks. of trepidation, over China’s potentially The three major pillars for a global dominant role in multilateral institu- economy in the post–World War II era, tions and forums. It seems that China namely, the International Monetary knows its limitation and has no super- Fund, the World Bank, and the World power pretensions in the American Trade Organization, manifest the way. Nevertheless, the country will try importance of networking. China has to play a bigger role in global affairs. consistently been a vocal advocate for a Whether China is an existential threat multilateral approach to addressing for- to other nations or a constructive player midable challenges facing the world. A in the international networking scheme change of representation at the Bretton will be determined by its actions. Woods institutions in 1980 rendered Perhaps the country should have the it possible for China to participate in ambition to shoulder greater respon- deliberation on global macroeconomic sibility and learn to be a global leader. situations, macroeconomic surveillance Cicero said, “You do not have to con- of individual members, broad policy vince me. Your authority convinces.” coordination, and development inter- China’s potential ability to claim such ventions, among other issues discussed authority depends on what it does and in the multilateral institutions. Being a will do, step by step, over years, and beneficiary of the international finan- maybe decades, by right intention and cial order established in 1945, China has right execution. reiterated that it has no intention what- A resilient network can’t be hege- soever of upsetting the international monic in the conventional sense. It needs order that has served the post–World governance to reflect multi­polarity. It War II world well, albeit with room also needs to permit others to mobi- for improvement. Bretton Woods insti- lize. China needs not only to play a tutions and all institutions that follow greater role but also to encourage other

REVITALIZING THE SPIRIT OF BRETTON WOODS | 99 members of the international commu- boot—but also to recognize the duties nity to do the same, if the established and rewards inherent in designing such leading nations decide to pull out and an architecture that enables others to abdicate their crucial responsibilities on flourish as it has flourished, that permits the global stage. In this sense, China’s greater integration as it has integrated, great destiny is not only to become the and where one country’s success begets largest economy—and a rich one to another’s.

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