Dynamics of global financial governance: Constraints, opportunities, and capacities in Asia Open Access

Abstract

Policy design, or the deliberate governmental effort to attain desired policy objectives, is an integral part of micro and macro-level fiscal and financial regulation. This paper seeks to address the role of regime coherence and policy capacity in contributing to effective financial policy design. Drawing on the cases of the Global Financial Crisis and Asian Financial Crisis and focusing on Asian states, we assess regime capacity at both international and domestic levels. We argue that it is the integration of analytical, operational and political capacities that have contributed to the overall ability of a government regime to address and respond to crises.

1 Introduction

Policy design, or the deliberate governmental effort to attain desired policy objectives, is an integral part of micro and macro-level fiscal and financial regulation whose salience has increased in recent decades, reflecting growing recognition of its role in driving economic growth (Beck, Levine, & Loayza, 2000; King & Levine, 1993; Levine, 1997). As a result, governments around the world have devoted considerable efforts to maintaining and promoting the ‘finance-growth nexus’ deemed crucial for continued economic and financial sector growth (Woo, 2015, 2016). In the context of Western developed economies at least, such efforts have largely focused on the development and implementation of financial regulatory and supervisory infrastructure, notably in the form of codes of conduct, disclosure laws, regulatory bans and rules of conduct (Capie, 2007; Murinde & Mlambo, 2011; Vittas, 1993), intended to enhance transparency and discourage risky behavior, including fraud and malfeasance.

However, neither policy designers nor policy analysts have been able to adequately address the conditions that trigger crises or the capacities required to prevent or ameliorate crises, as their continued frequency and pervasiveness appear to demonstrate. This is due at least in part to the fact that the nature and form of financial regulatory policies promulgated has often been motivated and determined by extant political interests and contestations as well as the influence of political and technocratic elites (Carney, 2001, 2010; Hamilton-Hart, 2002; Lall, 2012; Rajan & Zingales, 2001). However, the exact impact and influence of such activities varies and is little understood.

We seek to address this gap by relating the design of domestic financial policies to the coherence of the relevant internal and international policy regimes. By coherence, we refer to the extent to which the various components of a regime (policy processes, objectives, actors, institutions, etc.) are arrayed and directed towards some collectively defined purpose (Howlett & Rayner, 2006, pp. 168–169). We argue, following Wu, Ramesh, and Howlett (2015), that three types of capacities enhance regime coherence — analytical, operational and political — and that each of these is an important determinant of successful or unsuccessful financial policy design.

That is, a deficiency in any of the components of capacity may pose dire implications for policy and governance as this could lead to a lack of coherence in policy outputs and processes. More importantly, deficiencies in the capacity of either domestic or international regimes or both can result in undesirable policy outcomes. In sectors such as finance and banking, these deficiencies often manifest in crises, which occur when a regime is not capable of dealing with exogenous and/or endogenous shocks. However, and as we further argue in this paper, there are also positive aspects of such crises, as when they provide ‘windows of opportunities’ for policy designers to assess existing deficiencies in regime capacity, stimulate reconfigurations of regime dynamics, and embark on capacity-building efforts which can promote greater integration and regime coherence.

In order to explicate our argument, we draw on the cases of the 1997 Asian Financial Crisis (AFC) and the 2008 Global Financial Crisis (GFC). We focus especially on the impacts of these two crises on the banking and finance sector in Asia. However, unlike most comparative case studies, the two crises are studied as chronologically linked cases. Taking such a chronological approach allows us to assess changes and adaptations to regime coherence and capacities over time. It further allows us to establish a ‘checklist’ of regime capacity, which, along with our conceptualization of regime coherence, offers a useful analytical tool for assessing regime capacity and identifying any shortcomings or deficiencies in capacities which states and regimes may have. This provides a more systematic way of understanding the ways in which regime capacity and coherence can facilitate the design of effective financial sector policies which has implications for other sectors.

2 Multi-level governance and international regimes

In an interdependent and globalized world, public policies are increasingly characterized by transnational origins and consequences. This is particularly true for banking and finance, which in most countries has become increasingly globalized (Eichengreen, 2008). This globalization of finance and banking has brought new challenges for national policymakers as they now need to cooperate and coordinate policies not only at the domestic level, but also at the international level, with the consequence being a weakening of these policymakers’ autonomy, in addition to the growing difficulty of governing national regimes across this increasingly complex policy landscape.

Finance and banking policies increasingly require cross-border regulatory cooperation and coordination to be effective (Rodrik, 2012; Schoenmaker, 2011). This internationalization of regulation poses major challenges for national regulators, with states struggling to define the boundaries of monetary sovereignty in the globalized world economy (Lastra, 2006; Zimmermann, 2013).¹ The emergence of networks of policymakers in the form of “transgovernmental coalitions” (Keohane & Nye, 1974), or “transnational executive networks” (Slaughter, 2005), the rise of private sector and non-governmental organizations (NGOs) (Büthe & Mattli, 2013; Keck & Sikkink, 1998; Rosenau & Czempiel, 1992; Strange, 1996; Tsingou, 2015), and a greater role attributed to intergovernmental, regional, or international organizations are all recent developments and have raised questions over the extent, or indeed possibility, of the capacity of national authorities to effectively regulate finance and banking on their own.

The Basel Committee on Banking Supervision (BCBS) was established in the 1990s in response to these issues and serves as a mechanism for sharing information among national regulators to help address these mounting coordination and capacity problems (Goodhart, 2011; Kapstein, 1992, 1994; Walter, 2008; Wood, 2005). Over time, the Committee has become the de facto international regulator as more states adhere to successive Basel guidelines, especially the more recent post GFC-inspired Basel III standards (Cihák, Demirgüç-Kunt, Pería, & Mohseni-Cheraghlou, 2012). Among other things, the Basel agreements allow national regulators to discuss regulatory challenges and share information about international banks operating within their jurisdictions (Drezner, 2008; Raustiala, 2002; Slaughter, 2005). Following discussions and negotiations under the auspices of the Basel Committee, national regulators have developed international standards and principles to reduce inconsistencies across jurisdictions, and also define the rights and responsibilities of host and home jurisdictions in their regulatory measures.

This coordinating and capacity-enhancing role of the Basel Committee has been augmented by the growing influence of the International Monetary Fund (IMF), although the outcomes of this development remain mixed and even controversial (Rodrik, 2012; Stiglitz, 2003; Woods, 2006). As we will argue below, the IMF's strength lies in its technical capabilities, but limitations in its political capabilities and doubts over its ideological predilections have come to undermine the efficacy of its operations, undoing some of the advances in international or trans-national regulation gained through the Basel process.

Based on these concerns, it is increasingly clear that there is a need to focus on global public policymaking processes (Stone, 2008), in particular the interlinkages between the domestic and international levels of policy (Hobson & Ramesh, 2002; Howlett & Ramesh, 2002; Putnam, 1988; Ramesh, 1995) in order to understand developments and dynamics in this sector and deal with capacity issues. This requires us to reflect more on how the internationalization of public policies has changed the nature of both domestic and international policymaking, and how various preferences are transferred to and from domestic or international levels.

3 Policy regimes and international finance and banking regulation

The governance of globalized finance and banking sectors requires a multi-level governance system, and a theoretical and empirical understanding of how such systems function is essential for effective regulation (Helleiner & Pagliari, 2011). One way to study these relationships is through the heuristic of policy “regimes”. Such regimes have received a significant level of attention from international relations scholars over the past 2–3 decades but these studies have focussed almost exclusively on the international level and adopted a largely structural approach to understanding their subject matter, that is, ones which view regimes mainly as a source of constraints on domestic politics and policymaking (Cerny, 1993; Checkel, 1997; Cortell & Davis, 1996; Drezner, 2008; Gourevitch, 1978; Haggard & Simmons, 1987; Kastner & Rector, 2003; Keohane, 1982; Krasner, 1983; Levy, Young, & Zürn, 1995; Ropp & Sikkink, 1999; Ruggie, 1982; Young, 1989). The separation of the international from the national context often found in this work is, however, not helpful in guiding institutional and policy design in a trans-national or “intermestic” context such as finance and banking (Haggard & Simmons, 1987).

In contrast to the systemic-structural approach taken by scholars of international political economy (IPE), regimes in public policy studies are typically defined as a set and enduring configurations of actors, institutions, ideas and policies found in a policy sector, typically at the national but often at the sub-national level (Doern & Wilks, 1998; Doern, Schultz, & Hill, 1999; Esping-Andersen, 1990; Howlett, Ramesh, & Perl, 2009, p. 201; Kolberg, 1992; Rein, Esping-Andersen, & Rainwater, 1987). Aside from differences in nomenclature, there are substantive differences in the way that IPE and public policy scholars understand such regimes. For one, policy regimes emphasize the role of actors in determining both policies and regime formation (Howlett et al., 2009; Wilson, 2000), and even dominating these processes in the absence of state structural authority in this area of regulatory activity (Cutler, Haufler, & Porter, 1999; Haufler, 2001; Strange, 1996). A policy regime is seen as a set of “long-term stable power arrangements” (Wilson, 2000, p. 258), with the confluence of interests among different actors solidifying into a structured set of institutions designed to ensure policy-making unfold in correspondence to dominant interests and ideas about policy goals and the means required to achieve them. Indeed, scholars have found that policy regimes determine and structure policy design processes (Howlett, 2009) and actor behavior (Eisner, 1994) through their impact on national actors’ capacities, by imposing constraints on policy actors or in other instances enabling and empowering these policy actors existing within the institutional and ideational confines of a policy regime. Policy regime studies have therefore retained a relatively strong focus on history, institutions and ideas (Eisner, 1994; Harris & Milkis, 1996) which international regime studies lack.²

However, these and other similarly institution-centric approaches to studying policy regimes tend to take a static approach to understanding policy and institutional change, implicitly highlighting regime stability over instability and often equating change only with institutional change (Hall & Thelen, 2009; Heyes, Lewis, & Clark, 2012).

An effort to overcome this divide between IR and policy studies-oriented views of regimes can be found in recent work which place regimes on a continuum between integrated or comprehensive international regimes on one end and fragmented institutional arrangements on the other (Biermann, Davies, & van der Grijp, 2009; Biermann, Pattberg, van Asselt, & Zelli, 2009; Keohane & Victor, 2011). More often than not, empirical studies have found the reality to lie somewhere between the poles of the continuum. Policy regimes with hybrid national–international natures have been characterized as “regime complexes”(Keohane & Victor, 2011) or “governance architectures” (Biermann, Pattberg, et al., 2009) rather than pure ‘regimes’ in the IR sense of the term. As Putnam (1988) has so succinctly put it, such international and domestic regimes are “inextricably entangled” within a “two-level game” in which activities at one level affect the other and vice versa. This has important implications for policy design process and policy outcome attainment, with effective policy design contingent upon the coherence of the policy regime within which the designer is embedded, but the coherence of the regime itself being a result of somewhat contingent historical processes.

4 Policy regime type and policy design outcome

Policy design is an inherently spatial and contextual endeavor, carried out by policy elites situated within the institutional and political context of a ‘design space’ which determines what is considered appropriate and feasible activity on the part of governments (Linder & Peters, 1991; Weimer, 1992). Policy regimes, by virtue of the configurations of actors, institutions and ideas that they embody, constitute the design space within which policies are designed and implemented.

The ‘messy’ policy regimes found along the belt of hybrid regimes in areas such as finance and banking regulation often result from inconsistent policy design processes such as ‘layering’, ‘patching’ or ‘drift’ which occur as policy iterations in responses to crises. This perpetuates suboptimal designs and can lead to further crises and temporary and expedient changes rather than careful consideration of policy options and alternatives (Howlett & Rayner, 2006, 2007, 2014).

How can improved policy designs emerge in such contexts? There is emerging interest among scholars of international regimes on the specific factors or variables that contribute towards the coherence of a regime (Giessen, 2013; Keohane, 2012). For instance, Keohane and Victor (2011, pp. 8–9) have identified three ‘forces’ that determine the extent of coherence or fragmentation in a regime: (1) the distribution of interests (or concentration of power), (2) uncertainty over risks and gains, (3) linkages between issues.

Effective policy-making within a particular regime, however, hinges upon the extent to which the components that make up the regime, specifically policy objectives and instruments, are coherent or work together in the same direction rather than at cross-purposes (Howlett & Rayner, 2006, pp. 168–169). Regime coherence applies to the nature of goals pursued at both the international and domestic level and, especially, across both levels. This is illustrated in Table 1.

A coherent and optimal design space, the ideal scenario, requires a high degree of congruence between the elements making up an international and domestic regime. In such a situation, policies, norms, and socio-political considerations can be aligned across both levels and there is possibility for problems to be approached and addressed comprehensively. An example of this was the implementation of Basel III standards in Singapore, which involved both officials from both the MAS and international organizations pulling in the same direction and promoting the same goals and instruments of regulation (Woo, 2016). Conversely, the least desirable scenario involves low congruence between international and domestic regime elements which fosters incoherent policies and a sub-optimal design space as different interests and ideas are promoted and enacted by different levels of government. Such instances have resulted in misaligned interests and policy mismatches, such as the repeal of the Glass-Steagal Act by the US government, which was a major contributing factor to the GFC, undermining years of effort at the international level to lower risky behavior among financial institutions (Crawford, 2011; Lucas & Robert, 2013).

However, regime coherence and design spaces often fall between these two extremes. For instance, highly coherent domestic regimes may be faced with incoherent international regimes. This may result in the formulation of strong national regulations without the need to incorporate relatively weak international standards. This is most evident in the lack of support, and indeed compliance, among many national-level regulatory agencies with Basel 2 standards prior to the GFC. However, such a ‘political design space’ may also facilitate regulatory capture, as the interests of domestic regulators and bankers run unchecked by international regulators or external auditors, as was the case during the GFC, when many countries’ regulations were found to be biased towards major financial institutions considered to be “too-big-to-fail” (Baker, 2010; Claessens, Kose, Laeven, & Valencia, 2014).

Other problems emerge when highly coherent international regimes encounter incoherent domestic regimes. In such instances, regulatory standards and interventions from international organizations may be taken on wholesale by domestic regimes that lack a coherent policy or regulatory framework capable of effectively enforcing them. While such a technical design space can benefit domestic regimes that lack the capabilities to develop effective financial policy-making themselves, international organizations may also be insufficiently attuned to domestic political economic circumstances. This may result in policy recommendations from international organizations that turn out to be unsuitable or even detrimental to domestic financial governance, as was the case during the Asian Financial Crisis (AFC), when policy recommendations by multilateral organizations such as the IMF served to further exacerbate the situation for client countries, particularly in terms of fiscal and monetary tightening measures that placed additional pressures on companies and governments already in debt (Higgott, 1998; Stiglitz, 2003).

5 Governance capacity and financial policy

In general, a congruent international–national regime enables the development of more coherent policy regime. However, coherence remains a vague measure of policy effectiveness within a regime. There is therefore a need to further delineate the variables that make a policy regime coherent and hence ‘capable’ of effective policy design and implementation.

In general, the congruence of a regime requires a certain level of individual, organizational and systemic capability for effective policy-making (Wu et al., 2015). This focus on competence or skills has received attention in recent scholarly work on ‘policy capacity’, which has defined capacity as the “set of skills and resources — or competencies and capabilities — necessary to perform policy functions” (Wu et al., 2015, p. 2). While economists have long recognized the importance of information, or access to it, in ensuring efficient market outcomes (Akerlof, 1970; Williamson, 1979), particularly with regards to financial markets (Darrough & Stoughton, 1986; Hellmann & Stiglitz, 2000; Mishkin, 1990; Pauly, 1974), much less has been said about the ability of governments and regimes to process and use this information. It has nonetheless been noted by scholars of policy capacity that the effective use of data and evidence can contribute to inter-actor trust and cooperation (Hsu, 2015) as well as effective policy evaluation and analysis within governments (Howlett, 2015; Pattyn & Brans, 2015). Analytical capacities are therefore a significant determinant of a regime's ability to process, analyze, and utilize informational resources in addressing policy issues.

Yet, such ‘back-end’ data processing activities are not, on their own, sufficient for ensuring high levels of regime capacity. Regimes need to possess the capacity to facilitate policy action, based on the insights gleaned from information. This requires individual and operational and political capacities that frequently also require high levels of implementation capacity in the public administration system involved (Peters, 2015). Operational capacities, in particular, are significantly enhanced by high levels of policy coordination among policymakers and public organizations (Peters, 2015), as well as among elected political leaders and unelected public officials (Tiernan, 2015).

This need for coordination, particularly between political leaders and public administration, points towards the significance of political aspects of regime capacity. Such political capacities, often associated with issues of trust and legitimacy (Woo et al., 2015), which are especially important in dealing with the perceptions and norms associated with regulation (Ruggie, 1982). Indeed, high levels of such political capacities facilitate the formation of policy or political coalitions and the management of inter-actor interests and relations through political engagement and trust-building, two key aspects of financial and banking regulation (Dunlop, 2015; Pal & Clark, 2015; Woo et al., 2015).

Such political relations have been shown to be significant in the historical development of major financial centres and the formulation of regulatory policies over time (Carney, 2001, 2010). Given its role in managing political relations, political capacity is also strongly related to considerations of power and coercion, with its various modalities — soft/hard, public/private, formal/informal, institutional/personal — employed by entrenched interests in the attainment of state, industrial and/or private goals (Cutler, 2003; Cutler et al., 1999; Nye, 2005, 2011; Strange, 1996). Such power relations and modalities are not restricted to the domestic level but are apparent in international organizations and networks as well (Barnett & Finnemore, 1999; Flemes, 2007; Kapstein, 1992; Rhodes, 1984; Vlcek, 2011) Positive policy outcomes are closely associated with high levels of political capacity, particularly in terms of fostering effective collective action (Hardin, 1982; Ostrom, 1990). Studies in regional financial policy, for instance, have shown that greater policy coordination contributes directly to a regime's capacity to attain its desired macroeconomic policy outcomes (Levine & Brociner, 1994; Oudiz, Sachs, Blanchard, Marris, & Woo, 1984; Sibert, 1992).

While high levels of analytical capacities contribute to the reduction of uncertainty and the information asymmetry that has often been the bane of financial policymakers, operational capacities foster closer linkages between policymakers at the institutional and organizational levels, in the process enhancing inter-operability and linkages among increasingly intertwined policy issues. Finally, political capacities facilitate the management and distribution of political interests within a particular regime. These three capacities are applicable to both international and domestic regimes and can be used as operationalized measures of overall regime capacity. This is done below in the financial sector, focusing on the role of policy capacity in two specific case studies below, namely the 1997 Asian Financial Crisis (AFC) and 2007 Global Financial Crisis (GFC).

6 Technical design space: the 1997 Asian Financial Crisis

The Asian Finance Crisis (AFC) of 1997 has largely been seen as the result of weak regime capacity at the domestic level, with ‘crony capitalism’ and insufficient supervisory oversight resulting in systemic weaknesses that proved vulnerable to external shocks and financial contagion. External aid, in the form of loan packages, from international agencies such as the IMF served to exacerbate the crisis, as the various financial reforms that made up the conditionality of these loans proved unsuited to domestic financial and economic conditions (Radelet & Sachs, 1998b; Stiglitz, 2003).

These conditions emanated from deficiencies in regime capacity at both levels, as shown in Table 2.

The sources of the AFC have been perceived to be relatively local in origin. Goldstein (1998, pp. 12–13) suggests that the buildup of credit booms and maturity/currency mismatches that had contributed significantly to the onset of the AFC were largely a result of regulatory and supervisory weaknesses in the affected countries. These weaknesses in the regulatory regimes of affected countries emanated from the simultaneous deregulation of domestic financial systems and liberalization of capital markets that rendered them incapable of dealing with the risks associated with inflows of ‘hot money’ (Radelet & Sachs, 1998a, pp. 13–17; Wade, 1998, pp. 1539–1541).

While the cause and severity of the AFC have often been attributed to ‘crony capitalism’ or political rent-seeking, others have noted that these in themselves cannot explain the crisis, even as they have influenced post-crisis policy responses, particularly in Malaysia and Thailand (Jomo, 2000, p. 26). Such regulatory weaknesses have often been attributed to weaknesses in many of the countries’ political governance models. These range from political uncertainty (Radelet & Sachs, 1998a, p. 33) to excessive and/or inappropriate levels of government influence over banks (Wade, 1998, p. 1540) as well as alliances between financial interests and politically influential rentiers (Jomo, 2003, p. 13).

Political capacities at the domestic level were also not evenly distributed across the affected countries. It has been noted that countries which were able to foster legislative and interest group support, particularly democracies such as South Korea, had a better chance of initiating and instituting the various institutional and policy reforms necessary for recovery (Haggard, 2000, p. 2). However, in other instances, political resistance proved to be a stumbling block to reform. In other words, political capacities at the domestic level contributed towards regime (in)coherence by facilitating (or not) coalition formation and the (mis) management of interest groups.

While deficiencies in political capacity such as ‘crony capitalism’ or political resistance do suggest deficiencies in political capacity, the occurrence of the AFC can also be attributed to other factors and deficiencies in policy capacity. For instance, it has also been noted that the AFC was as much a consequence of ill-timed economic liberalization as it was a matter of weak regulatory infrastructure (Jomo, 2003). This suggests low analytical capacity in domestic regimes, given the inability of policy-makers to accurately perceive financial risks and at best, the presence of only moderate operational capacity, since policymakers were aware of the tools and consequences of market liberalization but not necessarily attuned to their implications — massive capital inflows.

However, domestic regimes were not entirely to blame, as most of these East Asian financial markets had been relatively successful and stable in the decades leading up to the AFC (Radelet & Sachs, 1998b). Deficiencies in international regime capacity also exacerbated the AFC and delayed recovery. In particular, much of the criticism of the international regime has been aimed at the IMF which through its loan conditionality encouraged the rapid liberalization of financial markets, closure of several financial institutions, and the tightening of monetary and fiscal policy, the most notable of these being the raising of interest rates (Radelet & Sachs, 1998b; Stiglitz, 2003).

The failure of these measures to arrest investor panic during the AFC was largely attributed to the IMF's misreading of the situation, which had resulted in the application of ‘one-size-fits-all’ measures that were not congruent with the fiscal position and situational needs of their client governments and a lack of confidence among investors and financial institutions in the IMF's ability to meliorate the situation in the first place (Radelet & Sachs, 1998b; pp. 61–67; Stiglitz, 2003). While the IMF possessed the resources and legitimacy to implement its policy recommendations and enforce the associated conditionalities, its inability to replace the outmoded Washington Consensus with a more effective mode of international governance suggests deficiencies in analytical capacity. In other words, the IMF was also beset with deficiencies in its analytical capacity. However, the IMF nonetheless possessed the political capacity to mobilize the resource and capabilities necessary to implement these, albeit flawed, measures (Cerny, 1994; Vowles & Xezonakis, 2016, p. 71).

Sachs (1998) has pointed out three bases of the IMF's political authority and power: its role as an instrument of the US Treasury's interventions in developing countries, perceptions of the IMF as representative of the ‘world community’, and its image of ‘infallibility’. Yet while the IMF possessed the political capacity for advancing its own interests, it was not able to assuage investors or stem massive capital reversals during the onset of the AFC (Sachs, 1998). This suggests a need for greater granularity in our understanding of political capacity, particularly in terms of the socio-moral dimensions of this particular form of capacity.

In other words, operational capacities at the international level were at a moderate level while analytical capacities were low political capacities, in so far as these allow the advancement of the IMF's interests and policies, were high (Jomo, 2000, pp. 25–26).

7 Political design space: the 2008 Global Financial Crisis in Asia

The 2008 Global Financial Crisis (GFC) also reflected deficiencies in international regime capacity. However and also unlike the AFC, national economies and governments East Asia were much better prepared to deal with the GFC, largely because of the deep financial reforms that had taken place in the aftermath of the AFC. As Table 3shows, domestic regime capacity (in East Asia at least) was relatively stronger than international regime capacity. This resulted in a political design space, with the emphasis placed on capacity of domestic regimes to undertake effective remedial action.

While the origins of the GFC have been traced to a real-estate bubble in the US and the mortgage loans crisis that ensued with the bursting of this bubble (Shiller, 2012), the crisis took on global proportions with the failure and government bailout of major financial institutions in many countries, from Iceland to Spain (Stiglitz, 2010). More importantly, these ‘symptoms’ of the crisis were themselves a result of deeper flaws in national regulatory systems (particularly that of the US but also countries like Spain and Iceland) and the global financial architecture which allowed these deficiencies to proliferate (Baker, 2010; Bakir, 2013; Claessens & Kodres, 2014; Claessens et al., 2014; Crotty, 2009).

At the international level, the GFC revealed weaknesses in a global financial architecture predicated upon neo-liberal approaches of laissez faire economic governance and minimal regulation of markets that facilitated the growing complexity and opacity of financial markets (Crotty, 2009; Woo, 2015). In particular, international organizations such as the IMF were unable to predict the crisis and even when warning signs were provided by their analysts, unwilling and/or unable to act on these signs (Rajan, 2011). These suggest a lack of analytical and operational capacities that would have proven crucial in predicting and managing the crisis. This lack of analytical capacity was further emphasized in the continued adherence of many international actors to the discredited ‘efficient market hypothesis’ and its underlying assumption of markets operating on perfect information and the impossibility of collective failure of financial institutions (Ball, 2009).

It has further been noted that the ideological-institutional conditions for the GFC had been established by policy and financial elites, particularly those from the US and UK, who had advocated rapid economic liberalism and spread neoliberal principles of economic governance (Drezner, 2015; Drezner & McNamara, 2013; Higgott & Phillips, 2000; Stiglitz, 2010) and were able to influence the form and substance of global financial regulatory policies (Baker, 2010; Baker & Underhill, 2015; Engelen et al., 2012; Tsingou, 2015). There are therefore multiple levels of political capacity deficiencies in the run-up to the GFC. Further deficiencies in political capacity played a significant role in causing the GFC, particularly through the pervasive ‘capture’ of regulatory agencies by private interests within the Anglo-Saxon context (Baker, 2010). Instead of managing and orienting material political interests towards financial sector development or stability, financial regulators were ‘captured’ by banks and other financial institutions and hence subservient to the interests of these private sector actors.

In particular, deficiencies in political capacities in the US and UK facilitated the formation of power financial interests who, together with vested policy elites, were able to advocate global financial liberalization and influence global financial regulatory policy through transnational policy networks that often involved international organizations (Tsingou, 2015). This suggests that deficiencies in the domestic political capacities of the US and UK had flowed into international regimes, through the influence of vested interests and policy elites, the outcome of which are deficiencies in international political capacity.

In other words, international regimes exhibited low capacity in all measures, with deficiencies in each type of capacity combining with shortcomings in other capacities to spark off a ‘perfect storm’. For instance, a lack of regulatory autonomy in the US and UK contributed to the further deterioration of these governments’ ability or willingness to identify and act on early warning signs and as a consequence of their influence over international regulatory policy, resulted in deficiencies at the international level.

In contrast, national governments in East Asia were better prepared to deal with the GFC. The aftermath of the AFC had stimulated deep financial reforms, both at the domestic and regional level. In particular, institutional and regulatory reforms resulted in greater liberalization and denationalization of markets, strengthening of regulatory regimes, and the establishment of various regional arrangements for closer inter-state coordination during future crises (MacIntyre, Pempel, & Ravenhill, 2008, pp. 1–3). These regional arrangements include the Chiang Mai initiative, a multilateral swap agreement that was established to ensure the availability of reserves to member countries that come under speculative attacks.

These arrangements served to enhance operational capacity in regional-domestic regimes during the crisis. More importantly, the AFC imbued in many Asian countries an urgent need to develop capabilities for predicting crises. An ASEAN Plus Three Macroeconomic Research Office was established in 2011 as the ‘surveillance unit’ of the regional grouping's members, namely ASEAN, China, Japan and Korea (ASEAN + 3 Macroeconomic Research Office, 2012). This reflects enhancements in the region's analytical capacities, complementing similar efforts in growing such capacities at the national level.

Furthermore, the failures of IMF conditionality during the AFC prompted Asian countries, particularly Hong Kong, Singapore, Taiwan and Korea to establish healthy surpluses (Obstfeld & Rogoff, 2009, p. 9). In the cases of China and Singapore particularly, the availability of surpluses allowed for the mobilization of fiscal stimulus packages that proved effective in meliorating the impacts of the GFC and ensuring swift recoveries from the crisis (Das, 2010; Wong, 2011). The availability of financial resources and funds constitutes an important aspect of operational capacity (Wu et al., 2015, p. 13).

More generally, the experience of the AFC had sparked off deep political and financial reforms among many East Asian countries, with the result being more stable financial systems and transparent corporate governance among these countries (Haggard, 2000, p. 2). These represent enhancements in political capacity at the domestic level, with market stability, competition and transparency seen by Asian regulators as an important factor for stimulating financial sector growth and development (Woo, 2016). As discussed above, the reform-driven enhancements in domestic regime capacity stands in stark contrast to the serious deficiencies that were found in international regimes.

8 Conclusion: crisis-driven windows of opportunity

The analysis and arguments made above provide a clearer understanding of how regime capacity and dynamics evolve over time and, especially, in response to crises. This is true both in general and in the case of the financial sector examined in detail above. Specifically, the onset of a crisis was found to (1) exposes deficiencies in regime capacity, and (2) provide the policy and political impetus for capacity-building and reconfigurations of regime dynamics.

We have also found that it is the integration of all three capacities — analytical, operational and political - rather than any single type of capacity, that is crucial for ensuring the overall capability of a government or regime in the face of a crisis such as the AFC or GFC (Wu et al., 2015).³ There is, therefore, a need to assess regime capacity as an integrated whole, with all three capacities — analytical, operational and political — developed to their fullest potentials. Shortcomings in specific capacities can then be easily identified, with regime capacity-building efforts focused on these weak-links.

While East Asian economies have largely recovered from the GFC, the story of regime capacity has not ended. The aftermath of the GFC had placed greater attention on regime capacity at the international level, with a specific focus on the G20 and the IMF (Helleiner, 2014; Veron, 2012; Woods, 2010). In terms of operational capacity, the IMF has been furnished with USD 1 Trillion by the G20, while new international institutions such as the Financial Stability Board have been established, even as central banks across the world pledged to work together more closely (Woods, 2010).

Analysts have also sought to address the information asymmetries that plagued financial regulators during the GFC, with efforts made at improving analytical capacity, both at the domestic and international level (Alessi, Ghysels, Onorante, Peach, & Potter, 2014; Gilson & Kraakman, 2014; Tirole, 2012). Regulatory reforms have been carried out in a bid to address regulatory capture and political lobbying by financial firms, as governments have sought to address deficiencies in political capacity (Claessens & Kodres, 2014; Claessens et al., 2014). All in all, the GFC sparked new policy efforts at establishing an optimal design space by strengthening both international and domestic regime capacity.

It has long been noted that periods of instability can stimulate institutional and ideational shifts (Gourevitch, 1978). Indeed, focusing events or external shocks can provide such ‘windows of opportunity’ for policy entrepreneurs to stimulate change and reform (Kingdon, 1984). More specifically, Beeson (2014) has pointed out that the potential for institutional and ideational change is significantly amplified during financial crises, although such change can also be tempered by institutional inertia or path dependence within a regime.

In both cases explored above, the onset of crisis exposed deficiencies in regime capacity and, in the aftermath, stimulated policy efforts at shoring up these deficiencies through capacity-building. Such crises or ‘windows of opportunity’ may well be necessary for reconfigurations of existing design situations to occur. As the experience of IMF economists such as Raghuram Rajan has shown, pre-2008 warning signs of impending crises were ignored (Rajan, 2011). In the absence of crisis conditions, the impetus for policy and/or regime change is largely missing.

This, of course, is not to say that all policy change is necessarily crisis-driven. Endogenous efforts at initiating financial reforms may also take place in the absence of crises, with countries such as Australia and Singapore facing the 2007 GFC with relative strength and resilience in its financial system (Das, 2010; Stapledon, 2009). However, it is equally plausible that the reforms that had contributed to the resilience of these systems had stemmed from lessons learnt during past crises, especially the AFC (Carney, 2011).

Such ‘crisis-driven’ understandings of regime change and capacity-building correspond with existing approaches to policy changes that are similarly focused on exogeneous shocks (Baumgartner & Jones, 1991; Baumgartner et al., 2009; Birkland, 1996, 1998) or inertia in the absence of such shocks (Pierson, 2000). However, these existing approaches have taken a broad macro-level analysis that does not delve sufficiently into the regime dynamics and design situations that bound policy design activities. Nor do these approaches separate between international and domestic regimes, focusing instead on domestic policy processes. Both are required if these events and their causes are to be properly understood.

This will require further research and conceptualization that are focused on understanding regime capacities and dynamics within different contexts. Furthermore, and as the cases have alluded, there is also a need for a clearer conceptualization of political capacity, especially with regards to its normative aspects.

References

Footnotes