From the days of the Bretton Woods Agreements to the beginning of the subprime crisis, the world witnessed an impressive resurrection of global finance and with it the re-emergence of international capital mobility (ICM). But the phenomenon of ICM is a contested issue among commentators. While some almost go as far as denying its existence, the most widespread discourse portrays ICM as a powerful external force, putting pressure on the state to adopt capital-friendly policies and reduce welfare expenditures. This notion of forced competition among states is manifested in the “capital mobility hypothesis”, which draws a parallel between the rise of ICM and its structural power to constrain the state. The following essay argues that this functional connection is not necessarily given, as the mobility of capital is derived from technical, financial and regulatory sources, while its power originates from discursive mechanisms. By looking at historical developments, it is shown that ICM did indeed re-emerge. But a close examination of the constraints it poses on the different categories of the state reveals that the latter retains significant “room to move”. To understand where the premise of the “capital mobility hypothesis” comes from, ICM is analyzed through discursive institutionalism. A number of relevant discourses are examined and it is concluded that the state itself plays a substantial role in creating and maintaining the idea of ICM’s power.
Financial markets form a highly globalized component of the current world economy, with a daily average turnover on foreign exchange markets alone averaging 3.21 trillion US$ in April 2007 (BIS 2007). Yet this central role had to be regained after a long period of relative subordination. The rise of international finance, “like a phoenix risen from the ashes” (Cohen 1996), can best be observed in the re-emergence of international capital mobility (ICM). ICM was intentionally kept low by the architects of the Bretton Woods Agreements, in order to allow the pursuit of Keynesian welfare programmes in the industrial states without jeopardizing their currency stability. However, the subsequent liberalization of controls, advances in technology and financial innovation saw capital swiftly regain mobility. This phenomenon has been of great interest to a vast number of commentators, resulting in a multitude of divergent opinions. While many economists are basing their models on the assumption of perfect capital mobility since decades (e.g. Mundell 1963), other scholars see obstacles that prevent capital from becoming more than partially mobile (Watson 1999). Those that agree on a substantial re-emergence of ICM are divided over its effect on state autonomy. The end of Bretton Woods and the widespread adoption of neoliberal policies across the industrial world gave rise to the popular discourse of ICM as an independent entity with inherent power, forcing states to pursue capital-friendly policies in order to survive in a competitive environment. This was incorporated into scholarly debate as the “capital mobility hypothesis”, which sees the state effectively constrained by ICM’s structural power (Andrews 1994). At the most extreme, states have been virtually reduced to an executive organ of the market (Strange 1996). Yet the “capital mobility hypothesis” and similar lines of argument do not distinguish between the mobility of capital and the power of this mobile capital, assuming that the second comes with the first. The following essay argues otherwise. The mobility of capital is shaped by technical, financial and regulatory factors. The power, on the other hand, is not inherent but originates from discursive mechanisms. Although ICM has re-emerged, the state remains a significant independent actor, itself creating and shaping discourses supporting ICM. Reminiscent of what Polanyi said about laissez-faire (Polanyi  2001:147), ICM was – to a significant extent – planned, and the state was one of its planners.
The re-emergence of ICM took place in the industrial economies before the current economic crisis and this essay will focus on these developments. The first section portrays this re-emergence by reference to important historic developments. Having argued that capital is indeed highly mobile, section two analyzes the constraints it poses on the state’s policy autonomy. The structural power of the “capital mobility hypothesis” is related to different categories of the state, with the result that the state, while limited in its policy choices, retains significant “room to move” (Mosley 2005). To understand how the discourse of ICM’s constraining power nonetheless came into being, the third section looks at it using discursive institutionalism. A number of discourses are analyzed, showing that the state played an active role in their creation and maintenance in order to follow its own political goals.
The re-emergence of international capital mobility
This section defines central features of ICM, which are used to highlight important historical developments framing ICM’s fall and rise. It ends with a critical evaluation of the degree of current capital mobility and establishes the claim that ICM did indeed re-emerge.
ICM is most suitably described as the capacity of capital to move within a given country and across jurisdictional boundaries without significant frictions (Andrews 2001). While the sum of all actual capital flows at any given time does reflect the capacity utilization, it is not a limit for ICM. Distinguishing the capacity from actual occurring flows of capital is essential, as it is the potential to move that indicates the integration of capital markets (Sinclair 2001). Since capital markets are a defining feature of capitalism (Gill and Law 1989), the degree of ICM is a central element of the world economy. The main sources of ICM, according to Andrews, are communication and information technology, financial innovation and the liberalization of domestic capital markets (1994). ICM is therefore also a political issue. According to the Mundell-Fleming Model, alternatively known as the “unholy trinity” (Cohen 1993), a national government can only obtain two out of the following three options at any given time: exchange rate stability, capital mobility and domestic monetary policy autonomy (Mundell 1963, Fleming 1962). Understanding ICM as capacity and recognizing its sources and its political implications proves useful in analyzing the following historical developments.
The first epoch where a high degree of ICM defined the international economy was the pre-war gold standard. Telegraphs started connecting the world and linked its financial centres, spurring international credit and investment (Bordo and Schwartz 1984). While natural barriers to transport and information remained, government barriers to capital flows were minimal (Cooper 1968). ICM was embedded in an international monetary system of fixed exchange rates. Domestic monetary policy was, in line with the Mundell-Fleming Model, reduced to safeguarding stable exchange rates (although limited policy autonomy was exercised (Knafo 2006)). Following World War I and the resulting economic turbulences, the leading powers tried to re-establish the gold standard economic setup, following the United States (US) belief that open financial markets could best stabilize the world economy (Costigliola 1977). But the Great Depression and the economic inability to maintain fixed exchange rates provoked a closing of economies, which saw countries building autarkic currency blocs shielded by capital controls (Eichengreen 1998, Frieden 2007). Experiencing the development of World War II against this background, the post-war planners that met 1944 at Bretton Woods to devise a new international monetary system introduced a profound change: while the adjustable pegged exchange rates were essentially fixed, domestic monetary policy autonomy replaced capital mobility as the second policy goal (Bearce 2007). The experience with floating rates during the Great Depression and the growing power of labour and unions through strike and electoral voice shaped this new interventionist setup, which Ruggie called “embedded liberalism” (1982). At its centre stood “national policy autonomy, especially in economic and policy matters” (Sinclair 2001:94). In order to ensure exchange rate stability while pursuing welfare policies, the International Monetary Fund (IMF) sanctioned the use of capital controls on the capital account to ward off “hot money” speculation (Article of Agreement VI, section III (IMF 2010a)). Current account liberalization had to be ensured by member states, but a transition period was granted (Article of Agreement XIV (IMF 2010a)). These arrangements created a dramatic decrease in ICM following World War II, a period Frieden calls the “world before capital mobility” (1991). While the duration of current account restrictions was significantly longer than anticipated, in 1958 the European economies restored convertibility. The ensuing liberalization of current accounts marked the start of ICM’s re-emergence (Helleiner 1996). The IMF proved unable to provide additional liquidity, which led countries to accumulate US dollars in order to supplement their reserves (Eichengreen 1998). This magnified the destabilizing effects of the Triffin Dilemma (Triffin 1978). In 1960 foreign dollar liabilities exceeded the US gold reserves, resulting in the adoption of outward capital controls (Eichengreen 1998). But relaxed regulations allowed the circumvention of these controls, most of all through the creation of the Euromarkets, an offshore market for dollar deposits situated in London (Goodman and Pauly 1993, Burn 1999). The Euromarkets, along with further liberalization of short term capital flows, boosted ICM (Pauly 1995). Financial innovation was accompanied by technical progress, e.g. the start of NASDAQ’s automated quotation system in 1971 (Ruder and Adkins 1990). Neither US controls nor supporting measures of European central banks could take sufficient pressure off the dollar, leading the Nixon administration to suspend convertibility in 1971. Successive devaluations of the dollar followed and the major currencies turned to floating rates, ending the Bretton Woods era by 1973 (Eichengreen 1998). From this point two divergent paths emerged, with the United States and Japan keeping floating currencies, while the majority of European states tried to avoid the corresponding uncertainties and pegged their currencies against each other. During the 1970s an arrangement called the “European Snake” dictated narrow fluctuation bands of 2¼ percent. It was replaced by the “European Monetary System” (EMS) in the 1980s (Frieden 2007). But pegging exchange rates was increasingly difficult after the 1970s, which according to Frieden marked the start of the “world after capital mobility” (1991). The removed exchange rate constraints initially boosted fiscal stimulation, as mobile capital became easily available for governments (Frieden 2007). But this trend was reversed in the 1980s with the emergence of a new set of neoliberal policies, encompassing deficit reduction and spending cuts, inflation fighting, privatization and further deregulation. Implemented in the US under Ronald Reagan and in the UK under Margaret Thatcher these became internationally known as the “Washington Consensus” (Williamson 1993, Williamson 2003). Advances in technology, financial innovation (Siegel 1990) and tax cuts for marginal tax rates on capital (Cohen 1996) increased ICM further. These developments destabilized the EMS and led to a severe widening of fluctuation bands, so as to render the whole system inoperative. With the prevailing forms of currency pegging becoming infeasible, a majority of European Union (EU) members chose the hardest peg of all, the establishment of the European Central Bank (ECB) and monetary unification (Eichengreen 1998). A parallel process saw the deregulation of capital controls within the European Community in line with the 1986 Single European Act (Helleiner 1996). Capital mobility thus reclaimed its place in the Mundell-Fleming model, while monetary policies geared to a considerable extent towards the reduction of inflation in order to reduce exchange rate fluctuation (Bearce 2007). Deregulation continued, but it were foremost technological advances in digital communications and financial innovation through new forms of derivates and trading technology that drove ICM to its peak (Lamfalussy 1985).
This “explosion in capital mobility” (Frieden 2007:402) is not uncontested. Opposing views are often based on empirical evidence of “home bias”, the preference of domestic investors for domestic firms. Citing Wall Street data from Piven (1995), Watson states that in 1993 Americans invested 95 percent of their capital in domestic stocks and bonds (Watson 1999). More recent studies confirm the international scope of this effect (Chan et al. 2005). Mittelman adds that ICM is exaggerated, as “flows of capital […] must eventually touch down in distinct places” (1996:229). These arguments are based on actual capital flows or allocation, not on the capacity of capital to move. Yet, as mentioned before, it is the capacity that indicates the degree of capital mobility. Asset-specificity is mentioned as a second limitation of ICM. This refers to a division of capital into highly mobile finance capital and specific capital, with the latter confined to a higher degree to territorial space (Frieden 1991). While this twofold division might be oversimplified (Sinclair 2001), it rightfully does point at differences in mobility. Thus it is true that perfect capital mobility, as used in many economic models (e.g. in Mundell 1963), is not applicable either. But the look at the historical developments offered conclusive evidence for the dramatic increase in capital’s capacity to move, supporting the claim that ICM did indeed re-emerge.
Returning to the Mundell-Fleming Model, it seems that domestic autonomy was reduced to safeguarding a minimum amount of exchange rate stability. The “capital mobility hypothesis” explains this as a consequence of the constraining power inherent in ICM. As this proposition is also reflected in the mainstream discourse, it deserves a closer look.
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- Capital Mobility Structural Power Capital Mobility Hypothesis discursive institutionalism state autonomy discourse