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Afterglow or Adjustment? Domestic Institutions and Responses to Overstretch
Mark R. Brawley
1998
7. The Rarity of Effective Adjustments
In the opening chapter, I raised several important questions about our understanding of the responses to overextension. While I generally agreed with existing arguments as to why overextension often occurs, I narrowed the discussion in the later chapters to cases of overextended hegemonic leadership. By specifying the cases under consideration in terms of leadership, I was attempting to keep international obligations (as determined by state goals) fairly comparable. 1 I also argued that overcommitment should be defined in terms of specific resources and obligations, and that these should be broken down by issue-area. I laid out the five broad categories of responses to overextension once commitments had been raised above a sustainable level: lowering commitments to match resources while raising resources (unsustained adjustment if resources had already crossed the level of sustainability, but adjustment if resources could be raised yet remained below the level of sustainability—since this would close both the gaps between commitments and sustainability on the one hand, and commitments and resources on the other), increasing resources to match commitments, or perhaps raising both commitments and resources (afterglow), increasing commitments while lowering resources (worsening afterglow), or lowering both resources and commitments (partial adjustment).
Several authors have previously noted that hegemonic leaders tend to respond to overextension with policies I define as afterglows. I then presented a possible explanation for the regularity of this occurrence and the rarity of adjustment: the afterglow hypothesis. According to this hypothesis (which has been floated in several forms, but never tested), liberal hegemonic powers would be likely to suffer afterglows because the domestic institutions created to pursue hegemonic aspirations would seek to continue leadership—no matter the costs—even after such policies were no longer beneficial for the country as a whole. This posed several questions. What were the likely goals of leadership? What were the institutional requirements for implementing policies to achieve those goals? How would support for these policies unravel, bringing on challenges to the institutions?
In the monetary issue-area, a liberal leader will seek to integrate markets. This is done most effectively when an international medium of exchange exists. The easiest way to create an international money is for a liberal hegemon to use its political powers at home to modify the national currency for international use. A central bank is required to manage the adaptation. Moreover, the central bank must be invested with specific powers that depend upon the currency’s characteristics. The real challenge for the central bank is to provide a balance between adequate liquidity for the national and international markets, while maintaining very high confidence in the money. This remains the main task for the central bank, especially once international use creates a currency overhang.
On the security side, a liberal leader will seek to defend and provide internal order to an international economic subsystem. This requires taking on military commitments beyond simply defending one’s borders. As noted in the opening chapter, sometimes these obligations are taken on in major war; nonetheless, the commitments become explicit in peacetime once military resources are reduced as the governments scale back their armed forces. To manage the development and deployment of military resources, to allocate resources to the different branches of the armed services, and to develop coordinated strategies, a combined general staff is necessary. This strategizing institution will then argue for the resources to maintain the extensive commitments made in earlier years. A reduction in commitments is likely to lead to a reduction in their resources and prestige, so the institution is likely to resist changes in their policy mission.
At the same time, I also noted in the first chapter that there was variation in the policy responses to overcommitment. Afterglows were not the only observable outcomes. To provide an explanation for variation in policy outcomes, I modified the afterglow hypothesis by adding two other factors. First, other institutions involved in the decisions had to be taken into account. The most important institutional actor that partakes in decisions about resources and commitments is the treasury, whose main concerns depend upon the fiscal situation. I identified a number of factors that make the treasury more likely to resist the allocation of greater resources to balance commitments, if not seek a reduction in obligations. Second, the degree to which the institutions of leadership seek greater resources in the face of overextension depends upon the size of the gap between commitments and resources, the presence of systemic rivals, and pressures from domestic constituents. Because I defined overstretch in terms of obligations, resources, and the maximum level of sustainability, I deliberately left out the likelihood of those commitments being tested. As the probability of a test of the commitments increases as a function of the interaction of the size of the overstretch and the presence of a systemic rival, the institutions of leadership are more likely to request greater resources. By combining these influences with treasury interests, and then offering some simple ways of understanding which institution was likely to prevail in disputes, I offered predictions about the likely responses to overcommitments. Let us turn to the sequence of questions posed in the opening chapter, and examine how this refined version of the afterglow hypothesis fared when applied to the cases.
Institutional Innovation
The first stage in the afterglow hypothesis concerns whether institutions were created to maneuver foreign policy toward leadership. I used the microfoundations of liberal leadership to identify when and where the pressures for institutional change would be voiced. Beyond simply asking whether the institutional changes occurred in the time-frame expected, I asked three more specific questions to explain when institutional changes would be successful. Did the policy in question need to be significantly altered, so that institutional change was actually required? Was there a wide consensus on the need for policy change? Did the expected institutional change sit well with existing institutions and traditions? I expected institutional changes to fail if the answer to any of these three questions was negative.
In the case of the Dutch, they began their hegemonic ascendance in the opening decades of the seventeenth century. The military command institution, the stadholderate, already existed. The Dutch had just been in a long conflict with Spain, so if anything the need for greater centralized military command and strategizing was called into question with peace in 1648. Moreover, there were fears that the stadholder posed a threat to republican institutions. These pressures ensured that the office’s powers were contested and ambiguous. Failing to improve the stadholderate’s decisionmaking powers (even over the military) meant the stadholder could not perform the complex functions required of balancing commitments with resources—hardly surprising given that in those days military staffs did not exist. Even within the practices of the period, the stadholder did not coordinate power as effectively as one might expect; both the stadholder and the different provinces could set commitments, while the individual provinces paid for military forces (and militia might even be paid for by municipalities). Despite being given nominal command in the specific posts of captain-general and admiral-general, a stadholder was likely to share decisionmaking power, and was entirely unable to coordinate between land and naval forces. This institution was not altered significantly by the Dutch aspirations to greater international leadership; instead, the Dutch tended to create and destroy the institution as the situation demanded.
On the monetary side, the picture is also mixed. The sectors most interested in creating an international medium of exchange were the source of pressure for the creation of the Bank of Amsterdam and other exchange banks in the other ports. The Bank was clearly designed as part of a broader effort to eliminate bad coins from circulation, and introduce coins evoking greater confidence. This was not a central bank in the modern sense, though its intended policy targets were to transform and then manage the currency in ways similar to a central bank’s tasks. The coins that were eventually produced were specifically designed to appeal to international audiences. The decentralized nature of the Dutch system (which hampered the development of military command as well) allowed the mints to remain in competition, however, which soon undermined the currency reforms. While an institution was created, it was unable to play its intended role.
For the British case of hegemonic ascendance, the situation was the exact opposite. The Bank of England was already in place, albeit as a private bank that handled government finances; there was no military staff yet (no mechanism for coordinating the army and navy, let alone coordinating the armed services with political decisionmaking), though reforms within the Royal Navy’s command took place. The economic issues tied up with the monetary problems of the early decades after the Napoleonic Wars and the economic rise of Britain were the source of the pressures for empowering the Bank of England. Parliament gave the Bank the powers to be a central bank in order to reduce liquidity and thereby instill confidence in the currency. The institutional design of the Bank itself, and of the Bank’s relations with the financial system, were specifically to eliminate the recurrent overexpansions of credit that undermined the international value of the pound, and not to provide the assurance of a lender-of-last-resort, suggesting strong support for the first part of the afterglow hypothesis.
Interestingly, Britain’s military strategizing institutions were relatively underdeveloped at this time, and remained so. There was some pressure to alter command institutions, though this pressure was aimed at making the top commanders answerable to Parliament, rather than the Crown. These efforts failed because of the opposition of the military, plus the opposition of former commanders—heroes such as the Duke of Wellington. Because the British military could claim to have successfully met previous challenges, reforms were blocked.
For the U.S. both the institutions in question were created before the nation began to aspire to international leadership. Once again, it is easier to see links between the domestic desires to assert leadership internationally and the creation of the central bank. East Coast financial interests provided the strongest political pressures for establishing the new institution, and they played a major role in the institution’s design. The Federal Reserve System was created to manage the currency—this time the problem with the currency was not overliquidity, because the gold standard rules limited any overexpansion of the dollar. The problem was not to raise confidence in the currency, but rather to make it possible to expand liquidity when necessary. In the terms of the time, the currency needed to be more “elastic.” This was linked to the development of responses to financial crises, so it is tied up with other functions of central banks. Nonetheless, the initial policy tools of the Federal Reserve were specifically to loosen the currency supply and add to New York’s competitiveness versus London, and little else. In pursuit of this latter goal, the legislation also supported use of other monetary instruments. This institution was firmly established, and its policy instruments strengthened by the end of World War II.
American military staffs were being developed by the turn of the twentieth century, because of shortcomings in the military’s performance in the Spanish-American War. Separate staffs were being created for the Army and the Navy, though there was a mechanism for coordinating between the two (the Joint Board). This development continued through the 1940s; a combined services staff could have been created out of the Joint Board during the interwar period, but this opportunity was missed. It was not until World War II that the Joint Chiefs of Staff was established. This body was in a position to execute the complex decisionmaking necessary to formulate a global strategy, and then develop and allocate resources accordingly. By the end of World War II, the U.S. had both institutions in place.
Looking at all the examples together, it is interesting to note how much more clearly central bank development is tied to hegemonic aspirations than is the creation of military staffs, undoubtedly because of the nature of hegemonic transitions. In each of the three cases, financial crises occurred as part of the economic developments that spawned hegemonic leadership. As noted in chapter 1, increased relative capital abundance is part of the dynamic building pressures to lead in international liberalization. That increased capital abundance also destabilizes the financial system. In the Dutch case, too many coins from different domestic and international sources were circulating. In the British case, capital accumulation gave birth to a great number of weak, inexperienced, risk-taking banks outside of London. Much the same occurred in the U.S. case. In both the American and British examples of leadership, the national financial system was not very well-integrated prior to hegemonic ascendance. The creation of the banking institutions was meant to eliminate the specific sources of instability in the currency and to integrate the national financial system. The Bank of Amsterdam was supposed to increase both confidence and liquidity via the creation of new coins. The Bank of England was empowered to reduce liquidity and increase confidence. The Federal Reserve was intended to boost liquidity without undermining confidence. Each institution’s design reflects the necessary adaptation of the currency given the specific problems of each case.
On the military side, hegemonic ascendance did not mean dealing with specific problems. That is, only in the U.S. case was it necessary to build the joint command structure in order to win victory in the major war that preceded hegemonic leadership. In the other two cases, success in war proved to be an obstacle to reforming command institutions. Moreover, in all three cases, the political leadership distrusted powerful centralized military command, and was reluctant to create military staffs. Military forces were drastically reduced in the early years of hegemonic leadership in each case, as well, although in the Dutch case this led to open conflict between the stadholder and the provincial authorities—conflict that would continue.
Domestic Institutions, Effective Leadership, and the Sources of Overstretch
Having established that in each case some sort of institutional innovation along the lines of a central bank was attempted, how did this institution affect the pursuit of leadership policies? How does this contrast with the military side of leadership, where institutional reforms were missing in two of the three cases?
In the Dutch case, the Bank of Amsterdam was created, but the other aspects of monetary reform failed to perform as planned. The mints did not work together to maintain the quality of the coins, and the good coins were not produced in enough numbers to meet demand. With those problems, the Bank of Amsterdam was forced to rely on its unit of account as the most effective currency for international transactions. This was effective though not ideal. But it also shaped what sort of success the Dutch had in integrating international markets. Individuals with accounts at the Bank were part of an international market, those who did not have accounts there were not. An international market of those dimensions might have been larger than before, but still relatively small.
The Bank of Amsterdam’s policies eventually led to a currency overhang, because the Bank did not hold on to enough resources to cover all the units of account on its books. However, two factors should be kept in mind when comparing this to the other cases. First, because the institution was barred from lending, its resources were never seriously in question; the loans it did engage in were secret. Second, because the bank-money was not in circulation, the impact of the overvaluation necessary to bolster its confidence once the overhang grew large was not necessarily felt throughout the domestic economy. Interest rate policies were not linked to the overhang, for instance. Instead, the overvaluation was done through currency market intervention.
In the case of the Bank of England, the empowerment of the institution led to the successful transformation of sterling into an international medium of exchange. Sterling was used more widely than other currencies, and its use gave British financial actors a competitive edge. The Bank and sterling were two of the key assets that made London the most important international financial center in the nineteenth century. For the U.S., the Federal Reserve made it possible for the U.S. dollar to challenge the role of sterling, and for New York to blossom into an international financial center rivaling London. Without the new institution, London could have remained the number one financial center much longer. Once the Fed was given greater powers over the currency (through discretionary policy on reserve requirements and open market operations) it was in a position to expand liquidity and maintain the currency’s confidence.
In both these instances, however, a currency overhang developed. With fixed exchange rate regimes, the international use of the currency led to too many units in circulation for the resources held in reserve. Several reasons for this tendency were noted in chapter 1, not least of which would be government fiscal policies. The attempt of the central bank in these two examples to manage international liquidity and confidence, as well as national concerns, also led to overextension.
On the military side, both the Dutch and the British lacked effective staff or strategizing institutions during the early decades of their attempts to provide hegemonic leadership. In both cases, the problem of overcommitment caused them to consider the need to create such institutions. In the British case, the need to develop strategies economizing forces led to the development of the Colonial Defence Conference, and then the Committee of Imperial Defence. Here was an institution that could possibly bring together naval and army commanders, along with cabinet officials, to formulate policies reconciling resources and obligations. The mere creation of the institution did not guarantee the quality of results, however. This was even true after World War I, when the single staff of the Combined Chiefs was formed. When the Dutch recognized the extent of their military overstretch, they toyed with an institutional apparatus to link the stadholderate and the politicians. All of these attempts, from the Secreet Besogne to Bentinck’s committees, and various formulations of the Council of State, were all frustrated by the competing political aspirations of the provincial authorities and the Princes of Orange. No stable institution emerged; they were instead created to deal with emergencies, and then just as soon disbanded.
The U.S. was the only one of the three countries to enter hegemony with a combined military staff in place. Further unification of the military soon took place, as the service departments themselves were united in the Department of Defense; postwar legislative reforms were also important for creating the NSC, which was charged with the duties of matching military and political policies. The U.S. should have been in the best position to make effective policies in this sphere. Yet again, the creation of the institution did not guarantee that the problem of overstretch would be avoided. If anything, the U.S. was overextended militarily sooner than the other two examples—sooner even than the Dutch who failed to achieve much in their attempt to liberalize the international economy. The U.S. had to develop policies to respond to overstretch during hegemonic ascendance.
The creation of central banks was pivotal for effective leadership in international liberalization. By establishing a domestic currency for international use, these policies also provided the possibility (if not likelihood) of a currency overhang. But the creation or lack of a military staff does not seem to be as important for effective hegemonic leadership. The joint military staffs do play an important role in the responses to military overcommitment once relative economic decline has set in, however.
Variations in the Responses to Overstretch
By breaking down the histories into specific issue-areas, we have at least six periods of overstretch to consider. In each case, it is impossible to say that overstretch was not recognized by contemporary decisionmakers. No matter which issue-area, or which time period, the top policymakers knew resources were inadequate to match outstanding commitments simultaneously. This is true for the Dutch military and for the Bank of Amsterdam after 1715, for the Bank of England and the British military from the 1880s on, and for the U.S. military even as the U.S. economy was pulling away from others (in the early 1950s), and the Federal Reserve from the early 1960s. It is impossible to say that any of these agencies failed to react to the problem. In fact, the more typical response was to explore several policies to resolve the shortfall in resources.
By pairing up similar cases, we can see how policy responses varied due to the interaction of the institution associated with hegemonic leadership and the institution charged with resource formation and expenditures (usually the Treasury). The degree to which the institutions associated with leadership desired to honor commitments was a function of the degree of overstretch, the emergence of systemic rivals, and pressure from domestic constituents; the Treasury tried to counter these by reducing resources or even slashing commitments due to a variety of factors indicating underlying budgetary constraints.
On the military side, both the U.S. and Britain exercised successful leadership, which made military overstretch much more likely. The U.S. grew overextended much faster than Britain, due to the bipolar structure of the international system after World War II. Britain had the luxury of few systemic threats at first, which allowed it to respond to overstretch by “doing nothing” about resources or commitments; instead Britain dabbled with troop deployments under the Cardwell reforms and institutional innovations. Redeployment of the Royal Navy would soon follow. Between 1880 and 1889, budgetary questions posed by Lord Randolph Churchill sparked an episode of underfulfillment of leadership. Additional obligations were made as the Empire was expanded, even though no new funds for defense were forthcoming. New money began to flow again from 1889 on closing the gap between resources and commitments (adjustment), as expenditures on the Royal Navy increased dramatically.
That gap was not closed completely, as the Boer War showed. When the budget became problematic again in 1900, the question of military obligations again became politicized; overstretch continued. In 1905, the systemic picture brightened for Britain as Germany emerged as the single greatest danger and the Russian threat to India subsided. 2 The Continental Commitment the following year, I argue, meant a serious overcommitment—Britain assumed new obligations without creating additional military units. Moreover, commitments were now beyond the level that the country could sustain, which qualifies as afterglow. After World War I, the “Ten-Year Rule” symbolizes worsening afterglow, as commitments were actually expanded while military assets were cut back. The end of the “Ten Year Rule” in 1932 marked a decision to invest in resources again (rather than to reduce commitments), which marks the return to afterglow.
U.S. responses to military overcommitment have also varied considerably. From 1945 to 1949, the U.S. sought to demobilize from its wartime buildup, despite extensive obligations. This underfulfillment of leadership was reversed with the outbreak of the Korean War and a realization of the need to devote more to military forces. From 1950 to 1960, American military commitments were kept, and greater military resources were developed though the cost was kept as low as possible under the Eisenhower Administration. There was a reshuffling of existing resources through new doctrines and redeployments, attempts to reduce administrative costs through centralization, then the reliance on nuclear weapons to deliver “more bang for the buck.”
Yet as the U.S. became vulnerable to Soviet nuclear attack in the late 1950s, reliance on nuclear weapons could not continue. The shift to the twin doctrines of “Flexible Response” and “Mutual Assured Destruction” required a military buildup, which brought on overstretch—especially when the Kennedy Administration proved it was willing to take on additional security commitments. Whereas the Kennedy Administration also thought additional expenditures were tolerable (or even desirable), such heavy commitments soon proved economically unsustainable. From 1960 until 1969, the U.S. underwent an intense expansion of the military as well as commitments, which marks continuing overstretch. Disenchantment with the war plus the budgetary problems of the late 1960s shows that the level of commitments became unsustainable. The Nixon Doctrine maintained commitments while reducing expenditures (partial adjustment); the Carter Administration made new commitments via the Carter Doctrine, but was unwilling to expand the armed forces (worsening afterglow). The Reagan Administration brought on an extensive buildup, even though the budget could not handle such spending for long (afterglow). Now that the Cold War is over, military forces are being lowered, and some commitments are in effect being reduced, though the reduction in the former has outpaced the reduction in the latter (partial adjustment), and commitments remain extraordinarily high and beyond sustainability.
In the monetary sphere, the British and American cases are particularly interesting to compare. The experiences of currency overhangs are quite similar; yet the policy responses are nearly opposite. In the early 1920s, Britain sought to maintain a fixed exchange rate system and sterling’s role in it versus the new rival (the dollar), in the classic example of afterglow. This policy was accepted by sectors hurt by the policy, as well as the Treasury, though opposition began in the period 1925–1930 as the afterglow worsened. The different bureaucratic concerns of the Bank of England and the Treasury plus the different interests of their constituencies helped to drive a wedge between the two. The fact that the pound’s role on gold was unsustainable brought about a partial adjustment, as the Treasury came to dominate the Bank of England in monetary policy.
For the U.S., the currency overhang emerged in the 1960s. The Fed and Treasury initially allowed the afterglow to worsen since there was little threat of a switch out of the dollar so long as there was no rival currency around. The U.S. could execute a partial adjustment in the 1970s, as the overhang grew too large: it tried to balance obligations and resources via a reduction in commitments (devaluation). This did not prevent the reemergence of the overhang problem (though technically an overhang cannot exist in a system of floating exchange rates—instead it is merely a matter of confidence in the currency dependent upon the country’s creditworthiness), and a worsening afterglow. In the 1980s, the emergence of possible rival financial centers—especially Tokyo—and the new reliance on foreign capital changed the relative views of the Treasury and the Fed. The Fed moved to raise interest rates to support the value of the dollar, while Treasury pushed fiscal policy in the opposite direction. The split became overt and politicized, and other actors became involved by the mid-1980s. Real adjustment took place in the late 1980s, as the commitment to the dollar’s value was then lowered, and resources devoted to managing its international position were also lowered.
Note that the explanations of the variation in responses are rather straightforward. There is no need to turn to the force of ideas as causal factors, nor does strategic culture play a role in the failure to respond. Instead, constraints on decisionmaking (originating in systemic rivalry, domestic pressures, and budgetary problems) are critical—and one of these (systemic rivalry) is largely beyond the control of the decisionmakers. This should lead us to consider the ability of the decisionmakers to change the fiscal situation. In short, why could taxes be raised in some instances, allowing for resources to be devoted toward closing the gap between assets and commitments, but not in others? Two periods should prove especially interesting for more in-depth scrutiny along these lines. First, Lloyd George’s government was able to raise several new taxes in the November 1909 budget, so that government revenues were increased by nearly a third in less than five years. Given how stringent the budgets had been in the late 1800s, how was this government able to execute such a change in government revenues (and thus in the expenditures devoted to the military in particular) when so many previous governments had failed to do the same?
Second, how was the Kennedy Administration able to increase revenues and expenditures on the military as well? Was this doomed to be only a short-run change (as Eisenhower expected), or did the Vietnam War unravel the budget? In both this example and the one mentioned above, expenditures were increased in an effort to make good the shortfall in security resources, in a manner that did not cause the budget to become unbalanced, because taxes were also raised—though such actions proved unsustainable within a few years. We in international relations, and perhaps in international political economy especially, need to devote more time and energy into how budgetmaking constrains the formulation and execution of policy. 3
The Systemic Consequences of Overstretch
One critical observation we should note in our comparison of the various cases is the manner in which the policies and politics of responses to overstretch spill over into the international system and, more specifically, influence the amount of international cooperation observed. This shows up most clearly in the British and American episodes of worsening overstretch in the monetary sphere. Since the central banks and treasuries were pitted against each other in a classic bureaucratic politics struggle (with the central bank defending commitments, but the Treasury undercutting the means to honor commitments) each institution sought to strengthen its hand versus the other. This could be done in two ways, which reflect different strategies for enhancing policy instruments.
First is the domestic route; institutional responsibilities could be changed via legislation, and/or new policy tools created. This occurred in the British case, for instance, when the Treasury won the Exchange Equalization Account which gave it a say in international monetary affairs, causing a shift from worsening afterglow to partial adjustment. In effect, the Treasury won the bureaucratic struggle. Second, each could seek out institutional allies. This is where we find an international spillover. What I am arguing is that international cooperation as seen in central bank coordination in the 1930s (through institutions such as the BIS) or in the 1980s (through agreements such as the Plaza and Louvre Accords) are not simply the results of international interdependence. Faced with domestic opposition from their own treasuries, the central banks of hegemonic countries experiencing currency overhangs may seek to make their own narrow policy effective by teaming up with other central bankers. I am not putting as positive a spin on this cooperation as most theorists. Instead of seeing policymakers come together to work out their own problems, spawned by the interconnectedness of their policy decisions, this interpretation I am providing is that heightened bureaucratic politics—the result of hegemonic decline and overstretch, more specifically—drives bureaucratic actors to seek out allies in other countries. International cooperation is the result of the internationalization of bureaucratic infighting, not a rational managerial approach to international welfare. Viewed in these terms, such cooperation is not likely to lead to better policy outcomes; it does not mean that national policy becomes more coherent, for instance, since it is really an escalation of bureaucratic politics. Instead the conflictual nature of the policies pursued by the treasury on the one hand and central banks on the other is intensified.
Implications for Hegemonic Overstretch in Other Issue-Areas
While this book has focused exclusively on two issue areas, it is important to note that the choice between afterglow or adjustment is not limited to the monetary and security realms, or to the institutions of central banks and military staffs. Other institutions were created during hegemonic ascendance to assist the state in its attempt to lead in the liberalization of international economic relations, and these too influenced the degree to which policies get adjusted during decline.
A similar story of overstretch might be found in the institutions created to handle the diplomacy of economic expansion. For instance, in both the British and American cases specialized institutions were created in the period of economic ascendance to facilitate international trade liberalization and expansion. In the British case, they again built upon an existing institution, by developing a separate branch of the foreign ministry to handle economic affairs. In the U.S. case, the National Association of Manufacturers (NAM), supported by other business groups successfully lobbied Congress to establish the Department of Commerce and Labor in 1903 (the Commerce Department was made a separate entity in 1913). This Department was created with the express purpose of furthering U.S. economic interests at home and abroad. 4 NAM had previously pushed for trade agreements in Latin America, more government assistance for the carrying trade, changes in the banking laws to allow U.S. banks to establish foreign branches, and alterations in the State Department’s consular corps to get better support for American businesses operating abroad. NAM’s own activities in support of trade (providing linguists, market information, bureaus of trademarks and patents, and foreign offices) were considerably stronger than government activities in these areas prior to World War I. 5
In addition to the establishment of the Commerce Department, Congress reformed the State Department’s Consular operations. Congress was responding to criticisms from businessmen who found their European competitors were receiving more effective support from their home governments. The State Department accepted these reforms because it was seeking to establish a domestic constituency, which would in turn defend it against further Congressional interference. 6 The State and Commerce departments then got into a number of fights over which had control over foreign economic policy. As Judith Goldstein has brilliantly displayed, even these institutions supporting international liberalization never fully replaced those which had been in place previously. As is the American way, the new institutions were simply added to an already crowded policy field. 7
The Dutch case is even more interesting when placed in comparison. In the British and U.S. cases, these diplomatic institutions were created to foster existing trends, and support ideologies of liberalization. In the Dutch period, the challenges to economic liberalization were much stronger, in both the physical and ideological sense. In those days, most trade over longer distances was handled by trading companies—monopolies. In general, governments were unable to provide effective protection to the long distance trade, and therefore allowed the monopolies to make large profits in order to finance and provide self-protection. Dutch practices were exceptions to this pattern. They agreed to the establishment of monopolistic trading companies to handle very long distance trade, such as with Asia. But proposals to create similar sorts of monopolistic trading companies to control the medium distance trade (with the Baltic and the Mediterranean, which accounted for the bulk of the commodities coming onto the Dutch market) were rejected. Competing European powers, such as England or France, employed trading monopolies to control their trade even with these regions. Monopolies were essentially guaranteed profits, with which they had to create their own armed forces to protect their interests from any threats. The Dutch opted for more open competition; the merchants who traded in these regions then asked the government to support their actions through diplomatic efforts and military protection. 8 The Dutch institutional solutions came in a variety of ways. Privately, they developed complex insurance schemes; the government and private interests cooperated to establish a system of peacetime convoy. Of more interest here, they created a network of consulates which had the task of gathering economic information and disseminating it to Dutch merchants (some 20 permanent diplomatic posts were set up in the Mediterranean between 1610 and 1625). Merchants were then taxed to help cover the expenses associated with these government activities. 9
In decline, these different institutions would react differently. In the Dutch case, the trade consulates would have been an important source of support for a continuation of open trade practices. In the case of British hegemonic decline, we would expect some sort of bureaucratically inspired political split between the foreign ministry officials and other institutions (some of which we saw played out in their interactions with the military policymakers). In the American case, the Department of Commerce lost its mandate to the State Department, though some fighting continues. The period of relative economic decline brought on the development of another institution, the U.S. Special Trade Representative.
All of this may suggest reasons for the different overall patterns of leadership and afterglow in each case. As with monetary affairs, Britain suffers the longest afterglow in a general sense. Free trade is maintained quite strongly—and when policy moves in a different direction, it comes in the form of a distinct break with past practices—with the switch to the Imperial Preference System. In the U.S. case we see free trade ideology challenged much earlier, and we find a pattern of steady erosion of the U.S.’s free trade stance as sectoral exceptions are made. The Dutch case stands somewhere between the two, since some exceptions were made to the general free trade policy, but these exceptions remained smaller in number.
What these various pieces of evidence suggest is not so much that the economic patterns of relative decline varied greatly between the cases, but rather that variations in political institutions filtered domestic economic interests differently. In the British case, the fact that government is unitary and parliamentary may have made for an all-or-nothing approach to policy. What is often presented as policy consistency, and explained via the strength of liberal ideology, might instead be explained through a closer examination of the process in which institutions react to economic interests. In the U.S. and Dutch cases, the federal and regional structure of government meant that industries concentrated in particular regions received better representation and could get government to respond to their own demands rather than those of more diffuse interests. In the Dutch case, reactions aimed at undercutting policies of hegemonic leadership were pursued in local level statutes. Protectionism began at the municipal level, and then rose to the provincial level—much in parallel to how the monetary institutions were developed earlier. The exchange banks were created by municipal authorities in the largest ports.
In the U.S. case, demands for protection came earlier. The effects could be found in Congressional actions in the 1960s, but then much more obviously in the 1970s and 1980s. Yet the power of sectoral interests was critical in the development of the institutions to pursue leadership as well. The Fed was created as a system of central banks to safeguard regional interests, and as I suggested above, this regional division may very well have prevented national market integration from proceeding to the fullest extent, and thus introduced ambiguity into the policy preferences of some sectors of the economy. In short, evidence from all three cases suggests that the patterns of foreign economic policy during takeoff and decline can best be explained through a closer examination of economic interests and the process in which they get converted into state policy and then institutionalized. Systemic or structural position of the countries matters, but the extent to which it matters is at least partly determined by domestic political structures.
Continued American Leadership and the Rise of Possible Rivals
The end of the Cold War has clearly removed the greatest systemic military threat to the United States. With the budget now moving toward an annual balance but government debt remaining huge, the probable outcome for American security policy will continue to be partial adjustment. I expect the U.S. to fail to reduce its commitments, even as it lowers its military assets to a more reasonably affordable level. A more successful adjustment would mean greater burden-sharing with allies to relieve the U.S. of some of its obligations. This component of adjustment suffered a serious blow when the Europeans failed to act in unison to stem the bloodshed in Bosnia, or to move at all in central Africa without U.S. involvement. Europe’s failure, contrasted with the apparent success of NATO’s intervention (backed by American ground and air forces), makes it abundantly clear that burden-sharing in defense may not go very far.
According to Ethan B. Kapstein, the difficulties central banks face when trying to maintain price stability and encouraging economic growth during military downsizing are immense. 10 Add to this situation the fact that more dollars are in use outside the U.S. than inside (perhaps around $250 billion in circulation outside the country, out of the total of $390 billion issued), the enormous government debt, the trade deficit, plus the numerous debts the U.S. owes to foreign creditors, and it is clear that the U.S. will face a serious problem with the dollar’s international role in the future. These potential problems could strike with a vengeance once foreign currencies come to rival the dollar in confidence and availability.
Of all the present currencies rivaling the dollar in international use, two are seen as the most likely to take on greater international roles in the future: the Euro and the Japanese yen. These two currencies are the greatest challengers to the dollar in terms of use in trade invoicing. 11 Ample evidence is available to show that the Germans and the Japanese have been well aware of the problems associated with having a currency as an international money, and have therefore resisted the internationalization of their currencies, not unlike what the U.S. was doing in the 1920s. It is also clear that any future hegemonic power is more likely to consider using an internationally created and internationally managed currency, than to install its own national currency as an international money. This has been most apparent in the German Bundesbank’s efforts to create a European currency to act as a buffer between the Deutsche Mark and the dollar.
Bundesbank officials have great freedom over monetary policy. While the Bundesbank is charged with supporting government policy, it has virtual veto power over interest rate policy. 12 Bundesbank officials have generally agreed that domestic policy objectives take primacy over international goals. The Bundesbank has also resisted any tendency for the Deutsche Mark to become a reserve currency, despite its role within various European currency arrangements. When the EMS had its first realignment in September 1979, then Bundesbank President Otmar Emminger stated that “Under no circumstance should the Federal Republic become a dumping ground for the unloved dollar which would only expose it to exported inflation.” 13 The Bundesbank may have been so positive about creating other mechanisms for international transactions so as to maintain its free hand domestically. In negotiations concerning monetary relations in 1987&-;1988, the Bundesbank worked hard to have its domestic autonomy recognized by the treaty on the Franco-German Economic Council. While the Bundesbank has generally kept international arrangements from driving decisions about the domestic money supply, interest rates are influenced more and more by international considerations. 14
Oddly, the recent difficulties in achieving stable exchange rates among the intended members of a European monetary union reflect some of the same tensions we find with overstretch. Although we were not observing the response to an overhang, some of the same elements of a monetary overhang and a failure to move into a leadership role have appeared in the case of German monetary policies since 1992—a large fiscal deficit being financed through international borrowing, which caused interest rates to rise and the currency to become overvalued. The loose monetary policy of the government’s fiscal operations in reuniting the country clashed with the traditional central bank concerns over inflation. The Bundesbank tightened money up even further, and the government was forced to bid up interest rates to finance its deficit. Many of the other European currencies could not honor their obligation to remain fixed in value relative to the Deutsche Mark.
Whereas the Bundesbank is often hailed as the most independent of the major central banks, the Bank of Japan lies at the other end of the spectrum. The Bank of Japan falls under the direct supervision of the Minister of Finance, who has the discretion to issue general directives, dismiss Bank officials, and veto most Bank activities. 15 The Ministry of Finance and the Bank of Japan have worked together to prevent the internationalization of the yen, in order to maintain tight control over the domestic money supply, and insulate it from outside disturbances. If the yen were ever to become a widely employed international medium of exchange, and Japan were to suffer a monetary overhang, the consequences would be very different than any of the cases discussed, since the internal institutional arrangements are so different. We would not expect bureaucratic differences to emerge, and there would most likely be smoother adjustment as relative economic decline began.
Once again, this analysis of the present situation highlights similarities with the 1920s. In the early years of the interwar period monetary authorities looked at the sterling overhang and recognized the dangers from having a domestic currency serve as an international medium of exchange. Even the most internationally oriented among them, such as Benjamin Strong, wanted the U.S. dollar to rival the pound—but not displace it. Much the same attitude can be found among the monetary authorities of Germany and Japan. This implicit policy lesson is perhaps not as valuable as one we might draw from the analysis here. Of the three cases, the one where an overhang was least threatening was the Dutch. Why? Because the Dutch failed to establish a domestic currency as an international money. The lesson to be learned is not to fail in this endeavor, but to separate the domestic and international currencies. This could perhaps be done in the European situation, where Germany could have maintained the Deutsche Mark’s qualities domestically and then created a larger role for a European currency alongside the Deutsche Mark, if monetary union were not pursued. The international role of a separate European currency could then be maintained without threatening the Deutsche Mark’s management for domestic purposes. This is now unlikely given the efforts being made toward uniting the European currencies.
The only problem with this evaluation is that the international currency must be attractive precisely because people can bring it into a market and purchase goods and services with it. Any European currency would have to be consistently interchangeable with the Deutsche Mark; this means that to the extent authorities could separate the two monies, people would have a preference for the Deutsche Mark over the other currency. This raises doubts about whether a substitute currency could be introduced into circulation to replace the role the Deutsche Mark already plays, let alone displace the dollar. This may explain why European monetary union is proceeding with the Germans at the helm. Still, a closer examination of the earlier cases does yield insight into present policy decisions.
For the U.S. monetary authorities, the policy lessons are also relevant. The dollar’s international role means an overhang still exists, albeit in a different form. Under the present rules, the reserves backing the dollar are no longer important—what is important is that the dollars circulating internationally remain claims upon American goods and services. As long as the dollar’s value remains relatively high, and rival currencies are limited in use, the overhang is not a problem. Yet the potential for a problem remains; once rival currencies are available and asset-holders face a choice, the overhang will reemerge. 16
For U.S. monetary authorities the tactical problem is how to eliminate the number of dollars in circulation internationally without slowing down economic growth in the U.S. unnecessarily. Any changes would have to come slowly. Since the British case showed the problems associated with an overhang when there were rival currencies, it seems the best course of action in such a situation is to accept decline and adjust out of the role of hegemonic leader. Yet that is easier said than done, and would involve limiting international financial contact with the U.S. economy—something presently unthinkable. A more positive step for the U.S. to undertake would be to assume that sooner or later another currency will arise to rival the dollar. That being the case, replacement of the dollar at the international level with an international currency would be a more logical solution of the overhang. It would allow the U.S. to play a positive role in any transition. And given the reluctance of the Germans and Japanese to have their own currencies replace the dollar, it might make more sense to have the U.S. lead the way to the establishment of a truly international money, one managed by a multilateral institution.
While that might prove the best technical solution to the problem, the political situation has to be ripe for such a change. It is safe to say that it is not, at least for now. Nonetheless, we need to explore more positive policies associated with leadership transitions, such as a conscious move to multilateralism. Based on past experiences, this sort of change is not only possible but necessary.
Conclusions: The Need for Reducing Commitments
In the first chapter, I identified a central goal for this book: to explain variations in the responses to overstretch. As part of that explanation, I laid out the various components of the afterglow hypothesis. I examined how domestic pressures for expanded international liberalization could lead to the creation of institutions specifically designed to support international leadership in liberalization, which illustrated the usefulness of employing the liberal leadership model and its emphasis on the domestic sources of hegemony.
In the second part of the afterglow hypothesis, I related the development of domestic institutions of leadership with the effectiveness of policies in there respective issue-areas. Not all attempts at hegemonic leadership have succeeded, especially when we compare across issue-areas. In the third facet of the afterglow hypothesis, I tackled the reasons why responses to overstretch have varied. The answer was rooted in bureaucratic politics, though the various pressures shaping the intensity and power of bureaucratic action were developed through a multilevel analysis. This highlighted not only the specific bureaucratic responsibilities of the institutions involved, and their overlapping responsibilities, but also how pressures emanating from systemic rivals and from domestic constituencies drive bureaucratic actors to take action. The argument I make shows that the policies of even hegemonic states must be understood through a complex interaction of domestic, state, and systemic factors. Taken on their own, the causal factors from each level of analysis would provide some part of the picture, but may be unsatisfying when used to answer pressing questions. Taken together, however, they can explain much more; evidence of how their interaction affects the actual outcomes reinforces the need to take domestic factors into account when studying international leadership.
For those concerned about the U.S.’s ability to adjust out of its current leadership role, the advice which flows from this argument is straightforward. On the military side, overseas commitments must be reduced. The lack of a serious systemic rival at the moment affords the U.S. the opportunity to reduce simultaneously its military commitments and its military forces. Today’s policy seems headed in this direction, though it has proven easier to cut forces than commitments. Of course, any risks associated with such steps are reduced when effective plans and strategies are adopted; given evaluations of past performance, reform of the JCS or the NSC could probably yield more effective linkage between American commitments and military strategy. In the monetary realm, the institutions that make U.S. monetary policy are already oriented toward the domestic situation, and more recently have managed the dollar quite effectively. Reducing the amount of dollars circulating outside the U.S. remains a potential problem, but it can be resolved without sacrificing the domestic economy’s health. New policy instruments to achieve such goals may need to be developed, especially those which can deal with the dollars in international circulation separate from the U.S. economy. It will be especially important to reduce the abilities of offshore banks to expand the international supply of U.S. dollars. Greater efforts to regulate international banking will be required to achieve this end. The fact that the U.S. has already moved away from a fixed exchange rate system also allows the U.S. greater freedom of action than the other previous hegemonic leaders could exercise. Foreign cooperation, something which was relatively unimportant in the earlier cases, may prove to be crucial.
If this research shows anything, it is that all these channels must be explored. Adjustment out of the leadership role can be achieved without catastrophic consequences, but it entails making hard choices. The United States’ present commitments are too extensive, and the current performance of the American economy should not lull us into complacency. Prudence must still guide American foreign policy, even in a post-Cold War world.
Endnotes
Note 1: Even if one does not accept the tenets of hegemonic stability theory, the cases under discussion here are clearly more comparable than those usually covered in analyses of overstretch. In each case, the military commitments of the countries included (or in the case of the U.S., still includes) defense of numerous allies and of trade, which requires control of the sealanes. In the monetary sphere, both the U.S. and Britain had extensive use of their national currency internationally under a fixed exchange rate regime. Even without thinking in terms of hegemonic aspirations, the specific problems these countries faced were different in nature than those of Imperial or Nazi Germany, the Soviet Union, or Imperial Japan. Back.
Note 2: I have difficulty seeing British security policy in this period being driven by strategic culture, as Kupchan would have it. If Japan had not defeated Russia in 1905, the arguments about the Russian threat to the Empire would have been stronger than ever. Back.
Note 3: Of particular importance will be work examining how domestic and foreign policy expenditures are evaluated together, as well as calculations of optimal revenue. Jonathan Kirshner has written a paper reminding us all that security issues have traditionally entailed a deeper understanding of political economy than we now admit. See “Political Economy in Security Studies after the Cold War” (unpublished manuscript, Cornell University). Back.
Note 4: William H. Becker, The Dynamics of Business-Government Relations, Industry and Exports 1893–1921 (Chicago: University of Chicago Press, 1982), p. xi. Back.
Note 5: Ibid., pp. 44, 60–63. Back.
Note 6: Ibid., pp. 94–97. Back.
Note 7: Judith Goldstein, Ideas, Interests and American Trade Policy (Ithaca: Cornell University Press, 1993), p. 138. Back.
Note 8: P. W. Klein, “The Origins of Trading Companies,” in Companies and Trade, eds. Leonard Blussé and Femme Gaastra (The Hague: Martinus Nijhoff, 1981), pp. 19–20. Back.
Note 9: Jonathan I. Israel, Empires and Entrepots: The Dutch, the Spanish Monarchy and the Jews (London: Hambledon Press, 1990), pp. 144–146. Back.
Note 10: Ethan B. Kapstein, “Conclusions,” in Downsizing Defense, ed. Ethan B. Kapstein (Washington: Congressional Quarterly, 1993), p. 216. Back.
Note 11: Michael Emerson and Christopher Howe, The ECU Report (London: Pan Books, 1991), Table 13. Back.
Note 12: Ellen Kennedy, The Bundesbank: Germany’s Central Bank in the International Monetary System (London: Pinter Publishers, 1991), pp. 13–14, 24, 27. Back.
Note 13: As quoted in Kennedy, The Bundesbank, pp. 81–82. Also see Emerson and Howe, The ECU Report, p. 127. Back.
Note 14: Kennedy, The Bundesbank, pp. 95–97, 100–102. Back.
Note 15: Yoichi Funabashi, Managing the Dollar: From the Plaza to the Louvre (Washington, D.C.: Institute for International Economics, 1988), p. 61. Back.
Note 16: Benjamin Cohen has highlighted in recent work how network connections shape the psychology of this choice; the decision to continue using an international currency depends on one’s calculations of its future desirability. Along those lines, the dollar appears to face few threats in the near future. Back.
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