Posts Tagged 'IR theory'

France and the New Balance of Power in a Crisis-Stricken Europe

So the main reason I’ve been neglecting my blogging duties of late is because I’ve been preoccupied studying for an exam on international relations theory and history. With the exam safely behind me I’m back to blogging, but still have academic IR debates on the mind, so today I want to write about what the history of early 20th century European relations can tell us about the continent’s current political economy.

To grossly oversimplify, back in the pre-WWI days Europe was controlled by a number of Great Powers of roughly equal strength, who were in continual competition with one another to run the world. They typically pursued their goals by forming loose and shifting alliances; whenever any one state seemed to be getting too strong, a collection of the others would team up to balance against it (hence the “balance of power”). Britain, which then as now prized its position as being of but not in Europe, considered itself the ultimate balancer, frequently weighing in against the strongest continental power to ensure no state could establish hegemony over the mainland.

Now fast-forward to the Europe of today, as the debt crisis stretches into its third year. Of everything that has been written on the Euro crisis so far, I think one of the most perceptive and insightful pieces was an op-ed by Anne Applebaum all the way back in September 2010 (doesn’t that feel like a long time ago?), which made one simple but important point: thanks to the crisis, the East-West divide, which had dominated intra-European relations since at least the end of World War II, has now been overtaken by the North-South divide. The “North” – represented by Germany, Scandinavia, and some Eastern European economies like Poland and Estonia – are ruled by budget hawks committed to fiscal discipline; the “South” – including Greece, Portugal, Spain, Italy, and perhaps Bulgaria and Hungary – are home to bloated public sectors and seem unable to get their public finances under control. The geography doesn’t match up perfectly, of course, and it’s easy to argue about which countries belong on which side, but the fundamental divide is hard to ignore. And while the two groups aren’t anything like formal alliances, the economic interests within each group are more closely aligned than those across the divide, and hence it’s easy to imagine the major disagreements about how to manage the European economy over the coming years falling more or less along this fault line.

As Applebaum noted at the time, “France floats somewhere in between”. I think this means that France is positioned, if it wanted to, to play something like the role Britain played 100 years ago, able to weigh in – perhaps decisively – on the side of either the North or the South. The analogy isn’t watertight – Britain’s role as balancer was based in its fundamental strength, whereas for France today it’s more about being considerably weaker than Germany but aspiring to be viewed as its neighbour’s equal. (Which, incidentally, is another theme that reappears throughout European history…) But still, in the new North-South Europe France could represent the crucial swing vote, and throw some political clout behind the interests of the South, preventing Germany from fully setting the economic agenda for the continent.

In any case, up until now France has clearly sided with the North, epitomized in the “Merkozy” romance. But as the French prepare to head to the polls it appears increasingly likely Sarkozy is on his way out, which could dramatically shake up the picture. From many of the campaign statements he’s made to date, it seems at least possible a Hollande government would rupture the informal Franco-German alliance and move the French into the “South” camp. (It’s worth noting that I’m not particularly talking about whether Hollande would actually harm the French economy and investment culture, as some seem to fear, but rather whether France will continue to stand behind Germany in intra-European political economy battles or rather take up the cause of the Southern nations.)

To bring back some academic IR terms, the impetus for such a transition can be understood in both realist/materialist terms and constructivist/identity terms. From a realist point of view, it could be that France’s interests no longer lie with the Northern interests of tight money and imposed austerity. From a constructivist point of view, it’s easy to imagine the French self-identity under Hollande evolving from Germany’s little brother to the champion of the downtrodden South. As these two forces interact, I don’t think it’d be that surprising to see France pivot from backing up Germany to balancing against the strongest power on the continent, and challenging the Germans on their vision for the future of the European economy.

Over the past several months the Eurozone has entered a strange period of stasis, what has effectively become a period of permanent crisis. Since the crisis first erupted pretty much every policy measure adopted has been an effort to “buy time”, but nothing’s really been accomplished with this time, and so nothing’s really changed. There aren’t a lot of ways to break out of this status quo; you could have some sort of surprise, disorderly default from a periphery economy, but no one really wants that outcome (though I’m starting to think it might be better than continuing down the current path). One thing that could really shake up this political equilibrium, though, would be if France decidedly announces that it no longer supports the current Northern establishment position of forcing austerity on the South.

I’m not saying this necessarily will happen, or even that it’s particularly likely to. But I definitely think it’s a storyline worth watching, and a reason we should all be paying close attention to the upcoming French election…

The Big Change in Sovereign Debt Politics No One’s Talking About…

So a few days ago there was an interesting story going around that hedge funds were going to try to sue Greece if the sovereign tried to force its creditors to take a loss. Now this was two or three news cycles ago and the story has since moved on (there was talk a deal was complete, then new talk that a deal was hung up on interest rates, then they were going to be kicking off a new round of negotiations, and I’ve since lost track…), but I want to go back to this hypothetical because it’s crazy for a number of reasons.

The first is simply the usual hypocrisy you hear whenever a creditor who has been earning outsized returns because they were taking on risk turn around and, ex post after the risk has been realized, are completely outraged about losing out on their investment. Look, the reason Greek debt always paid higher returns than risk-free German or US debt (side note: is there any risk-free asset in the world today?) is because Greek debt was never risk free. This is a pretty basic “there’s no free lunch” principle of investing, but it always surprises me how rarely it comes up in these kinds of discussions. Everyone is shocked, just shocked when someone who had a pretty good chance of defaulting actually defaults – it’s ridiculous.

There’s something extra interesting about this case though, which first requires a bit of background on international relations theory. Unlike at the national level, at the international level there is no supreme authority to enforce rules, ie the global system is ruled by anarchy. For sovereign debt, what this means is that if a country is considering defaulting on its debt to foreign creditors, there isn’t any authority that can force it not to. So why don’t countries default all the time? Because if they did they’d develop a reputation as defaulters (*cough, Argentina, cough*) and the next time they wanted to borrow money they’d find it extremely expensive, if not altogether impossible. So a rational state, knowing that it will want to borrow money in the future at reasonable rates, has an incentive to not anger creditors today, which serves as an enforcement mechanism for repaying sovereign debt.

But note that this mechanism depends on the negative reputation effects of not honouring a debt contract. If a claim on a country is viewed as widely illegitimate or unfair – say, for example, when greedy hedge funds buy up cheap distressed debt and then demand full payment – it seems reasonable that future creditors won’t judge this as harshly as if, say, tomorrow Germany announced it wasn’t going to pay back any of its debts. So when a state is internally debating whether or not to pay back debt, it weighs the legitimacy (in the sense of whether other market actors think the debt should be paid back) of the outstanding debt; as legitimacy falls, the marginal effect of defaulting on the debt on future borrowing ability falls, and so the inclination to default increases.

Now to the interesting part in this case: the hedge funds are essentially trying to get around this anarchy problem by threatening to take Greece to the European Court of Human Rights. Specifically, they’re claiming that changing the terms of Greek bonds would be a property rights violation, and according to European law property rights are human rights. Somewhat remarkably to me, the NYT article suggests this actually could be a successful legal strategy. I don’t know enough (read: anything) about European law to fully understand what kind of power this court holds over Greece; presumably this can’t fully get over the anarchy problem as I doubt the court can deploy soldiers to Greece and/or throw the government in jail, but I assume they have some sort of power to impose costs of some kind, rather than just making proclamations. So if the hedge funds won at court, Greece would have to choose between paying them or suffering the costs of being in violation of the court, a fact which should alter the government’s current calculation of whether to default. Which is a pretty big qualitative change in the international relations of sovereign debt. Did European states know this was what they were signing up for in creating the EU? (I don’t mean that in a rhetorical way to suggest it was a mistake, it’s an honest question – I don’t think the full ramifications of semi-sovereignty have yet been fully realized…)

A final funny point to consider is that everyone knows the hedge funds would happily accept a deal where they get paid 60 or 70 cents on the dollar of the debt they currently hold (the last figure being debated was 50 cents, with the Greeks (read: Germans and IMF) wanting to push it lower.) But, again with the caveat that I have no legal background, it seems to me like it’d be pretty hard to make the case that a cut of 30 cents on the dollar is legal but a cut of 60 cents on the dollar is illegal. Presumably the legal argument has to be built around sticking to the exact letter of the bonds, even though this is something that no investor/policymaker currently takes at face value…

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