From time to time, calls are made for a “new” Bretton Woods, including in the dark days of late 2008, when the global economy was thought be perched perilously on the precipice of an economic abyss. At the time, it wasn’t entirely clear to me what, exactly, was being proposed. In the event, the crisis response mobilized by the G20 in late 2008 and early 2009 succeeded in stopping the economic dégringolade and, seemingly, refuted Hegel. But, while the global economy was stabilized by 2010, for most major advanced economics, the subsequent recovery has been tepid. As Brad DeLong estimates, absent measures to restore U.S. growth to its pre-crisis rate, the potential output lost as a result of the “Great Stagnation” could well exceed that of the Great Depression.
Of course, that earlier economic catastrophe was followed by global war. The extent to which the latter was caused by the former, as the economic and social disruption of global stagnation in the 1930s provided fertile ground for the seeds of political extremism, is an open question. Regardless, in the midst of hostilities, efforts were undertaken to construct a post-war economic order that would avoid a repetition of the economic disaster that led to the Great Depression and that would lower the barriers to trade erected in the midst of economic stagnation. The Bretton Woods agreement, which created the International Monetary Fund (IMF) at the close of the Second World War, had three key objectives: full employment, growth and adjustment. These objectives reflected the enormous economic challenges that confronted the “United and Allied Nations” that met in Bretton Woods, New Hampshire, in July 1944.
The immediate challenge, it was believed, would be to sustain full employment once peace was restored. The worry was that, with the cessation of hostilities, reduced spending on armaments and the demobilization of the combatants’ armed forces could lead to a return of global stagnation. With the benefit of hindsight, however, we know this fear was misplaced — the wartime forced savings accumulated in countries such as the U.S. and Canada fuelled a post-war consumption boom, while labour market adjustments, notably women relinquishing their places on the production line, meant that returning GIs did not lead to a significant increase in unemployment.
Once this challenge was met, there would be a need to ensure sustained global growth to sustain full employment and to provide the benefits of prosperity to help preserve peace going forward. In this respect, a prevailing perspective was that the war was kindled by the breakdown of the global economy, and the adoption of beggar-thy-neighbour policies. Such policies transformed the global economy from a positive-sum game to zero-sum game in which the growth of one country was achieved at the expense of another country.
To address these fundamental challenges, the architects of the Bretton Woods system — Harry Dexter White negotiating for the U.S. and John Maynard Keynes representing the U.K.— needed to address the challenge of adjustment. That is to say, to create international monetary arrangements that would facilitate the timely, orderly adjustment in the balance of payments. To do so, they sought to promote a multilateral system based on fixed, but adjustable exchange rates, trade liberalization, and the creation of institutions (the IMF and World Bank) to enforce the system and spread the benefits of growth and development around the globe. To make the system work, they needed broad international participation, strict controls on the movement of capital, and measures to advance and protect the interests of labour.
In the 1930s, the world economy became fragmented by tariffs and payment restrictions that limited convertibility between currency blocs. This heightened political tensions, as resources were allocated on the basis of opaque state-to-state agreements. To maximize the gains from trade in the post-war world that they were planning, Keynes and White needed to have as many countries as possible join the system: Canada could accumulate sterling balances as payments on the very large loans Canada provided during the war, for example, but if sterling wasn’t convertible to the U.S. dollar, those balances wouldn’t help with a Canadian trade deficit with the U.S. At the same time, countries wouldn’t have the foreign exchange earnings needed to repay all those obligations to the U.S. that were accumulated during the war if trade flows remained blocked up by tariffs remaining at the levels to which they were taken in the 1930s. The goal was to bring about a general reduction of tariffs everywhere to reap the enormous gains from trade and opportunities for growth that trade liberalization would bring.
The decision to adopt capital controls is easily explained by the requirements of the international policy trilemma, under which a country can fix its exchange rate, pursue independent monetary policy (to, say, target full employment), or allow capital mobility, but not all three: the choice of two determines the third. With a desire to avoid competitive exchange rate devaluations, which led to retaliatory tariff increases in the 1930s, and the prevailing full employment ethos, capital controls were a given. At the same time, however, the experience of the dysfunctional gold standard of the inter-war years, during which capital flows were a destabilizing force in practice, in contrast to the stabilizing role they were supposed to play in theory, created a bias against any other trilemma tradeoff.
The focus on prioritization social protection, meanwhile, reflected the nature of the problem faced by war’s end. In the 1920s Keynes recognized, as Pigou and other classical school adherents did not, that the Great War had changed the social compact that prevailed in the Victorian era and which had made the gold standard a feasible and in many respects a desirable international monetary standard in the late 19th century. In that earlier time, labour bore the full burden of international adjustment through real wage changes. After the First World War, labour was both more organized and more militant in resisting nominal wage reductions (hence Keynes’ explanation of sticky wages based on wage “relatives”). This led to the monetary dysfunction in the 1930s and to the recognition in post-war planning that, if labour was going to be a partner in the sustained, difficult adjustment process going forward, there had to be something in it for the working man. Over time, these gains came through the de facto commitment to full employment and the rising real wages that growth in the 1950s and 1960s provided. But this compact started to erode in the 1970s and onwards in the face of supply shocks and the internationalization of capital. (Look, for example, at the stagnation in real wages/incomes for anyone below, say, the 80th percentile and recognition that inequality is the issue in ageing, mature economies of the North Atlantic.) In this regard, it should be recalled that, in contemplating the prospects for the U.K. in the post-war world, Keynes considered but discarded the option of “temptation” by which he meant the repudiation of obligations accumulated in defence of liberty and democracy. But, to resist temptation and pursue virtue, there had to be a social compact and the prioritization of social protection.
How relevant is the Bretton Woods consensus today?
The problem at Bretton Woods was not crisis management and resolution, but the tough slogging of adjustment and reconstruction, while avoiding a relapse into stagnation. To be sure, while the two situations differ in several important respects, the global economy faces similar challenges today.
Many of these challenges were present before the global financial crisis, including underlying demographic changes in the mature, industrial economies of the North Atlantic, which will contain growth going forward, and transition challenges resulting from the equally dramatic rise of dynamic, rapidly-growing economies of the South. At the same time, the global crisis has left a number of additional policy challenges — monetary and fiscal — in its wake; these policy legacies underscore the importance of international cooperation to identify a timely, orderly resolution of the adjustment issues they pose.
Restoring full employment, sustaining growth and promoting adjustment remain key policy objectives; broad multilateral support and a Roosevelt (Teddy, not FDR) “square deal” are necessary to support the adjustments that are required. The exception is the exchange rate and capital controls trade-off, which are neither feasible nor desirable at least in their use at Bretton Woods. In contrast to the situation prevailing at the close of the Second World War, in which the U.S. was the only economic and financial hegemon capable of backstopping the role of its currency as a global medium of exchange, store of value and unit of account, a fixed exchange rate system is not on. Rather than the Bretton Woods consensus on the trilemma, today flexible exchange rates are likely to be a key element of the adjustment process; indeed, there are strong reasons to support — not impede — capital flows. Rapidly-growing, dynamic economies have large infrastructure shortfalls. Filling those capital gaps would provide a source of domestic development and fuel global growth. Pension funds in the ageing, mature industrialized economies, meanwhile, need the higher returns that such investments could provide. But such mutually beneficial gains from inter-temporal trade require clear rules of the game and stability of policy frameworks.
In this respect, the need today is not so much to reproduce the Bretton Woods consensus as to “complete” Bretton Woods to allow countries to better reap the benefits of financial integration by reducing the virulence and contagion of financial crises. This will require international agreement — through the work already underway at the Financial Stability Board and other international fora — on the governance of global capital, as well as a better framework for the timely, orderly restructuring of sovereign debt.
The web of international institutions that has been created in the seven decades since the Great Depression was designed to facilitate the goals of full employment, sustained growth and adjustment. The need today is to bring the global community together once more around a set of responsibilities and obligations to each other and the system. If we don’t, the danger is that the global economy will fragment into regional, bilateral blocs and resource allocation will be conducted on the basis of opaque state-to-state agreements instead of through open and transparent markets.