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What were the most significant features of the “embedded liberal compromise”? Did the compromise allow for a “golden age” of capitalism? Why did it end?
Embedded Liberalism existed as an integral part of the global political economy from the end of World War II through till the 1970s. The system comprised a trade-off between domestic intervention and international liberalism. In this essay I will dissect the component parts of embedded liberalism compromise and argue what made them so significant in shaping the global economy post-depression of the 1940s-50s.
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This first part of the essay will demonstrate how Fordism ideology and the Bretton Woods embodied a system of embedded liberalism and enabled a so-called ‘golden age’ of capital. Social welfare regimes through Keynesian economics were also a prominent feature during this period. Many advanced Westernised countries experienced growth in wages and a provision of social welfare schemes funded through taxes as a result of state intervention. Characteristics of market liberalization – convertible currencies and fixed but adjustable exchange rates triggered exponential economic growth facilitating a fall in unemployment and poverty. Some developing nations even saw improvements as economies began shifting towards industrialisation.
Despite undeniable benefits the prosperity of an embedded liberal approach could not be sustained and came at large, detrimental expense to many countries. In the second part of my essay I will argue why the features of the embedded liberal compromise contributed to the end of this approach and eventually, crisis across states. Extortionate inflation, the collapse of the Bretton Woods and the development of Washington Consensus reforms ultimately are the basis of its breakdown. In its place a new economic regime was ushered in, neoliberalism manifested free market ideology, privatisation and deregulation. On this basis I will argue the embedded liberal compromise, a concept first used by John Ruggie (1982), had the potential to allow for a golden age however the features of the compromise were not managed effectively so ultimately had to come to an end.
During the 1950s-1960s embedded liberalism was so promising that it was described as the golden age of capitalism, in particular in the UK and US who adopted the system and its principals comprehensively. Labour markets were approaching full employment, poverty rates were at an all-time low and taxation was funding social welfare regimes. Quality of life was on the rise and states were regaining confidence and prosperity.
A notably important feature of the embedded liberal compromise was the Bretton Woods (BW), a system of monetary management created in the US and ratified by 44 participating nations. It was as a unified effort to finance the reestablishment of Europe post WWII and “save the world for future economic depressions” (Stiglitz, J 2002). It’s main objectives were to promote economic growth and devise a system of convertible currencies to facilitate transactions between countries. Bretton Woods embodied embedded liberalism, the approach of monetary tools directly aligned with principles of the compromise. The regime avoided the rigidity of other monetary systems whilst also addressing the underlying issue of a lack of cooperation between countries. It was an international gesture with crucial conviction that countries that trade together wouldn’t go to war with each other.
A focal point of Bretton Woods was exchange rates, these were fixed but adjustable to coincide with having some form of domestic stability whilst still maintaining a level of competitiveness. Benefits of having a fixed exchange rate included the elimination of uncertainty and the attraction of foreign investment, it also prevented competitive devaluations. Thus ‘providing a framework for relatively stable exchanges’ (Ruggie, J G. 1982) as Rugge stated in his seminal article. However, economists generally agree that an inflexible exchange rate can be difficult to maintain as it may conflict with other macroeconomic objective. Freely-floating exchange rates have automatic stabilisation and complete flexibility to react to market fluctuations, but they tend to discourage trade and investment due to uncertainty.
Therefore, Bretton Woods logic was to create a system of exchange rates which enabled the advantages of both a fixed rate and floating rates whilst also being attractive domestically and internationally. It enabled national stability but also allowed for slight fluctuations within a band of 1% to adjust to market conditions which encourage trade and cooperation between countries.
The International Monetary Fund and World Bank are both derivatives of the Bretton Woods system established during WWII with the goal of determining economic cooperation, stable development and a prosperous global economy. This emerged after negotiations between governments agreed there was a need ‘for an institutional form for international cooperation’ (Cohen B.J. 2001). The WB was supposed to focus on structural issues and promote long-term economic growth, while the IMF provided policy advice and financed loans to countries with balance of payments issues to achieve fundamental equilibrium. Both institutions manifested ideologies of the embedded liberal compromise; they encourage international exchanges whilst also maintaining domestically-led policies.
Henry Ford popularized the concept himself and by 1945 when WWII came to an end Fordism was a fully-fledged regime and a foundation for a post-war boom. Many of the methods Henry Ford introduced resulted in an increase in standards of living – economies grew, industries diversified and as Harvey described it ‘crises were contained, and mass democracy was preserved’ (Harvey, D 1990). Mass production was able to secure economies of scale in the long run and benefit from productivity growth through utilizing capacity resulting in increased profits.
Ford was able to introduce a social wage for workers, which steadily grew in the 1950s-60s, with the rationale being that workers were potential customers, so if incomes rose demand for goods may rise accordingly. He recognised that mass production through large-scale, vertically integrated factories which utilised division of labour would result in mass consumption. As a result, productivity increased and the rise of consumerism emerged.
State intervention played a role in facilitating Fordism, part of government expenditure was investing in Fordism technology to enable the reform to expand and have greater impact. Much of the ideology of Fordism coincides with Keynesian economics on the basis of creating a demand-led economy. Assisting people into jobs, enabling them to have an income to spend results in economic growth, this was Fords logic of paying a social wage. Bob Jessop identified the clear links between the two and argues “The Fordist state is a Keynesian welfare state…It manages aggregate demand so that Fordist firms have enough confidence to undertake heavy capital investment…The state must ensure adequate levels of demand through the transfer of incomes.” (Allen J, S Jessop, B 1992)
WELFARE & KEYNESIAN ECONOMICS
The fundamental idea of Keynesian economics was that state intervention can stabilize an economy and help it to achieve full employment. This corresponds with a key feature of the compromise as social welfare regimes were part of state involvement, the aim of these were to provide economic assistance to people in need through government provision. Steffek (2006) argues that the compromise is designed to considers the people made unemployed as a result of shifts in global patterns of production. He states it is a “major task of the state to manage adaptation to the world market by compensating the losers within the nation”. Particularly in the US many citizens were unemployed and reliant on handouts from the state as a result of the Great Depression. Confidence in the state was low until Franklin Roosevelt was elected into presidency and implemented a regime of social provision. Roosevelt legalised the sale of alcohol resulting in greater tax money for the government enabling expenditure on social benefits to increase. President Roosevelt also designed the Works Progress Administration (WPA) as another form of relief post Great Depression which put unemployed Americans into work. As previously stated, Keynesian economics centralized demand theory which is why so many policies adopted particularly in the UK and US took the approach of economic growth being consumer led. Progressive taxation systems funded comprehensive welfare provision and states were thought to be ‘crisis-proof’ as they could manage disequilibrium.
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For the next part of my essay I will explore the contributing factors of the end of the embedded liberal compromise and how this lead to deep recession across West by 1974. Ruggie argues that an embedded liberal approach only works for industrialized countries as “developing lack the resources, institutional capacity, international support and the political interest”. (Ruggie, J G 1982). However I will oppose this statement as not even the most industrialised countries could maintain an embedded liberal approach.
One of the main concerns of embedded liberalism was inflation, many features of the reform contributed to the increase in price level: rising wages, expensive welfare schemes and the oil crisis of 1973 all impacted inflation. As a result of Keynesian economics and Fordism wages grew steadily from the 1950s onwards to create demand driven economies across the globe. Wage pressure meant incomes rose and there was growth in the economy, but with this came excessive increases in the general price level. Similarly, social welfare schemes were becoming an increasing burden on the governments to finance. They were funded by taxes which were reliant on growth so not only did they fuel inflation through government expenditure but also by economic growth.
Inflationary pressures were exacerbated when the cost of oil notably increased, OPEC countries increased the price of raw materials in response to rapid demand for oil and political developments. They had incentive to raise prices after the abandonment of US dollar convertibility which ‘reduced the receipts of oil exporting countries by 15%’ (Rodgers, C 2014). Rodgers argues that due to hostilities in the Middle East there were oil supply issues resulting in the fourfold increase in oil. The US and other countries had no substitute form of energy so had no alternative but to continue to import energy from OPEC countries despite the rise in prices. Advanced economies had heavy manufacturing industries which were energy dependent, therefore their continued need for energy resulted in import and cost-push inflation.
Keynesianism proposed that there was an inverse relationship between inflation and unemployment, however during the 1970s the US and other industrialized countries entered a period of stagflation. The phenomena of stagflation can be characterized by uncontrollable inflation accompanied by a stagnating or declining economy. The capitalist system governed by Keynesian economics and Fordist methods of production was in fundamental crisis as a consequence of the “exhaustion of inner expansion” and declining levels of profit. This created considerable stagnation tendencies and rising mass unemployment, “these same forces that fuelled the stormy growth of capitalism in its “Golden Age” now initiated its crisis” (Konicz, T 2011).
The Washington Consensus, a term first used by English economist John Williamson in 1989, referred to set a of ten economic policies designed to promote growth and address macroeconomic objectives in post-crisis countries. In broad terms, the Washington Consensus encouraged countries to open their economies ‘through trade and capital account liberalization’ (Goore, C 2000). This was done by the implementation of structural adjustment policies and neoliberal reforms often under the command of the IMF and WB. The collapse of Bretton Woods made way for neoliberalism to rise, it was the end of a regulated monetary system and pre-existing levels of international cooperation provided the foundation for it. Facilitated by booming technology and privatisation, neoliberalism also had political backing from both the US and UK, Thatcher and Reagan both believed that economic freedom went hand in hand with political freedom.
A prominent feature of the Washington Consensus were Structural Adjustment Programmes (SAP), these were policies introduced as a condition of obtaining a loan from the IMF. Neoliberal ideals tended to underpin SAPs, for countries to be eligible for a loan they were required to deregulate their markets, promote privatisation and often countries had to have economic austerity. A significant amount of developing countries were in need of loans post crisis, many the countries were subject to IMF conditionalities. But frequently IMF programmes left countries “just as impoverished but with more debt” due being subject to counterproductive conditions “policies were not well suited to the country” (Stiglitz, J 2002).
COLLAPSE OF BRETTON WOODS
The collapse of the Bretton Woods system in 1971 contributed to the decimation of an embedded liberal approach as BW methodology encompassed the compromise. The abandonment came after Richard Nixon removed the dollar-gold peg due to speculative exchanges of dollars and an ever-increasing current account deficit. By 1958 the US’s balance of payments had plummeted to $3.5billion, reflecting a levelling off of business activity in Western Europe at the time and a marked rise in US imports as a result of increased incomes linked to Fordism and Keynesian economics. Cohen’s study of the Bretton Woods System concluded “almost two-thirds of the US cumulative deficit was transferred in the form of gold, mostly to Europe” (Cohen, Benjamin J. 2001). Further issues of the BW system are associated with the dollar glut, after the gold standard was deserted the US created a dollar-gold conversion as an attempt to restabilize international money. However, this led to manipulation of currencies, buying and selling of US dollars in a speculative sense through the Eurodollar market shaped foreign trade from the 1950s onwards. When Nixon severed ties with gold most major countries had to allow their currencies to float freely which embodied neoliberalism, a reform ushered in by the Washington Consensus.
Despite the collapse of the Bretton Woods the IMF and WB formed remained as separate identities and continued to intervene in markets under Washington Consensus agreement. Both institutions were to play a significant role in debt management and global development policy. The IMF was designed to be the ‘lender of last resort’ but has been heavily criticised for failing to do so. The IMF asserted its control through a supposedly equitable but complicated voting system when it came to decision making. However, arrangements tended to be largely influenced by countries with strong economic power at the end of WWII and the US often had power to veto decisions. Joseph Stiglitz (2002) an American economist and former Vice President and Chief economist of the World Bank is heavily critical of both the IMF and WB and believes much of the blame of the ending of the said ‘golden age’ should be attributed to them and their actions.
To conclude, the most significant features of embedded liberalism during the 1940-50s did contribute to the creation of a prosperous period in history. The Bretton Woods created a system that allowed states to pursue interventional expansionary policies whilst increasing the frequency and volume of exchanges through convertible a currency. It helped maintain political harmony and international cooperation. Fordism and Keynesianism enabled individuals to be provided with a social wage, thus increased demand for goods and services which fuelled economic growth. In addition, there was increased levels of employment across many capitalist states as a result of welfare regimes and firms increasing output.
However rather than creating a ‘Golden Age’ I would argue that the embedded liberal compromise constructed a bubble in which the global capitalist system excelled in but failed to consider the external ramifications that were occurring. Inflation was rocketing and eventually evolved into stagflation, economic growth had come to a halt and unemployment was on the rise. Speculation over the US dollar caused total withdrawment of the Bretton Woods monetary system which called for the Washington Consensus to oversee international relations. The combination of the abandonment of the Bretton Woods and the emergence Washington Consensus led to a truly global system of capitalism for the first time in history. As the negative externalities of the embedded liberal compromise failed to be managed effectively states were forced to implement neoliberalism ideologies in order to conform to political pressures from governments and institutions like the IMF and WB.
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