The economic threat of weak global governance

This month – the centenary of the outbreak of World War I – is an opportune time to reflect on big risks. As Michael Spence recently warned, the international order’s widening security deficit, reflecting the weakening of whatever global governance we have, is fast becoming the biggest risk facing the world economy. The same point could have been made a century ago.

On July 30, 1914, Austrian warships bombarded Belgrade, five weeks after the assassination of Archduke Franz Ferdinand in Sarajevo. By mid-August, the world was at war. The armistice that was agreed four years later, after about 20 million people had died, amounted only to an interlude before the horror of World War II.

In the years preceding August 1914, until the assassination of the archduke, the global economy performed relatively well: trade expanded worldwide, financial markets seemed healthy, and the business community shrugged off political problems as either temporary or irrelevant. It was a political breakdown that led to three terrible decades for the world economy.

Markets and economic activity can withstand a great deal of political stress and uncertainty – up to the point that the international order breaks down. Today, for example, the economic mood is rather upbeat. The International Monetary Fund forecasts 4% growth for the world economy in 2015, while stock market indices are up in many parts of the world; indeed, the Dow Jones reached an all-time high in July.

In the last few months, however, tensions have increased around disputed islands in the South and East China Seas, and chaos in the Middle East has continued to spread. The Israeli-Palestinian conflict is in one of its worst phases in decades. Terrorists may be on the verge of designing much less detectable weapons.

There are other, less “political” dangers. West Africa is afflicted by a terrible outbreak of the deadly Ebola virus. The outbreak has so far remained regional, but it serves as a reminder that in an age of air travel by millions, no one is safe from the spread of infectious disease. Containing a disease or a terrorist threat by curtailing international travel or transport would devastate the world economy.

Thinking about August 1914 should remind us that great catastrophes can materialize gradually. Leaders can be “sleepwalkers” who fail to manage risk by, say, establishing institutions that can channel the rival interests and claims that fuel international conflict. Such sleepwalking by policymakers caused the financial meltdown of 2008 as well. Its consequences were not as deadly, though the political effects of mass unemployment and the heightened perception of economic insecurity are still with us.

These examples should spur the world to find ways forward for cooperative action. But the opposite appears to be happening. The United Nations seems more paralyzed than ever. The US Congress still has not approved the IMF reform package agreed in 2010, weakening one of the most important international institutions. Partly because the United States makes capital increases and governance reforms in global financial institutions so difficult, the BRICS countries (Brazil, Russia, India, China, and South Africa) have launched their own development bank, to be based in Shanghai.

Likewise, instead of providing a shining example of supranational cooperation and pooled sovereignty for the twenty-first century, the European Union remains mired in rather petty disputes. While it still cannot fully agree on the design of its banking union, it is allowing Prime Minister Viktor Orbán of Hungary, a member country, to denigrate the democratic and liberal values upon which the EU rests.

The way forward cannot be a return to the past, with its clashing nation states. The future can be secured only by strong cooperation among all those committed to liberal democracy and the rule of law, with no double standards or excuses, and by patient strengthening of international institutions that embody these values and can translate them into practice.

Whenever a global or regional power acts in a way that contradicts these values, or allies itself closely with those who do, it undermines the international order, which should deliver security and increasing prosperity (and to some degree has). The global economy holds great promise, but it is a promise that can be realized only in an international system based on rules, consent, respect and a shared sense of justice.

The fact that neither the events in the Middle East nor Ukraine seem to touch financial markets should not lull us into complacency. The memory of August 1914 should remind us how the world stumbled into catastrophe. As we know – or should know – from the example of climate change, big risks must be managed, even if the probability of worse-case outcomes is low.

Published in collaboration with Project Syndicate

Author: Kemal Derviş, former Minister of Economic Affairs of Turkey and former Administrator for the United Nations Development Program (UNDP), is a vice president of the Brookings Institution.

Image: Poppies are laid among the names of soldiers on the World War One Wall of Remembrance on the eve of ANZAC Day at the Australian National War Memorial in Canberra April 24, 2014. REUTERS/Phil Noble