Enter the dragon : China in the new financial global governance

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Enter the Dragon: China in the New

Financial Global Governance.

Master thesis

Name: Merel van der Padt Student number: 10677089

Supervisor: Professor dr. Jeffrey Harrod Second reader: Dhr. Roel van Engelen MSc Master programme: International Relations

Research project: The global politics of investment and trade Date: June 24, 2016

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Acknowledgements

Here you see the thesis “Enter the Dragon: China in the New Financial Global Governance”. This thesis was written as part of my graduation from the Master International Relations at the University of Amsterdam. From February 2016 to June 2016 I have been engaged in the research and writing of the thesis.

The completion of this thesis was not without any obstacles and the process learned me a lot about perseverance, discipline and the importance of doing research. I would like to express my gratitude to who helped me during this process, I am very grateful for your support. I especially want to thank and express the deepest appreciation to professor dr. Jeffrey Harrod. His guidance, assistance and strict yet positive approach really helped me to complete this master thesis. I furthermore want to thank my friends, Tim and Boy, with who I spent quite some time in the library, my boyfriend Wouter who had to deal with me during the stressful situations and for his endless support and last but certainly not the very least I want to thank my parents for the support and the space they provided during the whole process. At last, I want to thank the people who contributed to the research by sharing their knowledge and expertise, this was extremely useful. I hope you will enjoy reading,

Merel van der Padt June 24, 2016

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List of abbreviations

ADB Asian Development Bank

AfDB African Development Bank

AIIB Asian Infrastructure Investment Bank APEC Asia-Pacific Economic Cooperation BRIC Brazil, Russia, India & China

BRICS Brazil, Russia, India, China & South Africa BWI Bretton Woods Institution

EIB European Investment Bank

FDI Foreign Direct Investment

GDP Gross Domestic Product

IBRD International Bank for Reconstruction and Development IMF International Monetary Fund

NDB New Development Bank

PPP Purchasing Power Parity

PRC People’s Republic of China

SWIFT Society for Worldwide Interbank Financial Telecommunication

UNESCAP United Nations Economic and Social Commission for Asia and the Pacific US/USA United States of America

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The United States of America (USA) managed to use the IMF and World Bank for its foreign policy despite them being multilateral - will this be the same with China? The USA did have a hegemonic cultural and ideational power that China does not have. But does China have economic, military and diplomatic ‘soft’ power; can therefore be called ‘a’ or perhaps ‘the’ new hegemon?

By the recent establishment of two new multilateral financial organizations, the global financial order as we’ve known it since the end of World War II might have come to an end. Much has already been written about the rise of China and the methods and procedures used by the World Bank and the IMF. But the two newly founded institutions may have a significant influence on China’s rise and the global influence of the Western multilateral financial organizations. This thesis will investigate this process.

From the history of the World Bank and the IMF, the history of China and the establishments of global institutions to the importance of infrastructure and monetary policy in the global order after the financial crisis of 2008. This thesis will look into old but still relevant theories to analyse and predict what hegemony means and how future global power relations will be shaped. Will it be China as a new hegemon, a developing country with still a long way to go or as a balancer of power?

In the last few decades (global) institutions have become more and more important. They shape social and economic actions and force countries to operate less on an individual level but taking part in larger communities. While China can be seen as the largest Asian regional power, it is slowly becoming a serious challenger of the US hegemony. The days where the US-led institutions were the global policymakers are over and the rise of the AIIB and NDB might mark the beginning of a new era.

Explaining and predicting power relations and countries’ intentions is impossible. However, one can try to describe, analyse and understand certain planning that comes with countries’ foreign influence. We will never know what really goes on behind the closed doors of internal and external policy, but when theory and practice are studied together, it will hopefully give insight into the new world order. The power of the Asian

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region and China in particular is not one to be underestimated. The AIIB might be a turning point in history and a serious challenger of the US hegemony.

The hardest part of this thesis will be the investigation and analysing of the AIIB and the BRICS NDB since they have not been into practice for a significant amount of time and have therefore not been able to carry out their strategies yet. However, when we have insight into these new influential institutions and are able to put them into perspective towards the rise of the US institutions and theories of power and hegemony it may give insight in future developments in the institutional world order.

I will start my thesis by introducing the subject, research question and methods in chapter one. Chapter two will describe the history of the existing global financial hegemony. How did we get here? The rise of the World Bank and the IMF will be investigated and the same goes for the rise of China and its institutions. The BRICS countries will play an important role in this thesis but because the main focus is on China, this is the country that will be most written about in this piece. The Chinese institutions that will be looked into are the Asian Infrastructure Investment Bank and the BRICS New Development Bank. The Asian Development Bank will also be used as an example of an already existing regional Asian institution. Chapter three will explain the importance of infrastructure investment. Various BRICS trade routes will be investigated and the New Silk Road will function as an example to explain the importance of infrastructure investment in developing and also developed countries. The role that currency plays within power relations and the rise of the renminbi and decline of the dollar in the global monetary system will be investigated in chapter four. The US dollar will not be the main trading and investment currency anymore, but the renminbi will play a more important role when it comes to such investments. In chapter five the literature as discussed in the early chapters will be applied to the findings in practice. There will be looked at to what extent there can be spoken of changes in hegemonic power based on what is researched. Chapter six will exist of concluding remarks about the findings in this thesis and may propose further research in the future.

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Methods

Because there is already done quite some research about the rise of China and the hegemonic power of the US, I am planning on adding to this by providing new research on the role of the Asian Infrastructure Investment Bank, the new Chinese development bank, on the hegemonic role of the US and China as a rising power.

This thesis will be of a qualitative design. The primary resources that I will use in this thesis are most importantly data provided by various global financial institutions. Data from the World Bank and the IMF will provide images on the economic and geographical positions of the various countries being investigated. For example Gross Domestic Product, infrastructure needs and financing and voting shares. Because the AIIB and the BRICS NDB have not yet provided data on their policies I will use reports from other sources. These include news agencies such as Reuters, the Wall Street Journal, the Economist, the New York Times and World Economic Forum. To clarify and strengthen my findings I will also interview Hong Tong Wu, economist and China expert.

The theories I will use during this investigation will mostly be theories on power relations and global governance to get to an institutional analysis. I will get the theories from articles from various online databases and books. After having explained the relevant theories I will look into news articles and reports on the AIIB to compare this with the earlier mentioned literature. Because the AIIB is such a new phenomenon, founded in January 2016, there is little academic literature written about it. Therefore, I will have to use the written reports that are documented on the internet to get an insight in their operating system and plans for the future.

It is important to mention that this thesis focuses on the AIIB and the BRICS NDB but I will try to shape it in a way that it can be generalised to other upcoming global institutions as well, because this is a time where global power is shifting and the AIIB will not be the last newly found major institution that will influence this process.

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Research question

How far do changes in institutional structure of global multilateral financial governance reflect changes in hegemonic power?

AIIB & NDB case study.

Sub question 1

How does infrastructure investment relate to hegemonic power?

Sub question 2

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Theoretical framework Liberal free market ideology

In 1981, Ronald Reagan became president of the United States. He was an advocate of the liberal free market ideology. Alan Greenspan, who at the time was a chairman of the Federal Reserve System, stated that “markets are an expression of the deepest truths about human nature and (…) as a result, they will ultimately be correct” (Wade 2002: 215). This means that individuals and organizations are capable of compromising and negotiating on what outcome is best for them and when everybody acts in their own interests everyone will benefit, this will ultimately create the perfect society. Following from this he characterized four main features that together form this perfect society:

1. Competition in free markets for goods, services and capital. 2. Corporations are managed to maximize the value of shareholders. 3. Stock markets are used for buying and selling corporate control.

4. Government intervention takes place only when the market obviously fails. This could give the government the ability to intervene in infrastructure, defence and minimal social security (ibid.).

At the time that this ideology spread, the world was in the middle of the Cold War era. The US and its policy faced communism, another market idealism. After the Cold War, the United States aimed to strengthen its international position towards the former Soviet Union and the free market ideology became part of its foreign policy. Anthony Lake, the national security advisor of president Bill Clinton, made a plan for achieving this. This plan was called the ‘enlargement strategy’ an aimed for the Cold War policy to be replaced with a different policy to peacefully strengthen and spread (enlarge) the democratic (free) market economies (Lake 1993). He explained his plan in a speech at the Johns Hopkins University, the School of Advanced international Studies in Washington DC. This ‘strategy enlargement’ consisted of four components:

First, the community of market democracies, including the United States, had to be strengthened. They would form the core from which the enlargement is taking place.

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Second, new democracies and free market economies must be helped and promoted where possible. This was especially the case for states that had a special significance and opportunity.

Third, the aggression of states against democracy and a free market economy must be countered and liberalization must therefore be supported.

Fourth, the humanitarian agenda had to be pursued by helping democracies and free market economies and not only by providing aid (ibid.) This means that countries facing humanitarian struggles would be favoured to be pushed into the direction of a democratic political system and free market access.

Both the World Bank and the IMF were important tools in spreading this enlargement strategy. However, the US faced a severe dilemma when enforcing the enlargement strategies through the World Bank and the IMF. On one side, they wanted to control these institutions and make sure their policies were promoted among their allies and other countries. On the other side, they had to make sure that the IMF and the World Bank were acting according to the rules of the international community (Wade 2002: 216). After all, the World Bank and the IMF could only have the aspired influence when a significant amount of countries were involved and they had to be careful in pushing their own agenda. It is a vicious circle, when the US is trying to make their own policies happen through the institutions, the international community will be less willing to be part of it and the institutions will loose their legitimacy, making it difficult for the US to have their share of international influence.

Washington consensus

In 1990, the term ‘Washington consensus’ came into existence. It was founded by John Williamson (1990) who identified “10 policy measures1_{about whose proper deployment} Washington can muster a reasonable degree of consensus” (Williamson 1990: 7). It is a term that is still being used over 25 years later because it shows the geography of power

1_{These were, amongst others, fiscal discipline, improving income distribution, a} competitive exchange rate, deregulation, trade liberalization and liberalization of FDI inflows.

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relations in the 1980s and the structural adjustment of American neoliberal policy around the world (Peet 2007). In its original meaning, the Washington consensus was mainly focused on the Latin American region but it soon spread all across the developing world. It was, however, not without resistance. Various east-Asian states still believed in the power of a state-led policy and as a consequence they rapidly grew. The World Bank tried to justify this by portraying the Asian growth as market-led and export-oriented industrialization (Sheppard & Leitner 2010: 186). More about the Washington consensus, the Bretton Woods Institutions and their influence on Latin America will be discussed in chapter 2.

John Williamson, the writer of the original Washington consensus, confessed that the term had become bigger than he intended. It had been used as a synonym for the spread of neoliberalism or even ‘market fundamentalism’ in the developing world rather than just being a summary of economic development policies (Williamson 2000: 254). Also, in the meaning that the term is adopted, the Washington consensus has also not quite worked out the way it should have. Neoliberal reforms had not gained the expected growth in developing countries in Latin America and sub-Saharan Africa and market-oriented reforms could not overcome public health emergencies (Rodrik 2006: 974). On many Latin American countries it even had a reverse effect, the regulations and restrictions that were forced on them made many economies even get into bigger debt, chapter 2 will explain the history, policy implications and effects of the Washington consensus on the Latin American economies.

Global financial hegemony

When speaking of hegemony, the example of the enlargement strategy can be placed in a bigger picture. As Antonio Gramsci stated, power within a social group can be claimed by either domination or intellectual and moral leadership. Domination, or hard power, means that an opposing group is conquered possibly by the use of violence or intimidation. Consequence of this is the opposing group being alienated or even eradicated (Gramsci in Arrighi & Silver 1999). Hard power is forcing others to give you what you want. Hegemony, therefore, is a form of soft power. The global hegemon must have the ability to make other countries and others in general want the same thing as the hegemon (ibid.).

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Becoming the hegemon is a matter of combining 1) the belief that the provided ideology by your country brings prosperity and is better than all alternatives and 2) the belief that your country will have fair and appropriate rules that will be enforced on the dominant and inferior groups (Wade 2002: 217). In other words, hegemony contains of a practical and a procedural pillar.

Robert Cox does not fully agree on Gramsci’s soft power theory. He states that soft power is an important feature of global hegemony, that international social relationships do reflect hegemonic power, but that economic and political structures are also essential facets. These, in combination with social structure, must all three be combined when describing hegemonic power relations (Cox 1983: 171). The US had become the hegemon due to its outward expansion of its neoliberal ideology; their hegemony is therefore necessary to maintain global stability. A dominant power in the international system, the US in this case, has shaped the international playing field to serve at its interests. They have created and generated approval by the international community and even by disadvantaged groups, according to the neo-Gramscian theory of Cox.

Gramsci and Cox do agree on the fact that international organisations and institutions play an important role in expressing hegemonic power. They function as the process through which the hegemon’s ideology can be spread and developed. Cox describes the characteristics of these institutions and the way they can express their hegemonic influence in five features; first, they embody the rules that facilitate the expansion of hegemonic world orders. Second, they are the product of the hegemonic world order. Third, they ideologically legitimate the norms of the world order. Fourth, they co-opt the elites from peripheral countries and last, they absorb the counter-hegemonic ideas (Cox 1983: 172). When it comes to the IMF and the World Bank, these institutions can be framed to promote economic expansion, ‘enlargement’ as mentioned earlier in this text. An example of this is the fact that both the IMF and the World Bank in were in their earlier days more often used as safeguards for social concerns in the domestic playfield like unemployment than for example the gold standard. The national policies of the United States were in this case consistent with the liberal world economy as an

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objective, so it was fully justified. The dominant state is usually the one to make the rules for the international community and carried out by the international institutions founded by this same state.

This causes various dilemmas for the hegemon and multilateral organizations. The hegemon, as discussed above, has to strengthen its practical pillar by making other countries wanting to follow its example but by intervening in spreading its ideology of free market access the procedural pillar will be undermined. Multilateral organizations, on the other hand, are supposed make and follow the rules as mentioned in the procedural pillar. However, they are taking a risk of not being supported by the hegemon and acting according to the hegemon’s ideas may lead the multilateral organizations to get unable to enhance the rules.

However, the US enlargement strategy may not be working for todays emerging markets. In this thesis, I will take the global financial crisis as a turning point. When it broke out, the US and the industrialized, ‘Western’ world spent most of the time fixing institutions such as the World Bank and the IMF and various other post-war international financial architectures. In the meantime, Russia and China were spending their time trying to build and shape a new version of it.

The US was hegemonic in the Gramscian sense, they were able to influence the rest of the world by the spread of their ideas and culture as well as being military and economically dominate. The multilateral financial institutions with which they were involved became part of the hegemony. China does not have ideational and cultural power but is moving towards military and economic dominance. The two situations are therefore different but the structure of the multilateral institutions share similarities. Will China be able to use the Asian Infrastructure Investment Bank (AIIB) and the New Development Bank (NDB) the same way the USA used the IMF and the World Bank?

The role of power in international relations

The two main approaches to power in international relations that will be used in this thesis are power as defensive realism by Kenneth Waltz (2010) and power as offensive realism by John Mearsheimer (2001). Waltz states that states have the tendency to

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balance their power to other states in the international playing field. When they fail to do so, they are at risk of being set aside, being unable to join the system. However, balancing power is not a continuous process. It can occur that in times of conflict or aggressive behaviour of other states, this balancing will take different (for example counter-aggressive) forms, which makes defensive realism a quite vague description of power within international relations. Defensive realism is not so much about becoming the most powerful nation, but more about being part of the system, about not being left out. However, it describes processes within and differences between national and international policies, but it often fails to tell us what states will do or to predict how they will react. It is a theory that can be used to describe how the international system worked in hindsight, but is unable to look forward. Mearsheimer, unlike Waltz, does try to predict how states react to and opposing power (Rosecrance 2006: 32). First of all, strong nations will try to gain regional influence and become the great power of a certain region, in this case China within the Asian region. To be able to become the biggest regional power, Mearsheimer divides power into three strategies for states to get and maintain a strong position in the world order. Of these strategies, I will only use his theories on maximum wealth and economic strength because that is the theory that is most important when it comes to the New Development Bank and the Asian Infrastructure Investment Bank. Because I have to limit my hegemony analysis to a few important factors, infrastructure seems to be the number one priority of the new development banks and the topic about which most information can be found.

According to Mearsheimer, economic strength is the foundation of military strength (Mearsheimer 2001). Various AIIB projects contribute to the economic gains of China. Trade barriers that will be removed and the Silk Road Project are examples of this. Beijing has played a key role in launching initiatives such as the New Development Bank (NDB) and the New Silk Road Fund, which are designed to increase infrastructure financing for developing countries. According to the Financial Times, China’s New Silk Road is becoming the largest program of economic diplomacy since the US-led Marshall Plan (Clover & Hornby 2015). The plan aims to cover dozens of countries and a total population of over 3 billion people and can be seen as a way of defining China’s place in the world and its relations with its neighbours. The economic gains of this New Silk

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Road are significant. Trade barriers will be removed and China will therefore strengthen its regional and global economic position.

Many scholars believe that the international system after the Cold War is unipolar. The strength of the US military is as big as over half of all global spending on military combined. According to Kenneth Waltz, the international system is unipolar and he views defensive realism as the way to describe this. States can only aim to balance their power to the hegemon, but there will also be one dominant power that is able to influence the rest, as described above. Mearsheimer, on the other hand, views the international system to be multipolar (Mearsheimer 2001). According to him, there is no international distribution of power where only one great power ‘has it all’. When taking the subject of this thesis into account, Mearsheimer’s multi-polarity means that the US can maintain its power over one region and China can do the same for its own region. Great powers can exist and operate next to each other. In sum: according to Waltz, China is starting to overthrow the US hegemonic power while Mearsheimer would see the rise of China as an example of multi-polarity, of multiple powers existing next to each other and operating in their own regions.

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2. History – how did we get here?

To understand the hegemonic influence of the US in the global financial market and the spread of the neoliberal ideology, one must first understand the processes that have occurred in the forming of the global order as we have always known it. The institutions formed in the Bretton Woods system have played a major role in multilateral financial policy, but have not always been successful. In this chapter, the founding of the institutions and their coping with international debt crises will be discussed. Various debt crisis and the flaws that occurred during this process will be analysed to eventually get a clear image of the history and policies of the Bretton Woods Institutions. This is essential to understand before analysing the newly found international multilateral institutions; it puts their rise of into perspective.

2.1 A neoliberal worldview and the rise of US institutions

At the Bretton Woods conference in July 1944, various governments signed an agreement that would form the creation and implementation of the International Bank for Reconstruction and Development (IBRD) that would later be known as the World Bank, and the International Monetary Fund (IMF), together forming the ‘Bretton Woods Institutions’ (BWI’s). Traditionally, the president of the World Bank is an American and both institutions are, close to each other, based in Washington DC. Not only are their offices located on either sides of the same street, they work closely together as well. How did these American global financial institutions relate to the spread of ideology? The initiators of the BWI’s aimed to balance the growth in the world economy. The institutions were established to protect living standards and employment in all the member countries and realise balanced growth in international trade, develop productive resources and stimulate income distribution and employment (Woods 2006: 2). The headquarters of both the IMF and the World Bank are located in Washington DC. The initial aim of the IMF was to reconstruct the international payment system and the IMF would act as an international lender (Peet 2003: 57). This means that governments that were troubling with problems with their balance of payment could get a loan from the IMF to secure their financial stability. When governments would cooperate and

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assist each other they would create a universal system of prosperity. An important agreement was made on politics and sources of political influence to be kept out of the institutions. Proficient technocrats would be leading and highly trained economics would staff them (Woods 2006: 2).

In 1947, when the Marshall Plan had come into practice, various European countries were receiving financial assistance from various other sources than just the World Bank. As a consequence, the Bank started to focus more on other developing countries outside of Europe in the following decades. The ability to grant bigger loans to these countries made them able to invest in various development projects such as infrastructure and social services (n.a., n.d.). However, this all changed between the founding of the World Bank and the year 1974. The World Bank then began to provide relatively small loans. Loans and grants had to meet strict criteria for it was a time of fiscal conservatism. The Bank was constrained by the belief that ‘loose lending’ was one of the causes for the financial collapse of the pre-World War II economy. Together with conservative political pressures from the United States government, the Bank had no other opportunity than to stagnate (Goldman 2006: 59). But after that period, in the mid 1970s, this all changed. International lending by banks had been exploded due to a growing European market and long-term loans were provided to mostly developing and emerging markets (Helleiner 1996: 138).

As mentioned in the theoretic framework, president Ronald Reagan promised a tougher foreign policy towards the former Soviet Union in particular but also towards other (to the US) hostile countries. Like Margaret Thatcher of Great Britain and Helmut Kohl of Germany, Reagan used monetary policy as a way to control inflation and privatization to improve efficiency in the public sector. The state influence on the market would be reduced (Woods 2006: 47). However, governments and creditors were forced to intervene when in 1982 the Latin American debt crisis broke out. Because in the last years of the 1970s the Fed had raised interest rates to control inflation (which was also widely believed to be caused by the oil crisis; oil producing countries were making more profit from the high oil prices, this profit was saved in Western banks and developing countries, particularly in Latin America, were now able to borrow cheap money because of the large liquidity), debtors were in even more debt and creditors were less willing to

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lend them the money needed. At this point, debtors could not return their payments to the creditors and this eventually led to the very beginning of a monetary crisis (Cline 1983). When in 1982 the first Latin American debt crisis broke out, creditors agreed that the governments had to intervene to make sure it was not going to impact other international commercial banks because that would bring the whole international financial system down. Governments needed to make sure that their creditor banks did not go bankrupt, or a major global financial crisis would break out. Besides, when they would not intervene the Latin American countries in debt would become a prey for the Soviet Union. That is why the IMF, World Bank, the Bank for International Settlements, the US treasury and the Fed took part in preventing this situation from happening and the IMF would lead this process.

Until the Latin American debt crisis, the IMF had used the Polak model to define monetary problems and debt crises. The Polak model dates back to 1957. When the IMF came into existence and allowed member countries to seek credit when they could not live up to their balance of payments, the Fund needed a model to understand the origins of these problems. When the problem could be analysed, the solution would be easier to find and countries could implement a sustainable new monetary policy. Jacques J. Polak, a Dutch economist and IMF advisor, created the model that was used to do get an image of the problem and to prescribe a solution. A few decades after its implementation, the IMF still used this model as a tool to analyse and adapt to economic crises (Polak 1998: 396). It described the 1982 crisis as a short-term liquidity crisis that was caused by an excessive creation of domestic credit. It prescribed, therefore, to tighten the monetary policy. This would lead to stabilization of the economy and a slow release of debt. The Latin American debtor countries (with Brazil, Argentina and Mexico as the highest debtors) were required to lower their government spending and to increase interest rates. Normally, this would lead to a contraction of the economy but it had only little effect on the crisis. This was not much of a surprise for there had been much critique on the Polak model. The Latin American debt countries where the model did not have the expected outcome was just one example of the model not giving the expected outcomes in debt restructuring. The Polak model was often seen as a policy of ‘overkill’; it underestimated the output’s side effects on the demand-sides as described by Sydney Dell (1982). He views the attack on inflation, which was the main purpose of the debt

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relief program used by the IMF, to be used as an end in itself. The other objectives earlier proposed by the IMF were being overshadowed and this led to a distortion of its priorities (Dell 1982: 597). He describes the economic cuts that were made to be going further than necessary, it went beyond the reasonable objectives (ibid.). The IMF loaned money to various Latin American countries under the condition that they would open up to free-market capitalism and strict rules were set to enforce the cut-back on spending. These conditions had a negative effect on the growth rate and living standards in many Latin American countries. The people of these countries were getting unsatisfied with their situation and therefore with the conditions the IMF had set. The IMF became a symbol for the aversion against international institutions controlling their countries. They felt controlled by outsiders and wanted to solve their problems within their own governments, they wanted to take responsibility back to their own governments to make their own policies. Some leaders even were discharged due to IMF involvement. At the end of the 1980s Brazilian officials even decided they would never cooperate with the IMF again (ibid.). The IMF did succeed in balancing some aspects of the Latin American debt crisis but was never able to fully solve it.

Dell, therefore, claims that the IMF program that was used to try and solve the Latin American debt crisis is not able to solve any crisis when the concept of unilateral adjustment is used. The IMF should make effort to avoid overkill and adapt to the needs of a country in crisis (ibid.). At that time, the IMF simply did not have the tools to do so. Because many Latin American countries still faced a severe monetary crisis and were not much closer to financial stability than they were in 1982, the IMF had to make sure that a stabilizing policy was implemented so these countries could access the global financial markets.

In October 1985, the Baker Plan was introduced at the IMF and World Bank meeting in Seoul. James Baker, United States Secretary of the Treasury, saw this plan as a way to handle the international debt crisis (Monteagudo 1994: 59). The idea of the Baker Plan was inspired by the trade surplus of China. This could be used for Third World’s middle-income countries, which were heavily indebted but still owned a large amount of money. China’s surplus could then be used to relieve some of their debt. Among the fifteen mentioned countries ten of them were in Central and Latin America (ibid.).

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Unfortunately, the Baker Plan failed to reach the goals it set due to the fact that the policymakers couldn’t agree on which countries needed aid the most. Again, a new approach was needed to help Latin America get out of its crisis.

The Brady plan marked this new approach. It was a relatively simple plan that provided financial assistance to debtor countries that succeeded to stabilize their national policies. This would mean a balanced state budget, free movement of goods and capital, policies aimed at stimulating economic growth and a willingness to tackle the debt problem in a pragmatic (so contrary to political or ideological) way. There was no one-size-fits all solution for debt crises, every case would need a different policy. The first country to negotiate with its creditors in 1982, Mexico, was also the first country that was being involved with the Brady plan. It was a successful plan in several ways. First, while the earlier mentioned Polak model was criticized for being too unilateral, the Brady plan allowed negotiation from both parties on their levels of debt service. Second, the risk that countries would be involved in the debt relief negotiations would be disconnected from commercial banks and third, emerging markets were more willing to adapt the conditions set by the IMF and granted easier access to international capital markets (Vásquez 1996: 234). The Brady plan did in fact not succeed to solve all the various economic problems that occurred in the Emerging Markets. However, it did bring the Latin American debt crisis down and led them into a more globalized, market-oriented relationship with their creditors and in 2006 most of the Brady debt had been brought back (ibid.).

The Latin American crisis of the 1970 and early 1980s were actually “helpful” in spreading the neoliberal worldview among global financial institutions while various other crises in the 1990s (especially the Asian crisis in 1997) made room for a different kind of neoliberalism promoting social sustainability (Güven 2012: 870). This paradigm is often labelled as the “Post-Washington Consensus”. Past crises influenced reforms within both the IMF and the World Bank; crisis management had become an adaptation to various past crises but still held on to a neoliberal ideology.

Crisis management mechanisms in Latin America show the power a country as the United States has when they control the IMF and the World Bank. There were various

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forces being used by the US in the Latin American case that give a clear view of how institutions can be used to spread ideology and to gain worldwide influence. Economic ideas such as the Washington consensus and the various debt resolution mechanisms can shape economic policy in other countries. Another important factor that explains global power is bureaucracy. Offices of both the IMF and the World Bank are located in Washington DC, the same city where US national policy offices are settled. When important decisions need to be made, the US policymakers will be the closest ones nearby the offices of both of these institutions.

As is shown in the previous examples of debt management, the Bretton Woods Institutions are often viewed to be asymmetrical organisations. Rich countries that are able to control their debt do not need the IMF and the World Bank but with their voting power of 60% they call the shots in both these institutions. Countries who are not in control of their debt and who do need the IMF and the World Bank have haven’t got a lot to say. This is one of the main reasons why the institutions are seen as tools of Western power. When they intervene, the IMF and the World Bank often call for Western measures for various problems; privatization, liberalization and deregulation.

More on voting power and the asymmetry of the Bretton Woods institutions will be discussed in chapter 2.3. The power of China and the BRIC’s economies within the Bretton Woods institutions and the reason they established their own multilateral development banks will be discussed in chapter 3. Economic policy is not only about debt-relief as a mechanism to spread ideology. It also highly depends on infrastructure and industrial capacity, which will be discussed in chapter 4. But before getting to China, the BRICS economies and the various ways of spreading ideology, one needs to understand how China has become the big and powerful nation that it is today. The US and their enlargement strategy have been highly powerful for the last 70 years, but China has become a serious challenger of the US hegemony in a relative short amount of time. How did they get here?

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2.2 China as a new power

When in 1976 Chairman Mao Zedong died, China has since engaged in various international institutions and has evolved into a state that might have the power to overthrow the international global order. David Shambaugh, professor at the George Washington University in Washington DC, describes this transition as a process of various phases: “a period of opposition to the international order from the 1950s to the 1970s; a generally passive position in the 1980s and 1990s, when China sought membership in international institutions and wished to learn the rules of the road, obeying them to a large extent and a more selective and activist position in the early 2000s” (Shambaugh 2013: 125). In Shambaugh’s so-called first phase, from the building of the republic in 1949 until the ‘reform and opening’ period in 1987, China’s position towards the international playing field could be best described as hostile towards the Western world, which rooted in the context of the Cold War. China did not take part in the earlier described global system, dominated by the US. Instead of cooperating within the Bretton Woods system, China teamed up with the Soviet Union until it fell apart. The United Nations were at the time seen as a puppet, a tool from the West to spread its ideology and only when in 1965 various nations called for a reform, China participated in 1971 (Shield 2013: 150). Ironically enough, China is now one of the key supporters of the UN. The rapid development that China experienced was partly due to the culture of working hard and the emphasis on personal development an education that were seen as important features since the ‘reform and open’ period. According to Hong Tong Wu (Appendix I), a reason why China could develop so quickly was that they made a 5-year plan. The government expressed their priorities and policies and how they expected their people to live up to them. This might be a different approach than the West had experienced and approved, but it did lead to the economic development that China had in mind. There were no labour unions and large-scale demonstrations were prohibited; the Chinese government was a government of guidance. The outcome of these policies was a rapid economic development of China. First, they needed welfare before they could focus on wellbeing (ibid.). This example of the Chinese way of developing is characteristic for nations developing later than the West and it shows the two different worldviews on global policy.

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With the following participation of China in international markets and economic governance, the engagement in the international financial playing field gathered speed. A decade after joining the UN, in the early 1980s, China started participating in the World Bank, the IMF, the Asian Development Bank and the, General Agreement of Tariffs and Trade (GATT), now known as the WTO. Even though China still had its disagreements with the international order for it was dominated by the Western (or actually mostly US) institutions, the fact that their economy kept growing by the increased access to international markets made it utterly beneficial for China to keep on participating. They engaged mostly by letting the US being the hegemonic power and learning and watching from the side than actually trying to be the dominant player (Shield 2013: 151).

But times have changed since then. China is on its way to become a serious challenger of the US hegemony. The Chinese economy has since the reforms of the 1970s quadrupled and is still growing, it maybe even doubling over the next decade. Especially the manufacturing business is booming in China with its centres consuming about a third of the global supply of coal, iron and steel (Ikenberry 2008: 26). The Chinese military spending has also increased and China has become a country nobody can and will underestimate. Both military and economically, China challenges the existing superpower(s) and might soon even overthrow them. As discussed earlier in this thesis, a powerful state has the ability to make international policy and enforce institutions and rules to pursue its interests through soft power.

For the US, China may be difficult to understand. When it comes to sustaining economic growth, investing in infrastructure, balance military power and maintaining stability, these countries simply have to cooperate and recognise each other’s ability to spread their ideology and influence. China also seems to influence American security and prosperity, it is an important relationship that might even be too important to ignore (Bergsten et al. 2007: 1).

Right now, China’s development into a global superpower is impressive to say the least. In just a few decades time, the country evolved from a communist, closed nation to one

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of the world’s economic and military leaders. It is now the fourth largest economy of the world and in the past three decades it has been growing by 10% each year. Over 200 million people were lifted out of poverty and it has become an open country, willing to get their economic gains from free and open trade. Of all the world’s trade, China has accounted for 12.7%, quite a lot more than the US with 8.8%. And with all this trade, China can also count on a large trade surplus. In 2006, now 10 years ago already, $1 trillion worth of exchange reserves, more than any other country, had reached the Chinese economy. The US, however, are still leading on Foreign Direct Investments (FDI’s) but China is catching up rapidly (Azevêdo 2015). The deep and quick integration to the world economy is a transition that has rarely been seen before. Coming from a developing country with the majority of its inhabitants living in poverty, China needed only a few decades to be one of the biggest players in the global economic field. However, this does not mean that all the Chinese people live in prosperity now as well. Remarkable is the fact that even though China has become such a major economic power that has saved so many of its people from poverty, there is still a relatively large group facing this same poverty. The per capita income is on average only one twenty-fifth of the US per capita income and the wages are also just a fraction of the minimum wages in other (Western) economic powers (Bergsten et al. 2007: 4).

This thesis will analyse if China can challenge the US as the present hegemon, even if they are still a country in developing, an emerging market. And what role will emerging nations in general play in the global economy? Is there room for countries like China and their Russian, Brazilian, Indian and South-African allies in the world order, shaped by the US, as we know it now? Will the unipolar power of the US remain intact, be overthrown by China or are we transitioning in a process where hegemony will be multipolar? To further research this, one must first analyse the biggest turning point in the world economy of the last decade, the global financial crisis that broke out in 2008. This is a crisis that changed many facets of the global financial order as it existed since the Bretton Woods system. It is a crisis that had a major impact on the US, the Western world as a whole and on the role of China in international relations.

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2.3 The 2008 financial crisis

Since the middle of 2007 the world faced a global financial crisis, also known as the great recession. Into 2008, this crisis reached its peak. Stock markets all over the world fell down, financial institutions collapsed and governments of many (wealthy) nations had to bail out their financial systems through rescue plans. Premier Wen of the Peoples Republic of China (PRC) stated that the crisis had “fully exposed the deficiencies in the existing international financial system and its governance structure” and called for “the establishment of a new world economic order that is just, equitable, sound and stable” (Shield 2013: 147). The fact that China and many other Asian countries were worried about the crisis in the West led to a number of countries demanding the US and its global financial institutions to set up restructuring mechanisms and bailout packages to prevent a resulting crisis in the Asian region. If the crisis in the West would not be solved quickly, it would have a dramatic effect on foreign direct investments and trade agreements around the world. Some believe that the Asian region was disconnected from financial systems in the West because Asia never had a mortgage crisis like many countries in the West had. They have experienced a major creation of wealth and a rapid growth of their economy, which led to various investments in Western countries and increased foreign investments from the West back in Asia. Unfortunately, in a globalized world, side effects are inevitable when so many countries break out in crisis and therefore Asia did feel the effects of the crisis in the West. Currency values dropped and stock markets suffered. In addition to that, many Asian countries are manufacturing countries relying on export. When Western countries are in crisis and cannot spend too much money importing goods and services from Asia, they will feel the effects of a crisis on the other side of the globe. A slowdown in Western countries will eventually lead to a slowdown in the Asian region with a possibility of job losses and various other problems that are associated with that such as social unrest. Following from the crisis, China was openly outspoken in its concerns about the dollar being the only foreign currency reserve and called for a replacement with a reserve currency by the IMF. As expected, the US did not agree with this plan and was not willing to give up the dominant power the dollar still has because it was and still it is a major source of global economic

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dominance (n.a. 2009). Not only China, but all the BRIC’s2_{countries were in favour of} backing up the dollar with a reserve currency and boosting the resources of the IMF. Not only is having a reserve currency to back up the dollar an important tool in crisis management, currency is an important tool in power relations as well. In chapter 5 will explain how currency can play a role in power relations and hegemony.

The crisis had a severe effect on the BRIC’s economies that were still developing and emerging and felt their exports decline. The easiest way for the BRIC’s countries to boost the IMF reserves would be to use their own reserves to invest in bilateral bailout schemes. International bailouts like the IMF had already done before would have the IMF’s conditionality as a downside but it was over all in an economic and political way less costly (Lesage et al. 2013: 567). Therefore, the BRIC’s countries helped strengthening the IMF and engaged in their policy instead of bilateral lending to stabilize the world economy. When a country is unable to pay the IMF back or to fulfil the IMF’s demands, the borrower is always responsible and will always carry the risks. That is why many developed and emerging economies chose to get involved with the IMF bailout plan instead of taking bilateral lending into their own hands (ibid.).

The BRIC’s countries were also interested in increasing their voting power within the IMF. At the Executive Board (EB), they demanded for a change within the ‘picking order’ and more voting power inherent to the size of their economies. The BRIC’s countries aimed for a restructuring within the IMF order and to renew financial commitments (Interview with BRIC’s official at the IMF in Lesage et al. 2013.). Unfortunately for them, the IMF remains a ‘quota-based institution’, where financial contributions from member countries determine their power within the voting system. In the battle for more voting power, India and Brazil are among the most outspoken BRIC’s countries, but China has not been so active within this debate (ibid.). China preferred a more gradual change instead of an immediate change of the IMF structure and voting system because of the risk of causing an institutional crisis (ibid.). The way of gradually changing policy fits

2_{This was before South-Africa joined the BRICS, when they were only the BRIC’s} countries, but despite the joining of South-Africa in December 2010, a relatively small economy compared to the other BRIC’s, their voting power is still not a decent

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perfectly in the ‘peaceful rise of China’ strategy3_{. Eventually, the BRIC’s countries} demanded a redistribution of 7% of the quota (and therefore of the voting power) from the advanced economies to the emerging economies (Wroughton 2009). The most powerful argument the BRIC’s countries had to make this change in quota happen was their creditor strength. Countries that were already developed didn’t have the possibility of bringing new money into the field, while developing countries could gradually and perhaps even exponentially contribute more; “the BRIC’s … could leverage their enormous amount of foreign exchange reserves to demand quotas and voting weight increases if they [were] to contribute more funds to the IMF” (Zheng 2008 in Lesage et al. 2013: 568). The financial crisis of 2008 might be just the time to propose and implement restructuring within the IMF.

The next half of this chapter will describe how the financial crisis was a turning point for the BRIC’s countries and how they tried to increase their power within the Bretton Woods institutions. Chapter 2.3 will further investigate the separate BRIC’s economies and their relationship towards each other.

The very first serious attempts to reform the IMF and the World Bank were made in Singapore in 2006 at the annual meeting of the Boards of Governors of the IMF and the World Bank. For an annual meeting, this specific one had the largest turnout that it had ever seen for a meeting overseas and in the history of Singapore. This meeting mainly focused on emerging markets and developing nations and their wish to have more influence in the IMF and World Bank policies. Voting rights and the prevention of financial crises were being discussed and this meeting was particularly important because emerging economies were for the first time actually acknowledged as influential players in the global field. As seen in figure 1, Brazil, India and China all benefitted from the restructuring policies that were found in Singapore, Russia has felt some negative change. Striking is the small effect the ‘influential’ meeting in Singapore actually had. With the slightest quota adaptations that were made, the US is still at 17.68% while China is only at 4% and Russia even underwent negative change and now

3_{When China was in the process of becoming a politically, economic and military} powerful nation, they needed other countries to not view them as a threat to peace and security. They promoted a peaceful international environment, aimed to become a responsible leader through soft power and avoided unnecessary international confrontation.

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only has a share of 2.49%. However, when looking at figure 1 and figure 2, it shows that in 2005, China had an 18% Gross Domestic Product (GDP) rate relative to the US. When translating this into terms of voting power, it should at least stand at 3%, so it seems to be a fair representation. However, given the fact that figure 2 shows the GDP from 2005 and the Singapore meetings were held in 2006 and the Chinese economy has been growing rapidly since then, the table does not take China’s rapid growth into account and when looking at the overall score, high income countries will still be having the most voting power and therefore the ability to veto or implement important policy changes.

When taking a closer look, figure 2 shows the exact differences between China and the US from 2005 until 2007, right before the financial crisis broke out and at the time the Singapore meeting was held. It provides a clear image of the financial status of both countries and how the voting power of 4% that China had after the Singapore meeting compared to the over 17% of the US is softy stated misrepresented. In 2007, both the economies of China and the US were rapidly growing when looking at the absolute numbers of GDP. China went from a GDP of $2.291.454 billion to $3.542.560 billion and the US from $13.093.700 billion to $14.477.625 billion. The US is still by far the largest economy but when looking at the relative numbers, China saw a growth in GDP of 20.1% from 2005 to 2006 and even 28.7% from 2006 to 2007. Compared to the US, with 5.8% from 2005 to 2006 and only 4.5% from 2006 to 2007, China is on its way to economically compete with the global superpower. Also, when looking at the volumes of imports and exports of goods and services, China is dominating the US as well. With import per cent changes of 13.4% in 2005 and 14.8% in 2007 of China against 6.3% in 2005 to and 2.5% in 2007 of the US and export per cent changes of 24.1% in 2005 and 20.9% in 2007 of China and 6.2% in 2005 and 9.3% in 2007 of the US, this table the immense economic power that China is becoming and how the institutional power of the World Bank and the IMF seem to misrepresent this.

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Figure 1

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Figure 2

Source: IMF

In 2009, when the global financial crisis was still in full swing, the BRIC’S countries combined had over 10 times of the currency reserves in stock the IMF had. However, even though combatting the crisis was a major priority for the BRIC’S countries, they did not want too much cooperation with the IMF. The reason behind this was that due to the IMF’s conditionality’s within their bailout programs, any country getting involved would pay a political price for doing so. While the Western, developed countries were contributing, the BRIC’s countries were able to possibly free-ride on the contributions of the West and save their own reserves for other (domestic) purposes (Lesage et al. 2013: 568). However, free-riding on the unilateralism of the West could endanger the US dollar value and therefore endanger the value of the US dollar reserves. The BRIC’s countries faced the risk that unilateral liquidity injections would have a negative effect on the value of the dollar because of inflation and/or devaluation due to the large amount of investments that were made in a single institution. This was even more a reason to distrust the IMF and to refuse cooperation (ibid.). Therefore, a multilateral response through the IMF was for the BRIC’s more preferable, but only when the voting

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shares would be redistributed from developed economies to the emerging ones. As the BRIC’s economies and especially China hoped for a more stable financial governance, they figured that when giving the IMF more responsibilities they would ensure monetary policies would to not lead to financial imbalances, because of the greater spreading of reserve currency-issuing countries (Interview with BRIC’s official at the IMF in Lesage et al. 2013; Chin & Wang 2010: 9; Otero-Iglesias & Zhang 2012: 10). To try and impose the restructuring of voting power within the IMF, the BRIC’s position within the institution appeared to be too weak. Before the IMF reformed its policies in quota and governance again in 2010, the BRIC’s had a combined voting power of less than 15%4_{and were unable to block or impose certain decisions within the Fund, even after} the attempted reforms of 2006 in Singapore (Lesage et al. 2013). But despite the fact that the BRIC’s countries still had very little formal power within the IMF and that the IMF was unable to restructure its voting system more fairly, countries around the world were aware of the economic power that the BRIC’s countries had. Even the highest IMF officials knew that the voting system did not reflect economic capacities and that the BRIC’s countries were still influential, big players in the world economy, even though the were not recognised as such by the IMF. This gives the BRIC’s countries a strong position in negotiating for more voting power. They can always refer to their own economically powerful position in the global market to address the IMF’s legitimacy and credibility. After all, the IMF needs a decent representation of their GDP’s if it wants to be taken seriously by its allies, even if this means that advanced economies have to hand in some of their power within the institution for the better good of a fair representation.

The 2008 financial crisis made reforms within the IMF a necessary change, there have been more calls for restructuring the Fund and reshaping the global financial system than ever. The crisis appears to affect so many advanced economies that even countries that have benefitted from it and from the on-going inequalities within global economies were calling for a reform. Developing countries have tried this for years before the crisis broke out already, but it seems that since 2008, they have been more heard than ever. When comparing China and the US again but now in the heat of the crisis, from 2008 until 2011, some notable changes have occurred. As seen in figure 3, since the financial

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crisis broke out, China’s GDP has grown from $4.564.951 billion in 2008 to $7.442.032 billion in 2011, an overall growth rate of 63% in only three years. When comparing this to the US, the numbers are not as positive. The US started at $14.718.575 billion in 2008 and only increased to $15.517.925 billion. In absolute numbers, the US is still far ahead of the Chinese economy, but their GDP only grew 5.4% in three years. A shockingly low number compared to the 63% growth of China. These numbers particularly show the significant impact that the financial crisis had on the US economy and how China managed to somehow stay relatively undamaged. Of course, little is known what the absence of a global financial crisis would have done to the Chinese economy and the height of their growing GDP. Looking at the import and export numbers, figure 3 also shows that China did experience a setback, perhaps due to the crisis. In 2009, they saw their export of goods and services drop by 11.3%. However, one year later in 2010 they had already climbed up again and the export increased by 25.7%. The US imports and exports again suffered more. In 2008, when the crisis had just hit the US economy, the import of goods and services decreased with 2.6%, what might be due to the financial breakdown and market protection mechanisms that backlashed on imports. In 2009, one year later, the import even dropped to a negative 13.7% and also the export suffered with a negative 8.8%. One way of managing a financial crisis is restrict imports so money stays in the country; a way of actually building a economy is exporting goods and services to money flows into the country. In 2009, the US had negative percentages in both cases. In 2010 and 2011 the imports and exports were positive again but still only half or even less of the Chinese import and export percentages.

Numbers like GDP, exports, imports and relative growth rates are important to get a clear image of how China is economically rising. The importance of export rates and why because of these export rates, China survived the crisis relatively well will be further explained in the following chapters, just as the link between export rates, infrastructure and monetary power.

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Figure 3

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2.3 The BRIC’s countries

A 2005 Goldman Sachs Economic Research report shows that the US and Japan will be the only two economies who will remain in the top six largest economies worldwide (O’Neill et al. 2005). In the next 40 years, the BRIC’s economies will combined be bigger than the US and the four largest EU economies (being Germany, France, Italy and the UK, amongst others in the G6). This is due to the fact that the BRIC’s economies have an average yearly growth of 5%, as seen in figure 4.

Figure 4

Source: PricewaterhouseCoopers

To get to the point of being a major economic power, the BRIC’s countries have restructured their political system and embraced global capitalism (ibid.). Economist and head of the global economic research group at Goldman Sachs Jim O’Neill has developed a so-called ‘BRIC thesis’. This thesis describes how the BRIC countries, being

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Brazil, Russia, India and China, have changed their political systems to open up to and embrace global capitalism. He predicts that once they are capable of competing with the neoliberal, capitalist global system, China and India will be dominating in the manufacturing of goods and services and Brazil and Russia will be the suppliers of raw materials (O’Neill 2001). Therefore, it would be a logical decision for the BRIC countries to cooperate, they can transform into a powerful block due to the exporting and trading of their own manufactured goods and services and will not need the powerful establishment, the developed countries. Brazil has enormous supplies of soy and iron ore, Russia is dominant in oil and natural gas, the BRIC countries have all the ingredients to eventually become an industrial power, independent of the Western world (Cheng et al. 2007: 144).

Before the end of the Cold War, the governments of the countries now known as the BRIC economies proposed various economic and political reforms to open up their economies for the global market. Policies regarding education, domestic entrepreneurship, foreign direct investment and domestic consumption were important pillars to gain access to the world economy. Various studies have pointed out that India would have the most potential for economic growth within the BRIC countries in the 30 to 50 years following from the first proposals. The reason for this is the fact that China, Russia and Brazil will experience an increasing in age of the working population, something that will happen later in India (Cheng et al. 2007: 145). Figure 5 shows the population structure in the BRIC economies and the Western economies such as the US, EU and the OECD. It provides an estimation of the development of these nations and the expected share of the working-age population. It shows how India may not yet have the biggest share of working population relative to the total population, but is slowly increasing. China and India are both the most populated countries in the world. In 2014, the Chinese population counted approximately 1.39 billion people and India is right behind with approximately 1.27 billion people, expected to have more inhabitants than China by 2030. Together, they hold 36.41% of the total world population (n.a. 2015c). Their share in the world population, the share of the working age population within these countries and their manufacturing power make the BRIC countries the economic power they are and the even bigger power they will become in a foreseeable future. Figure 5

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Source: World Bank (2006) World Development Indicators

Ever since the BRIC’s economies opened up to global capitalism, their contribution to the globalizing markets have increased with approximately 28% of growth in terms of US dollars and 55% in PPP (Purchasing Power Parity) (O’Neill et al. 2005). Since 2001, the BRIC’s economies combined had a share of global trade of 15% annually and trade within these countries increased to 8% of the total trade when in the year 2000 it was only 5% (ibid.). Together, they hold 30% of the world’s reserves and their FDI increased to 15% between 2000 and 2007 (ibid.). The major role the BRIC’s countries play in the world economy is already discussed before, but it will also have a significant influence on their currencies. When productivity increases, their currencies are likely to appreciate and that will again be beneficial for the GDP growth. The importance of currency and the influence it can have on dominating the global markets will be further discussed in chapter 5.

For China to cooperate within the BRIC’s economic block cannot simply be seen as an answer to US power. They may have tried to minimize their dependency on the US and its unilateralism but it would be an underestimation of the BRIC’s power and cooperation to solely call it a tool to overthrow the dominance of the US. China also benefits from this cooperation by strengthening its identity as a developing country, stabilizing its international environment, coordinating its position with other BRIC’s to maximize leverage, helping other developing countries and taking part in a group to cope with negative attention. When China would cooperate within the BRIC’s economies

Enter the dragon : China in the new financial global governance