After Bretton Woods?

The underpinnings of the old order are giving way. It's unclear what replaces them.

Delegates from fourty-four nations assembled at Bretton Woods, New Hampshire, 1944. (Bettmann/Contributor).

I was recently asked to speak at a conference sponsored by the International Monetary Fund and World Bank to mark the 80th anniversary of the original Bretton Woods conference at which they were founded. At the same hotel as the 1944 meeting, I was asked to reflect on how those institutions had evolved over this period, and what that might mean for their future in the next 80 years. The need for strong and cooperative institutions is greater than ever today, given the present conflicts and turbulence and the new challenges that have arisen like climate change and pandemic preparedness. But what are the actual prospects for something big and new emerging?

There are three conditions required for the creation of new international institutions, or for the major overhaul of existing ones. First, there needs to be a large redistribution of international power, a redistribution that wipes away older stakeholders that are defending the status quo. This can come about as the result of a war, major financial crisis, or some other triggering event cataclysmic enough to create demand for change.

The second condition is the emergence of a hegemonic leader with the power to guide the establishment of a new order. It is in theory possible for less powerful players to work together to craft an agreement, but there are huge collective action problems to overcome. Look at the failure of the United Nations to revise the membership of the Security Council, which everyone understands no longer reflects the true balance of power in today’s world.

The third condition is that there has to be a “big idea” animating the need for change. A couple of decades ago, Lant Pritchett and David Lindauer wrote an article about international development entitled “What’s the Big Idea?”¹ They argued that the “big idea” has always revolved around the appropriate role of the state in the economy, and that this idea has swung like a pendulum between greater and lesser degrees of state intervention.

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Since the beginning of the 20th century, there have been four critical junctures that met the first condition of redistributing state power: the First World War, the Second World War, the period of the oil and debt crises in the 1970s-80s, and finally the period today.

At the beginning of the 20th century, the dominant big idea governing the international order was classical liberalism, shaped by Britain, the world’s leading economic power. The world was on the gold standard, which was believed to be self-equilibrating; states intervened to protect specific sectors but did not assume responsibility for protecting populations from the vagaries of market forces. The people by and large had to take care of themselves.

The First World War severely weakened Britain, and the United States at that point could have stepped into a global leadership role. It chose, however, not to do so when the Senate defied President Wilson and failed to ratify membership in the League of Nations. This rejection reflected the powerful strand of isolationism that characterized much of U.S. foreign policy since its founding, and was very much in line with the hegemony of classical liberalism on the part of American elites.

Without a global hegemon, the world fell into a chaotic nationalism. Countries pursued beggar-thy-neighbor monetary policies and self-destructive protectionism, leading to the Great Depression and unemployment rates of 25 percent or more in the United States and other industrialized countries. The gold standard proved unable to deal with the global banking crisis in 1932-33, leading the new Roosevelt administration to pull out of the system. Economic nationalism gave way to political nationalism, and the Second World War was the result.

The Bretton Woods conference took place towards the end of that war, when it was increasingly clear that the Axis countries would be defeated. This time around, the United States stepped willingly into the leadership role that had been abdicated by a victorious but gravely weakened Britain. Moreover, classical economic liberalism had been replaced by another big idea, what John Ruggie labeled “embedded liberalism.”² The latter rejected socialism, but allowed liberal states to intervene in the economy both to actively manage monetary policy and to protect populations against the vagaries of the market. The Great Depression had produced the New Deal in the United States and a vision for a far more activist state. It also decisively rejected economic nationalism, pushing for trade liberalization and international cooperation in managing the reconstruction and the development tasks that lay ahead once peace was achieved. This was the setting for Bretton Woods, which created an International Monetary Fund to manage monetary policy and an International Bank for Reconstruction and Development (the World Bank) to promote economic growth.

By the 1970s and ‘80s, American hegemony had slowly eroded, with decolonization and the emergence of a “Third World” of newly independent countries that were not aligned with either Washington or Moscow. These countries flexed their muscles after the October 1973 Middle East war when OPEC imposed an oil embargo against countries supporting Israel. This led to a spiral of inflation in the United States, and a growing debt crisis in Latin America and sub-Saharan Africa as petrodollars were recycled to countries that could not sustain the debt levels they took on in the face of rising oil prices. At the same time, the United States faced calls to “come home, America” after its defeat in the Vietnam War. Over this same period, the United States was beginning to shift from being the world’s largest creditor to a new position as debtor, and President Nixon ended gold convertibility altogether.

At this point, many people began predicting an end to American global hegemony and major shifts in the international economic system it had created. There were some alternatives to “embedded liberalism” in this period, particularly on the left; Latin American dependencia theory was accepted by many academics at the time. But something surprising happened along the way. Defeat in the Vietnam War did not trigger a return of isolationism in America; rather, the American economy showed amazing resilience and political self-confidence during the 1980s. By the end of the decade, the Soviet Union and Communism both collapsed, leaving America once again in a hegemonic position with regard to the global distribution of power. This dominance was reflected in the economic, political, cultural, and military realms; with regard to the latter, the U.S. defense budget in the 1990s equaled that of most of the rest of the world combined.

This newly resurgent America was animated by another big idea. It rejected embedded liberalism in favor of what has been labeled “neoliberalism,” which pushed the pendulum back in the direction of classical liberalism by seeking to remove the state from economic intervention to the extent possible. Washington exercised its newfound hegemonic power through the Bretton Woods institutions to push developing countries suffering from hyperinflation and currency crisis into structural adjustment.

The rise of neoliberalism and the “Washington Consensus” had both good and bad effects. Globalization and trade liberalization permitted developing countries like China, Vietnam, and India to enter the international trading system and achieve unprecedented rates of growth. On the other hand, the displacement of jobs from North America and Europe to East Asia laid the groundwork for a powerful political backlash in the 2010s.

This period of renewed U.S. hegemony lasted for approximately two decades, from the fall of the Berlin Wall in 1989 until roughly the subprime financial crisis in 2008. American stewardship of the international system had good aspects, creating the framework not just for economic growth but for the spread of democracy to many parts of the world. Unfortunately, it was marred by two major mistakes in U.S. policy, which were underpinned in turn by two mistaken ideas that were derivative of the then-dominant neoliberalism.

The first was the 2003 invasion of Iraq, built on the belief that hard military power could be used to reshape the politics of a distant and culturally different part of the world. While the invasion achieved its short-term purpose of removing Saddam Hussein from power, it did not succeed in building a stable democracy in Iraq. That country today is more closely aligned with Iran than with the United States. The knock-on effects of the invasion continue to unfold: together with the decades-long occupation of Afghanistan, the American public grew tired of “forever wars” and international engagement more broadly.

The second big mistake was the promotion by the Bretton Woods institutions of capital mobility — that is, the ability of banks and other financial institutions to move large amounts of short-term money across international borders — as a key part of the Washington Consensus. That this happened is ironic, since the original charter of the IMF did not include this injunction. Indeed, Article VI Section 3 of the Articles of Agreement explicitly gave countries permission to establish currency controls. This began to change in the 1980s, driven in part by technological advances that allowed very rapid movement of liquidity across international borders. But it was also driven by a big idea, namely that capital markets could allocate capital efficiently if left to their own devices.

This unfortunately turned out not to be true: capital markets were subject to manias, pile-ons, and sudden panics. The financial stability experienced by much of the world after World War II was suddenly broken by a series of currency crises in the 1990s. Mexico and several countries in East Asia saw global investors shift massive amounts of liquidity into their local markets, only to retreat just as suddenly when confidence took a downturn. At the time of the 1997 Asian financial crisis, many American observers attributed this to weak financial regulation. But then, in 2007-08, America itself with its supposedly strong regulatory institutions was hoisted on its own petard as investors rushed into, and then out of, the US subprime credit market.  

U.S. power has been in relative decline since its peak in 2008. The American share of global output has been declining as a result of the rise of China and other East Asian countries. The United States has become a huge debtor country, with enormous pools of capital residing beyond its borders and outside its control. The American military, while still the world’s most powerful, is increasingly challenged by rising great powers Russia and China, as well as by new middle powers like the Gulf states, Turkey, and others. The American political model is no longer broadly imitated or even admired. America’s greatest global weakness is its internal polarization, which makes it difficult for Americans to agree on issues like aid to Ukraine. This then makes the U.S. model less attractive internationally. While the number of democracies around the world grew steadily from the mid-1970s to the first decade of the 21st century, they have been in decline for nearly the past 20 years.

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The conditions for a major reform of the Bretton Woods institutions, or the creation of new institutions to take their place, is therefore not propitious. While there has been a major redistribution of international power in the early 21st century, the other two of the three conditions for reform are not present: no hegemon has arisen to take Washington’s place, and there is no big idea to guide reconstruction of world order.

While neoliberalism has been criticized endlessly in recent years, it is not clear what set of guiding principles will emerge to underpin global development. The only plausible alternative hegemon is China, but that country does not seem eager enough to invest in global public goods to play that role, nor will its legitimacy be broadly accepted. The Chinese have a big idea embedded in their Belt and Road initiative, but that project has already run into serious problems and backlash. It remains likely, therefore, that the Bretton Woods institutions will continue to adjust to their new conditions slowly and cautiously. But anything like a major institutional innovation of the sort that took place in 1944 seems very unlikely at this critical juncture.

Francis Fukuyama is Senior Fellow at the Freeman Spogli Institute for International Studies at Stanford University. He writes the “Frankly Fukuyama” column, carried forward from American Purpose, at Persuasion.

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1. Pritchett, Lant, and David Lindauer, “What’s the Big Idea? The Third Generation of Policies for Economic Growth”, Economica 3: 1-28 (2002).

2. Ruggie, John G., “International Regimes, Transitions, and Change: Embedded Liberalism in the Postwar Economic Order”, International Organization 36: 379-415 (1982).