A Financial 9/11

After 2001, the foreign policies of many countries were shaped in response to the terrorist attacks of September 11, which had wrenched minds back to the imperative of national security. Today those foreign policies are again being reshaped—but this time by the economic crisis. And the changes will be as profound as those wrought by 9/11.

An economic crisis does not kill and maim in the same way as do terror attacks. In the current case, its impact will be more diffuse, more long-term and less visible. But the effects may be just as far-reaching, stretching across more countries and covering more aspects of nations' lives, not just security.

The history of past crises shows that our fate will be determined less by the event itself than by how we respond. The U.S. Smoot-Hawley Tariff Act of 1930 is an often-quoted example of how a mismanaged recession was turned into a depression. By contrast, the financial crashes and panics of the early part of the 20th century sparked a wave of institutional innovations, with changes to central banking, labor and competition laws, and consumer safety regulation.

In the current case, the wrong response is clear: to pander to protectionism, defer action on climate change, turn inward and succumb to extremism. Such warnings a year ago would have sounded alarmist. Today, with governments struggling to hold on to power—those in Latvia, Iceland, Hungary have already fallen—they feel all too real.

But while the crisis is giving new momentum to the politics of fear, it is also giving new energy to the politics of hope. What the legal scholar Roberto Unger calls "false necessities" no longer constrain our thinking. Old orthodoxies have crumbled, leaving space that either progressives or reactionaries can fill. To ensure they prevail, progressives must address the deep economic, environmental and political imbalances that gave rise to the current mess.

Economic imbalances between rich and poor created the market in subprime mortgages as banks lent to people who could not afford to repay loans. Growing global financial imbalances between countries with surpluses and those with deficits depressed interest rates and created the demand for risky securities.

Americans are now beginning to save more. China is boosting domestic consumption. Certain risky financial services look less attractive. But some imbalances will not correct themselves. In fact, the gaps between rich and poor, within and between countries, may be exacerbated. That is why governments need to rebalance the relationship between the state and markets to create a fairer, more equal distribution of rewards. And the developed world must not abandon its commitments to increasing aid to poor countries, achieving the Millennium Development Goals and completing the Doha round of trade talks.

The second imbalance is environmental: between the resources we consume and the capacity of the planet to replenish itself. This mismatch between demand and supply—the resource crunch—exacerbated the credit crunch. With oil imports representing about a third of the U.S. current account deficit, the increase in energy prices added to the financial imbalances.

Addressing this imbalance is made both more possible and more necessary by the crisis today. It has become more possible because the various fiscal stimulus packages have created a major opportunity to step up investment in low-carbon energy, transport and housing. And it has become more necessary because when the economy begins to recover, a return to 2008 oil prices of $140 dollars a barrel will pull $800 billion per year out of the U.S., the EU and Japan—about half the value of their current total stimulus packages.

The final imbalance is political. It concerns the location of power: not just within countries but between the national nature of politics and the global reach of markets; between Western-dominated multilateral institutions and the eastward shift of economic wealth. The weakness of multilateral institutions is making it hard to deliver adequate concerted policy responses appropriate to the scale of the problem. The crisis, however, is creating a new impetus to strengthen multilateralism and share power and responsibility. Instead of theological debates about whether we need new institutions to include the new economic powers, the G20 format has been created to address this economic crisis at the highest level. The IMF is being strengthened with greater financial capacity and a more representative structure. Governments are coordinating as never before on fiscal responses, interest-rate cuts and regulatory reform.

U.K. Prime Minister Gordon Brown has set out the demands of a "global society." One is a new and effective multilateralism—rights and responsibilities that are enforced. That is important not just on the economy, but regarding nuclear nonproliferation, conflict prevention and human rights as well.

The economic crisis has unleashed competing forces, both progressive and reactionary. In today's interdependent world, imbalances create insecurity and make us all poorer. Now is our chance to find a new equilibrium.