Confronting the New Reality: Globalisation, the Global Financial Crisis and the State

By John Farrar &David Mayes

Globalisation and the Global Financial Crisis (GFC) have presented major challenges to orthodoxy. John Farrar and David Mayes discuss the implications of these challenges for the role of the state across the globe and argue that it is high time to confront our theory with reality.

The Portuguese lawyer and sociologist, Boaventura de Sousa Santos, has described the globalisation process as a “multifactored phenomena with economic, social, political, cultural, religious and legal dimensions, all interlinked in a complex fashion.” He emphasises the paradoxical character of these processes, how they manifest universality on the one hand and localisation on the other.1

The GFC developed out of the US subprime mortgage crisis which was complicated by the securitisation of mortgages and financial innovation in the form of complex derivatives. These led to the development of the shadow banking system which went unregulated by banking, insurance or securities regulation. As such it represented systemic failure, ultimately on a global basis. This led to the failure of financial institutions, a major economic recession, sovereign debt crises, the Euro Crisis and the need to prop up systemically important financial institutions.

As part of the new reality we have multinational enterprise rivalling nation states and state-owned enterprise having varied relationships with nation states. The resulting complexity which is in a state of constant flux has led to increased scepticism about existing trading blocs and the Washington Consensus policies. The domination of the West after the collapse of the USSR and the leadership of the US are now being challenged. We see the rise of Asia and the BRICS alliance. The G8 has been overtaken by the G20.


As part of the new reality we have multinational enterprise rivalling nation states and state-owned enterprise having varied relationships with nation states.

The collapse of the USSR and the rise of globalisation led to an assumption of the triumph of capitalism and even claims about the end of history. Theoretically this was premised on the assumption of the rational market. Eugene Fama explained the efficient market theory and its relationship with capitalism in the following way:

 It says prices reflect all available information, so that it’s difficult if not impossible to beat the market. Now efficient markets and capitalism are very closely interrelated, because one of the founding principles of capitalism is that prices provide good signals for the allocation of resources, and that’s basically the principle of efficient markets.

However, as Fama has recognised, “[markets] cannot predict what’s basically unpredictable.”2 Sometimes the theory works, sometimes it does not as we saw in 2008-9. Arguments about cause and effect are difficult in the area of financial markets which are not like other markets. Prices are signals as to the future and confidence plays a significant role. Absence of confidence creates havoc.


GFC and the Role of the State

For a time the Washington Consensus provided a dominant agenda for development and found favour with the IMF, World Bank and OECD. Since the GFC this dominance has been challenged and there have been arguments for a different model through alliances such as BRICS. New developments like complex derivatives and shadow banking seemed to take place under the radar. There has also been the rise of new mercantilism and resource nationalism. In this process global imbalances have led to an increased role for state-owned enterprise and sovereign wealth funds seeking to invest in undervalued assets in the West. These have shown that there is more than one model and that developing countries can be greater beneficiaries of globalisation than the West.

Governments in the West had to step in and provide support for the financial sector, which raises fundamental questions about the role of the state.

The new reality has highlighted the weaknesses of the West and the failure of many prevailing policies to pass the stress test. A significant part of the Washington Consensus was deregulation, particularly of financial markets. This system failed. Also emphasis on self-regulation of matters such as corporate governance failed in the Enron period. On an international stage this led to ineffective international cooperation and governance.

What was the immediate outcome? After desperate measures taken in a mood of near panic, governments in the West had to step in and provide support for the financial sector. This raises fundamental questions about the role of the state. The Washington Consensus had advocated a retreat of the state. Necessity led to a reliance on the state as financier and investor of last resort. The Third World countries which suffered least and gained most from the crisis have activist states. This has led to a debate as to the merits of the two models. Since the Washington Consensus was first developed with Latin America in mind, it is interesting to see the developments in that region. This is reviewed by Francisco Panizza in his excellent work Contemporary Latin America: Development and Democracy Beyond the Washington Consensus.3 This deals with changes in World Bank thinking over the role of the state, the rise of democracy often leading to governments of the left but a continuation of market reforms. It is significant that Brazil is now a member of the G20 and BRICS.4

The Financial Stability Board and IOSCO increased their activities since 2008. All of this was positive but then the US and the UK took individual steps to reform their banking sectors, and this impeded the search for an international solution. The G20 after initial progress seems to have had less effect. The Euro Crisis still continues and demonstrates weakness in the European Union (EU). BRICS seeks to enlarge its field of activity and influence.

Where will all this lead? In a new work which we have edited, Globalisation, the Global Financial Crisis and the State5, a team of international scholars in law and finance attempt to deal with these questions.


The Case of New Zealand

Margaret Wilson describes the experiences of New Zealand in following the Washington Consensus and coping with globalisation. However, the changes were made not just because of outside pressure but from the conviction of the government of the day that the previous approach of substantial protection and government intervention in the economy was just not working. These changes were made, not by a government of the right, but by a Labour government. However, as the benefits of the rejuvenation of the economy did not spread to all parts of society and inequality increased, enthusiasm waned. Although the process picked up speed again with the election of a National Party government in 1990, Wilson shows how there has been more questioning of globalisation since 1993.

Wilson provides a thorough review of the nature of the state in New Zealand, including the unusual complication of the Treaty of Waitangi and the relationship between Maori and the Crown. This special relationship can affect decisions such as privatisation and the sale of state assets. One feature of the New Zealand system which is of widespread interest is the new management of the public sector, whose impact is still being debated. However, perhaps the biggest challenge to globalisation has come simply through the democratic process. New Zealand has a rather participative democracy and with the introduction of proportional representation following a referendum, it has become much more difficult to push policies through. While the balance between globalisation and social welfare has moved back somewhat towards the latter, New Zealand’s scope for action has been reduced by the force of international law.


South Africa’s Integration Post-Apartheid

Laurence Boulle shows how the GFC has affected the post-Apartheid South African State. South Africa has been a major beneficiary of Africa’s increasing integration into the global economy over recent decades, but this sometimes clashes with the political processes and constitutional values. The construction of the post-Apartheid State in itself has altered the system substantially, inter alia introducing more positive duties on the South African State to provide social services under the 1996 constitution. Not surprisingly as an emerging economy, South Africa has much more in common with the BRIC countries (Brazil, Russia, India and China) which it has now joined, with a much more substantial role for the state and a more interventionist approach following what Boulle describes as the “Seoul Consensus” for such countries. With the move to the G20 as the grouping for dominating international cooperation, such countries are now able to have some real influence on international developments in a way that was not true before the GFC.


China and State Capitalism

While Xiaohua Yang and Clyde Stoltenberg deal with China, they focus on the changing relationship of Chinese multinationals and the state since the GFC. The chapter documents the extent of their activities and explains that this is very much a deliberate strategy, focused on key industries, particularly where they are difficult to relocate. What these Chinese firms appear to be succeeding in is a form of state capitalism, where the firm is given sufficient independence to take commercial decisions but where the state provides the overall vision and assists financing and competitive advantage.


Germany’s role in the Euro Crisis

A different facet of the challenges to the state comes from the EU, where member countries have voluntarily agreed to delegate a number of key areas of decision-making regulation and policy to the supra-national level. The boundary is naturally contentious and the working relationship has obvious challenges. Jurgen Bröhmer describes the experience of Germany in the EU and its critical role in the Euro Crisis. Germany in particular has found itself having to take on more of a major role in handling the consequences of problems in other member states than it wants, leading to a tension between narrow and broader interests in the successful development of the EU. Germany is, however, particularly interesting in this regard because of its federal structure. Thus there are pressures on the nation state from both the EU and the local levels. In some other EU member states, the sub-national level sees the EU as a possible partner in gaining greater autonomy – Scotland and Catalonia for example.

These first few chapters, therefore, not merely set up a framework for the analysis of how globalisation and the GFC have been affecting the role of the state, but they illustrate the practice with respect to four countries.


State Interaction with Private Commercial Sector

In the section that follows we look at the way in which the role of the state is changing in the realm of commercial activities. We have already noted the case of China. Adrian Noon looks at the case of Queensland and argues that their experience with state-owned companies has been good. Careful governance arrangements encourage efficient operation. International evidence suggests that for such efficient operation, companies need similar governance structures to the private sector, need to have to raise their own funds directly on the market and face competition in their activities. Such companies need to be clearly separate from direct influence from politicians but require a clear route of accountability and incentives for their performance. Noon argues that these companies have played a major role in the development of infrastructure in Queensland, which would not have been achieved through a purely private framework. This view, however, has now been challenged by the new state government.

These characteristics for successful state-owned companies set out by Noon also apply to the companies set for partial privatisation in New Zealand, thus making the chance of gains from the change in ownership smaller. This forms the topic of the analysis by Susan Watson in the case of New Zealand. New Zealand is particularly interesting at present as the government has decided to privatise some of its key state-owned enterprises in the energy sector and the national airline. These privatisations will be only partial with the government retaining control. Furthermore the airline has already been privatised once before but had to be repurchased following disastrous losses.

Michael Regan looks at a different way in which the state can interact with the private commercial sector, by considering the growth of public/private partnerships (PPPs). While much of the literature on PPPs points out the problems which have occurred with them, Regan considers the successes. More importantly he evaluates their success, not against some ideal but against the plausible alternatives, which would be sole state or private provision. In this light, PPPs tend to show up as preferable, given all normal routes to designing, financing, constructing and running such projects have their drawbacks. Not all projects are suitable for PPP, but where both parties cannot achieve their full objective without the other, a joint project stands a much greater chance of success.

Graeme Hodge takes a much wider view of the role of the state as regulator, suggesting that we can view much of the way in which the government seeks to control the workings of the economy and society as “regulatory governance.” Thus rather than providing some services itself it regulates how others do it. The range of regulation is considerable, including licensing, planning and environmental controls, a framework of corporate law, competition and restrictive practices regulation, procurement, PPP and rules on disclosure and intellectual property. All of this operates with the parallel framework of taxes, subsidies and services which can provide further influence and direction. All of this is a political activity.

Sovereign wealth funds highlight the tension between market capitalism and state capitalism and the contradictions in the latest permutations of globalisation.

The Role of Financial and State Regulation in the Global Financial Crisis

Louise Parsons considers the role of central banks and the state in dealing with the GFC. The rise of independent yet accountable central banks has been one of the notable features of the last 25 years. One of the means of assisting the achievement of price stability has been to elevate it above party politics and make it the goal of an institution that can be judged independently on its technical competence over the medium term. Leaving monetary policy as the direct responsibility of ministers runs the risk of it being subject to short-term considerations which would introduce just the volatility that policy seeks to avoid. Central banks have been very transparent in their actions and reasoning so they can be judged. In the years leading up to the GFC these arrangements seemed to have been highly successful with the fall in inflation and much smoother economic development – famously labelled the “great moderation” by the current Chairman of the Board of Governors of the Federal Reserve System, Ben Bernanke.

With the GFC this view has begun to look rather complacent, as generally speaking, central banks did not foresee the problems and still less took adequate action. The moderation has been replaced by the most substantial financial crisis since the 1930s and the pendulum of political independence is likely to swing back – certainly from its most extreme example, the Eurosystem where the Governing Council has been able to decide itself what constitutes price stability, without a ‘government’ to decide on objectives, beyond what is laid down in the Maastricht Treaty and maintained in the subsequent revisions.

The relation between the financial regulators and the GFC is developed further by David Mayes when he focuses on the issues behind the Euro Crisis and their implications for increased integration. The euro area was set up very much as a fair weather system which worked well if it was not subject to severe adverse shocks. Although the euro area was far from an optimal currency area it was expected that it would slowly grow closer and restructure steadily so that it was more able to withstand shocks – as illustrated by the case of Finland which has changed markedly in the last 20 years and survived a heavy external shock in the early part of the GFC. The big mistake, however, was to bend the rules for entry and allow countries with high public debt ratios, such as Greece, to enter and then fail to enforce the Stability and Growth Pact which should not merely have stopped indebtedness increasing, but helped it fall to safer levels. The GFC has demonstrated the interconnectedness of economies, particularly through the banking system. While other member states may be reluctant to lend to those in difficulty through fear of making losses, they are aware at the same time that a refusal to lend will result in bank failures and hence domestic losses through a different route. Hence the GFC is inevitably bringing countries closer together in Europe, not just through the agreements on much closer fiscal surveillance and the increased lending, but through the realisation that problems with the weaker affect all.

Ronald Reagan once said, ‘economists see a thing work in practice and wonder if it will work in theory’. Reality has now confronted theory in an extreme way and we need to adjust to this new reality.

Sovereign Wealth and the Global Financial Crisis

In the last chapter of the book, Mohammed Ariff and John Farrar deal with the governance of sovereign wealth funds and foreign exchange reserves, their role in the GFC and the relationship with the modern state. Sovereign wealth funds highlight the tension between market capitalism and state capitalism and the contradictions in the latest permutations of globalisation. Countries that are less open are able to buy important stakes in the economies of the more open, which may lead to a response on the fairness of the international system. At the same time, the build-up of foreign exchange reserves and the keeping of exchange rates artificially low (often by the same countries), creates serious imbalances in the world, which are not merely inhibiting the recovery of some of the countries most affected by the GFC, but offering a much greater chance of another crisis or the prolongation of the present crisis, as occurred in the 1930s.

This book shows the power of the state has indeed changed very substantially and continues to change, affected inter alia by the forces of globalisation. By imposing a severe adverse shock, the GFC has exposed the weaknesses of the changes that have taken place over several decades. In the future these weaknesses are likely to be addressed, probably with an increased role for the state and a more pragmatic approach to economic management, with greater emphasis on social and political concerns.

Ronald Reagan once said, ‘economists see a thing work in practice and wonder if it will work in theory’. Reality has now confronted theory in an extreme way and we need to adjust to this new reality.

About the Authors

John Farrar is Emeritus Professor of Law at Bond University. He is also Professor of Corporate Governance and Joint Director of The New Zealand Governance Centre at the University of Auckland, New Zealand.

David Mayes is Professor of Banking and Financial Institutions, Joint Director of the Governance Centre, and Director of the European Institute at the University of Auckland.


1. Boaventura de Sousa Santos, The Processes of Globalisation, (22 August 2002).

2. CNBC, Father of Modern Finance, (28 May 2010).

3. (London: Zed Books, 2009).

4. See generally, Fernando Henrique Cardoso, The Accidental President of Brazil – A Memoir (New York: Public Affairs, 2006).

5. (Cheltenham: Edward Elgar, 2013).


The views expressed in this article are those of the authors and do not necessarily reflect the views or policies of The World Financial Review.