The dynamics of financial globalization: Technology, market structure, and policy response

Policy Sciences 27: 319-342, 1994. © 1994 Kluwer Academic Publishers. Printed in the Netherlands.

The dynamics of financial globalization: Technology, market structure, and policy response

PHILIP G. CERNY Department of Politics, University of York, York YO1 5DD, UK

Abstract. The development of increasingly transnationalized ('globalized') financial markets raises several key issues for the analysis of pGlitics, public policy, and the national state. This article suggests that financial globalization increasingly constrains policymakers and circum- scribes the policy capacity of the state. After looking briefly at a range of approaches to the process of financial globalization itself, the author suggests that technological change is the main independent variable, by reducing transaction costs and dramatically increasing the price sensitivity of financial markets across borders, while at the same time making possible a range of economies of scale. These very developments have a knock-on effect throughout the domestic and international economies. They in turn make obsolescent the political economies of scale - the governance structures - which have characterized economic policy in modern nation-states, undermining the capacity of the state to produce public goods. At the same time, globalized financial markets interact with rapidly changing interest group structures and divided state structures, especially through 'regulatory arbitrage.' Without the development of transnational regimes capable of regulating global financial markets, the structural basis of the national state itself is being undermined, and Polanyi's 'Great Transformation' is over.

Introduction

How significant has the internationalization of finance in recent years been for the way that the international system works and for the decisional capacity of the state? The core of the problematic can be seen in Karl Polanyi's identi- fication of international finance - hautefinance, as he called it - as the culmi- nation of the ill-fated 19th century attempt to create an international economic (and political) system rooted in a 'self-regulating market' (Polanyi, 1944). In his analysis, the social dislocations - including, of course, wars and depressions - caused by the failure of supposedly self-regulating markets in- evitably lead to political upheavals, and these are followed by attempts to institute new or refurbished regulatory systems in order to stabilize market systems, or even to abolish or replace them. Since the breakdown of the Bretton Woods system in the early 1970s, the concept of basing the international financial system once again on the model of a self-regulating market has increasingly dominated the agendas both of the major financial powers, especially the United States and the United Kingdom, and of the main economic actors in the international system, especially financial services firms and multinational corporations.

Market structures in the financial services industry have been transformed in this process, and at the core of this process of transformation, catalyzing

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and accelerating other changes, has been technological change in finance in general and in the transnational financial services sector in particular. These changes have led to a quantum jump in the sensitivity of prices of financial instruments across the world, drawing market actors big and small - and their capital - into the search for paper profits. Changes in the global financial structure have in turn driven the evolution of a range of structural developments both in the wider economy - national and international - and in the forms of the state apparatus engaged not only in financial market regulation but also in wider economic policy - again, on both domestic and international levels. The centrality of finance and financial markets to economic change has been dramatically reinforced by technological change, and this is leading to a new hegemony of financial markets in a more open and interdependent world. This new global transformation has gravely challenged the capacity of the state to provide effective governance not only of financial markets themselves, but also of economic affairs generally.

1. Approaches to the analysis of financial globalization

The relationship of structural change in financial markets, on the one hand, and the widespread policy shift toward the deregulation and liberalization of those markets, on the other, is a central problem for an understanding of contemporary trends in public and economic policy and policymaking. The momentum of this deregulatory shift has generally been analyzed by ex- amining the interaction of two intertwined trends. The first of these trends has been more 'political,' i.e. the adoption in finance as in other aspects of economic and social policy of a neoliberal agenda as epitomized by Reaganomics and Thatcherism. The second has been more 'economic,' i.e. the evolution of the international financial system itself, especially as characterized by the acceleration of international capital movements. As with so much in political economy, the relationship between political change and economic change has been at the heart of debates about the significance of financial globalization and its impact on world political generally. The core of the debate concerns the problematic identified by Polanyi: Can self-regulating financial markets operate in a stable and productive fashion? or will their inherent volatility cause unacceptable social dislocation and political crisis? If the latter is true, what can (or will) be done in response to the situation?

In the absence of a world government, the regulation of transnational financial markets can only be done in one of three ways: through workable international institutions; through a hegemonic state or group of states working through less formal mechanisms of power and influence; or through the reestablishment of much closer and more direct state control over the markets. Each of these mechanisms, to work effectively, must have sufficient institutional capacity and autonomy for the task. However, we are today very aware of the weaknesses faced at each level. With increasingly tightly-knit

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global market structures, expanding international capital flows, and a political context in which states and public agencies within states can be 'whipsawed' against each other in what is called 'regulatory arbitrage' or 'competition in laxity,' any attempt at genuine transnational re-regulation of financial markets faces a vast array of structural and conjunctural obstacles. The conditions which made effective regulation possible in earlier eras no longer exist. Some of these earlier conditions stemmed from the fact that capitalism itself was at an earlier stage of development both in absolute terms (levels of production, trade, financial flows, standards of living, etc.) and in terms of the structural complexity and sophistication of technology, production methods, communications, etc. Other conditions were related to the stage of political development, with the 'modern' nation-state expanding its functions and apparatuses in an uneasy and uneven attempt to deal with pressures from both above and below, embodied in both authoritarian and democratic forms. I argue that these conditions - which I regard as particular 'political economies of scale' characteristic of the political and economic structures of a specific historical era - no longer exist in the contemporary international system (Cerny, 1994a).

Analysis of the political side of the equation has been dominated, as has so much of the debate in international relations and international political economy, by hegemonic stability theory. Yet the 'hegemonic decline' of the United States in and of itself does not explain the emergence of new patterns of interaction and the forms that they take. Some approaches to this last issue look to the structure of the state itself and to the actions of state actors to explain change and restructuring in the international financial marketplace. My own analysis of the political character of the 'post-hegemonic' (or even ~post-realist?') world has focused on the argument that the endogenous structural character of the state itself has fundamentally changed (Cerny, 1990 and 1993). The character of the domestic state (as well as the state as structural unit in the international system) is, I have argued, fundamentally a function of the character of the international and transnational environment - not the other way around. In a changing - globalizing - international and transnational environment, the state has been not only an agent of its own transformation (through what I have called the 'competition state'), but also a major source of the development of globalization itself. This is particularly true, as I will argue below, in the financial issue-area. 1

However, states also subsequently lose much of their general hierarchical and holistic character in this process. The central paradox or dilemma facing states in public policy terms in today's world, therefore, is not that states simply lose power to other structures; rather, they undermine and legislate away their own power, confronted by the imperatives of international competitiveness. In this way, state policies have tended to converge on a more liberal, deregulatory approach because of the changing structural character of the international system - its greater structural complexity and interpen- etratedness - which in turn transforms the changing position of states them-

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selves within that system. It is this global structural change which has brought about the decline of American hegemony, for example - not the decline of American power resources or international 'structural power' (Strange, 1988) per se. In other words, the causation is in the opposite direction from that usually posited by neorealists; the loss of hegemony is the result of the changing 'deep structures' of the system, undermining the very significance of the configuration of states and their relative power resources (the 'states system' itself) as an independent variable.

Competition between states is no longer simply a rivalry over market shares, but a race to participate in the benefits of transnationally inter- penetrated and structurally integrated economic processes. In this context, the globalization of finance has played a disproportionate role by cutting across structures of state power in such a way as to channel state power into reinforcing the structural power of private financial markets, thereby increasingly undermining state power itself and institutionalizing that of the global marketplace. Geoffrey Underhill, following Polanyi, proposes a paral- lel analysis, but expressed in a somewhat different way - arguing that markets are not mere abstract economic processes, but highly elaborate institutional structures. Markets, therefore, are generally created, shaped and maintained by states themselves, although states can subsequently lose control of the markets which they themselves have established. This is just as true of transnational markets as of nationally-bounded markets. Indeed, states, having set up the conditions in which more open international financial markets were established in the 1970s and 1980s, are now having difficulty controlling their own creations (Underhill, 1991).

Another politically-oriented approach - derived mainly from the interaction of realist international relations theory and comparative state theory (as has occurred in the comparative political economy of the 'Cornell School') - has focused on the differences between the responses of distinct types of states to international pressures (especially small states and large states) and on the interaction between those responses. This approach emphasizes the significance of continuing divergences between state responses (see Goodman and Pauly, 1993, for an important recent example), in contrast to the more convergence-oriented approaches - including the approach taken here. An even more directly comparativist approach focuses not so much on the state itself as on the different patterns of corporatism in major countries and how they are changing (and converging) (Moran, 1991). 2

A somewhat different approach is derived more directly from realist theory in international relations (and also public choice theory) but seeks to modify it in one crucial way. This approach focuses on changing forms of international bargaining, but introduces a wider set of systemically significant variables into what is still essentially a realist international negotiation framework. In essence, domestic and international private interests - and their rather different objectives and modes of decision-making - are introduced into what was traditionally an interstate bargaining context. The aim is to identify and

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characterize a wider set of both actors and bargaining processes analogous to those which Stopford and Strange (1991) in their analysis of multinational corporations have called 'triangular diplomacy' (state-state/state-firm/firm- firm) and Brian Hocking and Michael Smith (1994) have called 'multilayered diplomacy.' In applying a not dissimilar analytical framework to the financial sector - in this case, the establishment of the Bank for International Settle- ments in 1929, a period of hegemonic interregnum - Beth Simmons (1993) identifies a form of bargaining which both integrates significant private actors and introduces time asymmetries in a form of 'dynamic contracting.' A similar approach, although less explicitly theorized, is found in Eric Helleiner's historical work on Bretton Woods and its breakdown (Helleiner, 1993 and 1994).

Other politically-oriented but essentially international-level approaches examine (a) the development of old and new international regimes in the financial services area (Porter, 1992), (b) the role of epistemic communities (Kapstein, 1992), and (c) the emergence of a transnational Gramscian hegemony (Gill, 1993). These authors stress the development of transnational forms of regulation - whether in terms of the development of more formal- legal regulations, on the one hand, or through a more socio-political focus on the transnational and transgovernmental convergence of elite approaches toward the stabilization of finance capital in general, on the other. In the former case, attention is often focused on the 1988 Basle Agreement on capital adequacy rules for banks, which was negotiated by central bankers (led by the Federal Reserve and the Bank of England) through the Bank for Inter- national Settlements. In the latter case, the focus is on 'regulation' in the much more sociological sense used by the French 'Regulation School' - i.e. the development of a range of sociological as well as institutional mechanisms for regulating and controlling the destabilizing tendencies inherent in capitalist competition and in the divergent interests of opposing groups and classes.

But the answer to the Polanyian question obviously requires an analysis of the economic side of the equation as well as the political. That debate, in the field of international political economy, has been dominated by the 'capital mobility hypothesis' (cf. Webb, 1991, and Andrews, 1994). The CMH has mainly pointed to the exploding volume of international financial transactions, arguing that the ability for capital to move increasingly freely across borders provides the best explanation for a variety of changes - from deregulation and liberalization to the convergence of monetary and fiscal policies - across a range of different countries. Andrews (1994, and also in this volume) modifies the CMH in an important way, by arguing that it is not so much the volume of capital flows which is at issue, but the possibility for potential capital flows to occur, i.e. the lowering of barriers to such flows; I will return to this issue below. Each country reacts differently to capital mobility (real or potential) because of its different size and state structure, of course; however (the CMH posits), the increasing volume, speed and fungibility of caPital movements on a transnational - if not yet homogeneously global - scale makes all

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states more vulnerable to what are clearly economic system-level changes (although some states are more vulnerable than others). This vulnerability is manifested in the way that these capital flows undermine a growing range of traditional policy instruments of both a fiscal and a monetary nature. The capital mobility approach has also been at the root of the debate over the changing nature of capitalism itself and the sort of social and political changes which are likely to occur over the next few years and decades - i.e., whether increased capital mobility will solve socio-economic problems or exacerbate them (cf. McKenzie and Lee, 1991, and Reich, 1991).

Capital mobility arguments are extremely attractive, especially because they have the theoretical advantage of being extremely parsimonious. Capital mobility itself - whatever the original causes of its expansion and whatever the market structures and institutions through which it is mediated - is the main (and sometimes the only) independent variable, the key explanans of change. The channels through which it flows are often to be seen as mere epiphenomena, as the consequences of capital mobility itself. For neoclassical and, especially, neoliberal economists, the CMH is primarily a reflection of the increasing inherent efficiency of markets as they are widened; the increased mobility of capital flows undermines the capacity of states and other monopolistic institutional structures to distort markets. Most of the work published by economists and financial analysts on deregulation, for example, starts from this premise (a typical example is Khoury, 1990). For many political scientists and sociologists, however, this analysis raises the specter of Polanyi's self-regulating market and the potential for social as well as for economic instability which the volatility of such capital flows might cause. For some neo-Keynesian economists and liberal-institutionalist political economists, in turn, the main probl~matique raised by such capital flows is how and whether they can be effectively regulated (or re-regulated) to ensure the benefits of efficiency while also controlling the potential negative effects of instability and market failure. The focus of this last category of literature is the debate around the relative effectiveness of transnational regime formation versus intergovernmental policy coordination as alternative modes of policy response to capital mobility.

Furthermore, it must be stressed that the CMH - in its volume version, at least - enjoys the benefit of being easily illustrated and/or tested empirically. Even a brief glance at the analyses produced by international organizations provides a ream of useful figures on the acceleration of such flows and their impact on governmental policy and policy-making (Goldstein, Folkerts- Landau, et al., 1993a and 1993b). 3 It is well known, for example, that especially in the period since the breakdown of Bretton Woods, the volume of capital flows has grown exponentially, dwarfing the volume of merchandise trade flows (see Giry-Deloison and Masson, 1988). If money and goods were indeed wholly commensurable - i.e., if use value were identical with exchange value - then the fact that financial flows have regularly been estimated at 20- 40 times the volume of trade (and with that gap increasing from year to year) would speak for itself.

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It must be remembered, however, that the significance of the CMH for the analysis of financial globalization transcends its role as an independent variable, and, indeed, brings its impact into question. For increasing transnational capital mobility also appears as a crucial dependent or facilitating variable for demonstrating the validity of other hypotheses, whether of the political type or the economic type discussed above. Its universality under- lines its importance. Yet as with so much in social science analysis, this very universality can hide a range of problems; the CMH has become a clich6. Taken in this wider context, the CMH can be seen to explain everything; at the same time it perhaps explains nothing. The importance of the CMH may well lie not in its role as explanans, but in its role as explanandum. What needs to be examined, then, is the context in which capital mobility increases (and has its dramatic feedback effects). This concern draws the analyst back to a range of other political, social and economic structures and processes.

This paper will argue that the most important single independent variable in understanding the structural significance of financial globalization is neither the changing political context in which globalization is taking place nor the simple expansion of transnational market processes (and capital mobility) taken in isolation. What is central to understanding financial globalization is the changing infrastructure - especially the technological infrastructure - of the economic-institutional system within which not only financial exchanges but economic processes in general are taking place in the world today. The argument will draw its analytical premises from what is called the 'new institutional economics,' the attempt by certain structuralist economic theorists in recent years to come to grips with changing institutional forms in the economic sphere, or what Oliver Williamson has called structures of governance (Williamson, 1975 and 1985). These structures are similar in con- ception to what Michel Crozier and Erhard Friedberg (1977) called 'structured fields of action' - i.e., different yet interacting structured patterns of rewards and penalties which elicit different forms of strategic behavior from actors operating within these fields.

For Williamson, such patterns consist of distinct blends or mixes of ideal- type market organizational forms and ideal-type hierarchical organizational forms. Which mix proves to be most efficient in production terms depends on certain key characteristics of the structure itself: on the one hand, the technology of production and exchange creates material parameters which constrain the effectiveness of some organizational forms and enhance the effectiveness of others ('technological economies of scale'); on the other hand, a range of processes entailed in the actual management of production and exchange involve different types of costs, costs which must be minimized ('transaction costs', or managerial economies of scale). Such an approach is inextricably intertwined with politics, too. Different political structures may also be said to be characterized by distinct 'political economies of scale' (Cerny, 1994a). In a recent article, Herbert Kitschelt (1991) has further developed the conceptualization of industrial governance structures and linked

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them systematically with state structures, although he does not deal with the global level. I hope in this paper not only to elaborate on the notion of political economies of scale, but also to extrapolate them from the comparative to the transnational financial level. Major changes in the character of financial exchange itself, some having emerged from long-term developments in areas such as information technology, some involving shifts of scale which have transformed the structure of transaction costs in financial services, have now become so consolidated and interwoven that they operate to a large extent autonomously of traditional forms of political action and state intervention. Of course, the development and impact of technology does not involve merely the machinery of (in this case) financial transactions - the electronic equivalent of nuts and bolts - but also the culture of production, competition, and innovation in the financial sector and, indeed, in all of the other sectors of economy and society, which are inextricably intertwined with finance (Cerny, 1994b).

Thus the financial market changes which I will be looking at most closely in this paper are among those which concern the actual structure, rather than the simple volume, of capital flows. It is the way that financial flows are structured, not just those flows per se, that gives global financial markets their autonomy and their capacity to impose 'embedded financial orthodoxy' (Cerny, 1994b) on governments and societies. It is the structure of competition in financial markets which gives rise to financial innovation. It is the character of financial innovation, in turn, which gives the market a complexity - involving 'circular' rather than 'linear' forms of causal interaction (Kitschelt, 1991) - which states and limited intergovernmental regimes cannot match. Furthermore, it is not simply the speed of capital flows but the fact that they flow through market structures characterized by what Kitschelt calls 'Mark V' technological structures (Kitschelt, 1991: p. 461) - with the innovation strategies which are thereby enabled and the almost infinitely variable economies of scale which result - which allows the markets to stay ahead of the regulators. And it is the rapidly evolving capacity of companies and market actors to manipulate the structures of firms and organized markets through complex and flexible mixtures of market and hierarchy which makes the territorial state and its international extensions structurally unsuited to the task of effective regulation. Just as state industrial policy suffers from insufficient flexibility vis-6-vis evolving production structures, financial regulation is becoming more and more difficult in the face of the flexibilization of financial markets. What that flexibilization has most dramatically increased is the transnational price sensitivity of those markets, and this new global-level price sensitivity constitutes the main driving force of the wider structural transformation.

2. The Third Industrial Revolution and changing financial market structures

A range of key economic issues today reflects the differentiation of economic structures both upward to the transnational and global levels and downward

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to the local level - in turn interacting with each other in multilayered circular or feedback processes - with signfiicant consequences for the structure of the state. The core of this problematic involves the interaction of political and economic structures and the complex fusion of market and hierarchical forms which characterizes the way that different patterns materialize. The form which this interaction takes flows to a large extent from the character of the different kinds of material and non-material resources and values which are needed and/or desired by individuals and by society. These resources and values are largely embodied in the different kinds of goods or assets (including services) which are (a) used as inputs or raw materials in the production process, (b) utilized as part of the production process itself, (c) produced, (d) exchanged, and/or (e) consumed by final users - whether through the state or through non-state economic mechanisms. 4 It is standard, in different con- texts, to start from a distinction between two main polar types of goods or assets. The best-known distinction of this sort in Political Science and Inter- national Relations is Olson's contrast between the notion of 'public goods" on the one hand (i.e., those which are non-divisible in crucial ways and from the use of which specific people cannot be easily or effectively excluded), and 'private goods' (i.e., divisible and excludable) on the other. In between, and deriving from the interaction of, these polar types, stands a range of crucial intermediate categories of semi-public or quasi-private - mixed - goods (Olson, 1971). A second and more recent distinction, found primarily in institutional economics, is that which Williamson makes between 'specific assets' and 'non-specific assets' (Williamson, 1985).

For Olson, public goods cannot be efficiently provided through a market, for there will always be 'free-riders' who will escape paying their fair share of the costs of providing such goods and thereby load extra costs onto others. Only authoritative structures and processes - especially those associated with the state - make it possible for costs to be efficiently recouped from the users of public goods. On the other hand, of course, private goods can be most efficiently provided through market mechanisms; public provision would create monopolistic effects, raising costs and misallocating resources. In analogous fashion, for Williamson, specific assets - those which are difficult or impos- sible to trade efficiently on a market, because they are characterized by technological economies of scale and/or high transaction costs - are also more efficiently organized and managed authoritatively, through hierarchy. Such authoritative allocation is done through long-term contracting (keeping the same collaborators) and decision-making by managerial fiat (integration, merger, cartellization, etc.) rather than through the short-term, 'recurrent contracting' of marketable, easily substitutable, non-specific assets. Whereas efficient regulation of the market for the latter merely requires post hoc legal adjudication through contract law and the courts, the former requires increasing degrees of proactive, institutionalized 'governance' in the allocation of resources and values. The most extreme form of 'efficient hierarchy' is found in the 'natural monopoly,' but various different kinds of structural inte-

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gration - distinct mixes of market and hierarchy - may be judged to suit particular mixes of specific and non-specific assets.

The economic structure of the world today is not only in the process of changing rapidly. It has already changed dramatically since the 1950s. Glob- alization has altered the scale of the 'structured field of action' in which the relationship between the provision of different kinds of goods and assets is shaped. Many of what constituted public goods in the Second Industrial Revolution are either no longer controllable by the state because they are transnational in structure, or have essentially become private goods in a wider world marketplace. The Third Industrial Revolution has also profoundly altered the structure of both public and private goods and specific and non- specific assets through a process of differentiation within production processes and through the segmentation of markets. The globalization of finance has increasingly divorced finance capital from the state. In this context, political control, stabilization, regulation, promotion, and facilitation of economic activities have become increasingly fragmented. From international regimes (Krasner, ed., 1983) to local pressures and subaltern forms of resistance (Sathyamurthy, 1990), new 'circuits of power' are emerging (Foucault, 1980) not so much to challenge the state as to overlap with it, cut across it, and frag- ment it.

This has, for example, fundamentally altered the nature of public goods. Regulatory goods - crucial to the financial issue-area - are an obvious case. In a world of relatively open trade, financial deregulation and the increasing impact of information technology, property rights are increasingly difficult for the state to establish and maintain. Cross-border industrial espionage, counterfeiting of products, copyright violations and the like have made the multilateral protection of 'intellectual property rights' a focal point of international disputes and a controversial cornerstone of the Uruguay Round negotiations. International capital flows, the proliferation of 'offshore' financial centers and tax havens, etc., have made the ownership of firms and their ability to internally allocate resources through transfer pricing and the like increasingly opaque to national tax and regulatory authorities, Traditional forms of trade protectionism are both easily bypassed and counterproductive (Nivola, 1993). Currency exchange rates and interest rates are set in rapidly globalizing marketplaces, and governments attempt to manipulate them often at their peril. Legal rules are increasingly easily evaded, and attempts to extend the legal reach of the national state through the development of 'extra- territoriality' are ineffective and hotly disputed. Finally, forces and actors seeking to evade, counteract or constrain the state are becoming more and more effective. The ability of firms, market actors, and competing parts of the national state apparatus itself to defend and expand their economic and political turf has dramatically increased. Activities such as transnational policy networking and 'regulatory arbitrage' - the capacity of industrial and financial sectors to 'whipsaw' the state apparatus by pushing state agencies into a process of competitive deregulation or what economists call 'competition in

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laxity' - has both undermined the control span of the state from without and fragmented it from within (see Cerny, ed., 1993: chs. 3 and 6).

This transformation, however, has not merely involved the changing scale of public goods per se, but the changing technological and institutional context in which all goods are increasingly being produced and exchanged. The so- called 'Third Industrial Revolution' is characterized by several profound and far-reaching structural changes which have been major factors in the globalization of economic structures. As the character of public goods is less controllable by the national state, so the character of the mix of specific and non- specific assets in industrial production and finance has shifted in even more complex ways. States and policymakers are increasingly having to experiment with new policy structures and techniques - what in the United States has been called 'reinventing government' - in order to cope with the fragmenta- tion of the structural environment (Osborne and Gaebler, 1992).

The Third Industrial Revolution has a wide range of characteristics, but the ones which are most relevant to our concern with scale shift include five trends in particular, each of which is inextricably bound up with the others. The first is the development of flexible manufacturing systems, and their spread not only to new industries but to older ones as well. The second is the changing hierarchical form of firms (and bureaucracies) to what has been called 'lean management.' The third is the growing capacity of decision- making structures to monitor the actions of all levels of management and of the labour force far more closely through the use of information technology and thereby to use such methods as performance indicators far more widely. The fourth characteristic is the increasing segmentation of markets in a more complex consumer society. Finally, the Third Industrial Revolution has been profoundly shaped by the emergence of more and more autonomous and global financial markets and institutions, which is our concern in this paper.

The abstract nature of finance - the link with trade in commodity gold having been broken in the 1930s - makes trading in financial instruments virtually instantaneous. Indeed, Keynes believed that financial markets were too easy to play, too readily divorced from the 'real economy,' for socially and economically necessary production to take place. The financial regulatory reforms of the 1930s, especially those of the New Deal in the United States, and the financial arrangements incorporated in the Bretton Woods system after World War II, were intended to control speculative financial flows (blamed by many for the Great Depression) and to ensure that finance was channelled into productive investment. But in the period since the 1950s - and especially since the breakdown of Bretton Woods in 1971-73 - finance has once again become globalized, with newly deregulated markets increasingly absorbing money from the real economy (Allen, 1994).

Indeed, finance embodies, reinforces, and catalyzes all of the other characteristics of the Third Industrial Revolution mentioned above. In product terms, it has become the exemplar of a flexible industry, trading in notional and infinitely variable financial instruments. Financial innovation has been

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rapid and far-reaching, affecting all parts of the industry and shaping every industrial sector (see Crawford and Sihler, 1991). Furthermore, product innovation has been matched by process innovation. Management structures have evolved a long way from the traditional staid world of domestic banking, and traders and other financial market actors and firms are expected to act like entrepreneurs (or intrapreneurs) as a matter of course. The expansion and globalization of the financial services industry in recent years has been virtually synonymous with the rapid development of electronic computer and communications technology, which transfer money around the world with the tap of a key (for some of the implications of these changes, see Strange, 1990). The ownership and transfer of shares and other financial instruments are increasingly recorded only on computer files, without the exchange of paper certificates - what the French call 'dematerialization' - although a 'paper trail' can always be printed out for financial controllers, auditors or regulators (in principle, at least). 5 With the increasing globalization of production and trade, market demand for financial services products is continu- ally segmenting, too.

But probably the most important consequence of the globalization of financial markets is their increasing structural hegemony in wider economic (and political) structures and processes. In a more open world, of course, financial balances and flows are increasingly dominant. Exchange rates and interest rates, essential to business decision-making as well as to public policymaking, are increasingly set in world markets (see, e.g., Fukao and Hanazaki, 1987). Even more important, however, is the fact that as the trade and production structures of the Third Industrial Revolution go through the kinds of changes outlined earlier, they will be increasingly coordinated through the application of complex financial controls, rapidly evolving accounting techniques, financial performance indicators (because non-financial performance measures are more and more complex and difficult to apply in a globalizing world), and the like. These structures are of course equally applicable to a range of organizations, including government bureaucracies. In this context, however, the globalization of production and trade and the globalization of finance reinforce each other - with, however, the global financial tail increasingly wagging the 'real economy' dog. In other words, financial markets epitomize, in Williamson's terms, the structural ascendancy of almost purely non-specific assets over specific assets in the global economy. In terms of institutional as well as neoclassical economic theory, therefore, financial markets should potentially be the most 'efficient' markets of all.

The development of new information and communications technology is probably most important in this context. With no physical commodities to find, to move, to transform, or to sell, in finance - in contrast not only to the primary and secondary sectors, but to much of the tertiary sector too - electronic messages are the sum and substance of what is produced and traded in the markets themselves. O'Brien has called this the 'end of geography' (O'Brien, 1992). Although the firms whose stock or bonds are traded may be

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physically located in one place, the actual exchange of their securities no longer even requires the physical transfer of paper certificates, and can take place anywhere in the world. Where governments attempt to regulate such trading by prohibition or protectionism, the trading can just as easily be done offshore - undermining not only the regulatory power of the state, but also causing capital to flee and the benefits of investment to accrue elsewhere, thereby undermining the state's taxing and spending powers as well as its ability to foster economic growth and competitiveness. Banks, too, when they make loans, are able to 'book' those loans virtually anywhere in the world - that is, to record those loans on the books virtually anywhere and thereby to choose what regulatory jurisdiction to operate in, depending on the size and scope of their operations and their connections with other institutions and markets - offshore as well as onshore (for a key recent example, see Beaty and Gwynne, 1993, esp. pp. 114 and 144-5). With the 'securitization' of many traditional operations - in the narrow sense, the transformation of bank loans, mortgages, credit card loans, etc., into negotiable securities 6 - the new flexibility of both financial markets and banks are combined into ever more potent global bundles (Stone, Zissu, and Lederman, eds., 1993).

Of course, financial transactions have always had something of this character, although the predominance until the 20th century of physical 'commodity money' such as gold limited its scope. However, it has often been argued, ever since the invention of the telegraph and the telephone, the process of financial innovation has always had the potential to become de-linked from geography - both in the sense of being geographically detached from the location of material resources and productive facilities and in terms of being constituted, in the most essential sense, by information and communication itself (Strange, 1990). In treasury functions, foreign exchange, and securities operations - the main branches of financial management - the new information and communications technology has revolutionized the way that financial products are designed, systems are developed for supporting financial operations, high-risk as well as low-risk transactions are managed, managers and traders understand and interact with each other and interface with the technology itself, transactions are followed up and systems maintained, and a whole host of other functions are carried out. The development of artificial intelligence, expert systems, intelligent networks, and knowledge engineering are merely some of the more complex potential aspects of this process (Chorafas, 1992). In this context, the mathematical complexity of financial innovation and transactions has been running ahead not only of the ability of regulators to follow (much less to control a priori) but also of the ability of many firms and financial firms to understand. Markets and institutions are still at the beginning of the learning curve. For example, recent experience with derivatives trading - currently running at S 12 trillion globally - indicates that it is this very complexity which makes derivatives so attractive not only to investors and borrowers, but also, of course, to the financial firms that design them, sell them, and profit from the rise in turnover.

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Finance, in this sense, is the basis for linking together all of the other economic processes in the global marketplace. The most fundamental characteristic of markets is that they are arenas for the setting of prices. Prices, in capitalist society, embody the only measurable value which can be placed upon an asset, good or service - what Marx called 'exchange value.' 'Efficient' prices clear markets - i.e., everything that is offered for sale is sold at mutually agreed prices between buyers and sellers. 'Self-regulating markets' - whether that term is used in the positive sense of classical economic theory or the negative sense of Polanyi's critique - can only work if the price-setting mechanism is sufficiently efficient to clear those markets. The key to setting efficient prices is the clarity and precision of the price signals conveyed and exchanged between buyers and sellers. Market actors must be aware of the impact of changing price signals too, for rapid response to those signals - as in an auc- tion - is necessary for those signals to converge on an equilibrium which will clear the market. Market actors must also be aware of the marginal utility to themselves of complex and rapid price changes. In theory, then, the more price sensitive a market, the more efficient it will be. Many traditional cri- tiques of capitalism have concentrated on the inefficiency of markets in pro- ducing desired outcomes - not only in terms of economic utility, of course, but also with regard to moral values, social utility, 'use value, etc. But in main- stream economic theory itself, the search for more efficient markets is the key to maximizing utility, and the development of increasing price sensitivity is the key to making markets more efficient in the economic sense.

The issue of price sensitivity is particularly important for this paper for two reasons. In the first place, price sensitivity is at the heart of the globalization of markets. What makes markets truly interdependent internationally - indeed, the very definition of economic interdependence, according to Richard N. Cooper (1972) - is two-way price sensitivity across borders. As Cooper explains, though mainly with regard to trade, price sensitivity is not directly related to the volume of transactions; rather, it concerns the marginal utility of the market actors, i.e., when deciding to buy or sell more or less of a particular good or service. 'Although merchandise imports account for only 4 per cent of total U.S. expenditure, for example, imports account for a much larger share of the increment during periods of rapidly rising expenditure (17 per cent in 1968, in real terms). When demand tuns ahead of output, the rest of the world fills the gap' (Cooper, 1972: p. 161, emphasis added). It is the dramatically increasing transnational marginal price sensitivity of financial markets, not the volume of transactions (as in the CMH), which best explains globalization. In the second place, that price sensitivity is much easier to foster and expand in financial markets because of the abstract character of those markets. No physical goods need be produced or exchanged; numbers on a piece of paper, or, nowadays, on a computer screen which can be linked into almost any market in the world at any time of the day or night, are all that are needed. At one level, genuinely price-sensitive financial markets will attract holders of capital because of the ease and scope of

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participation in those markets, compared to the slog and the longer-term risks of actually making things; the wider their net, the better. At another level, even those who wish to make things need capital, and are forced to go to the financial markets to find that capital; there, they are subject to the rules and the marginal utilities of those who operate on those markets full-time or who have a high level of financial market power or market share. The price sensitivity of the increasingly 'paperless world' of the global financial marketplace is increasingly controlling market - and political - decisions elsewhere.

These circuits have reached deep inside the US financial system itself. It was American dollars, American banks and American multinational firms that were the major players in the earlier stages of the globalization process in the 1960s and 1970s, especially the so-called 'Euromarkets.' These internation- alized markets were also the first to produce, out of competitive necessity, two more features which shaped structural change: (a) complex types of financial innovation which went far beyond the traditional instruments of bank loans and fixed-rate bonds, including a range of currency hedges, variable-rate bonds, perpetual notes, interest rate swaps, and 'off-balance-sheet' instruments such as revolving credit facilities; and (b) the introduction of new technology to process orders and trades. In.this fiercely competitive environment, profits came increasingly from volume and volume-related fees and spreads rather than from safe, regulated returns. Commissions on transactions were fully negotiable, not fixed as in most domestic financial stock and bond markets at the time. There were no interest rate controls, but interest rate competition - nurtured in the unregulated Euromarkets and other offshore markets of the 1960s and 1970s - led to the convergence of market rates; spreads between bid and offer prices narrowed. Profits would increasingly come from the volume available from global trading, rather than from the larger but more static - protected - profit margins available under the old system. Ever- increasing price sensitivity was the critical element in this process. It was widely understood in the financial sector that pressures of international competition could no longer be blunted by further financial protectionism or a return to fixed exchange rates and capital controls. Although the larger institutions were the spearhead of the deregulation movement, it infected the smaller institutions too with the view that their only future was to be able to compete on price with the big boys for their specialized services.

The competitive deregulations of the 1980s have been compared to the competitive devaluations of the 1930s. An international 'ratchet effect' has been at work. Each deregulation led in turn to increased structural complexity, making a return to tighter national-level regulation less possible (but cf., for France, Cerny, 1989 and Loriaux, 1991). The same process can be seen in the 'securitization' and 'disintermediation' of finance - i.e., the trend away from traditional bank loans (particular contracts between specific bankers and borrowers, based on the former's knowledge of the latter's creditworthi- hess) towards the selling of negotiable securities (which can be bought and sold by any 'bearer'), from certificates of deposit to complex mixes of debt

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and equity. The crucial feature is that these instruments can later be traded in a secondary market, and the most attractive and efficient such markets - i.e., the most liquid and price-sensitive - are international markets.

This process has also led to financial innovation - the design of new, complex and often specially tailored instruments. A notable example is the development of 'derivatives' markets - mainly futures and options - in which imaginary financial instruments are traded, ostensibly to hedge against loss in volatile markets. Derivatives markets developed mainly in Chicago out of the longstanding commodities futures markets. They first focused on currency options and futures to compete with the Euromarkets. From these begin- nings, an American regulatory system for futures has developed that has provided a model of arms-length regulation widely copied in other countries. Indeed, futures and options markets, because they are the most 'abstract' markets (they do not require the actual buying and selling of the 'underlying' securities), are rapidly becoming one of the most globalized financial markets. However, the interaction of derivatives markets and markets in real financial instruments has also been seen as a source of volatility, especially in the way that stock market futures and options are 'arbitraged' against the basic stocks. Price sensitivity does not necessarily lead to stable prices - especially in the short term (Pratten, 1993). Thus new and volatile international circuits of capital reminiscent of the 1920s mushroomed, but through a much more complex system than that of the interwar period. The possibilities for development - as well as for destabilization - are enormous.

3. Political processes and policy responses: The erosion of state capacity

These far-reaching changes in financial market structures have generated equally far-reaching challenges to the capacity of national governments to make and implement public policy. Government decisions - sometimes the strategic decisions of core political leaders, sometimes the micro-decisions or even non-decisions (Strange, 1986) of bureaucrats, regulatory agencies and other elements of the state apparatus - often lead to irreversible structural changes. These changes thereby reduce the regulatory power of governments in general and, in turn, further increase the autonomy of financial markets. The essential mechanism of change is regulatory arbitrage. Once the dikes of domestic regulatory compartmentalization and international capital controls have been breached in key sectors and the centrality of money and financial markets reasserted - as in the breakdown of the New Deal system in the United States and of Bretton Woods (Cerny, 1994c) - other market sectors seek to reduce existing regulatory barriers in their own areas in order to compete for business. Governments and regulatory agencies desire to promote the health and profitability of their 'own' national financial systems (in the global context) and their 'own' sectors (in domestic terms). To this end they will seek to 'level the playing field' (to remove competitive disadvantages) and

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even to provide their own clients with new competitive advantages vis-a-vis rival nations or sectors. Globalization and deregulation are thus inextricably intertwined aspects of a virtuous - or vicious - circle, undermining attempts to regulate price-setting in such an acutely sensitive and interdependent context.

This process, however, is neither smooth nor uniform. There is what economists call a 'stochastic' element at work here - a situation where the random or unpredictable interaction of elements produces outcomes which are 'sticky.' The terms of the equation no longer hold with the same random dis- tribution of probabilities in subsequent 'plays of the game;' future inputs and outcomes are constrained and shaped in structurally new and distinct ways. The development of the American financial system, for example, should be seen as the outcome of an ongoing dialectic or set of games linking the American political system, on the one hand, and the pressures of market change, on the other. Specific conjunctural outcomes have become 'sticky' in both political and economic terms as they feed back into the process. Politi- cians and bureaucrats have lost much of their autonomy with (a) the erosion of domestic systems of protective financial market regulation (like the New Deal system in the United States) and (b) the collapse of international regimes which could sustain that capability, i.e. Bretton Woods.

However, states acting unilaterally do still possess the capacity to take decisions which open financial markets rather than attempting to keep them closed. This political cycle of market opening constitutes the essence of the 'competition state' in the financial arena (cf. Cerny, 1994b, Underhill, 1991, and Helleiner, 1994). But as that opening process has, in turn, increased the complexity of those markets in transnational terms, states are finding it more and more difficult to take the kinds of decisions which control those markets - decisions which can effectively and systematically shape, stabilize and control not only the workings of the markets themselves but also the wider economic and political ramifications of their operation. In the world of more open financial competition characteristic of the 1980s and 1990s, then, it is the complex (circular) linkages between markets - and prices - rather than the simple (linear) volume of capital flows which drive and facilitate ever- expanding processes of regulatory arbitrage. Competition between states and between different branches and agencies within states interact with structural changes in international financial markets to promote processes of deregulation and re-regulation. Institutions and markets will continue to be drawn into more complex transnational structures of interaction - in other words, structures which cut across and link elements once seen as distinctly domestic with those once seen as distinctly international. This distinction now makes little difference to the markets.

This crucial feature of the markets also reflects the growing domination of money and finance over the 'real' economy - the productive and trading system. Without a much denser transnational regulatory order wi.th the capacity to impose systematic controls on the financial markets - a system with not

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only a stabilising but also a Keynesian, pro-production rationale - narrowly financial criteria will continue to play an ever-larger role in the allocation of capital across the world. In terms of financial structures themselves, there has been a complex process of both concentration and flexibilization of markets and institutions. Of course, this process has not been wholly homogeneous or even. The most short-term and liquid markets like the foreign exchange markets and U.S. Treasury bills are by far the most transnationally integrated, while equity (share) markets are probably the least integrated in terms of the proportion of transnational capital flows to the volume of overall turnover in these sectors (Giry-Deloison and Masson, 1988). However, not only has the transnational price sensitivity within each of these markets dramatically increased, but the arbitrage between them - represented, for example, by derivatives trading - has probably been the main feature of their development in recent years.

Securitization - the shift of financial services from traditional 'relationship banking' to the trading of negotiable securities - is probably the most important single factor in reshaping different markets and institutions into a single system. The key advantage of securitization is that it provides geometrically increased prospects for flexibility and price sensitivity. Securitization cuts across what were once distinct sectors of the overall financial marketplace, making prices in each sector more sensitive to price changes in the others. Market actors can 'arbitrage' their funds almost instantaneously between different types of financial instrument in order to take advantage of such price changes. With regard to securitization in particular, the capacity of institutions to avoid being burdened over long periods with specific assets and liabilities, i.e. their ability to trade those assets and liabilities in liquid secondary markets at a discount, has always played a role in the development of banking as well as being at the heart of stock and bond markets.

But the possibility of selling literally anything - from huge 'block trades' of standardized securities to packages of small bank loans to specific customers (Stone, Zissu, and Lederman, eds., 1993) - on to other institutions is growing vaster, and a whole range of new markets have grown up in and around traditional stock and bond markets to service this demand (Crawford and Sihler, 1991). Many of these new securities can only be sold on because they are attractive to buyers - and they are attractive to buyers because they can be sold on again, and again, if need be, in liquid secondary markets. It is therefore likely that international finance will become even more concentrated, because only the big institutions - often dealing with only the biggest non- financial firms - wilt have the economies of scale to be both flexible and profitable in a highly competitive environment where profit margins will be cut to the bone. Perhaps the most striking example of this tendency is the recent rapid growth of massive pension funds and mutual funds (unit trusts) - known as 'institutional investors' - which increasingly dominate the high end of the markets. Of course, as the population of the developed industrial countries continues to age demographically, pension funds in particular may find

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their growth peaking; indeed, their practices may be in the process of changing (O'Barr and Conley, 1992). But they have already been at the forefront of transforming the markets.

But this raises another question which goes beyond market concentration or flexibilization per se. That is whether the sort of continuous trading we have been describing merely privileges a structural short- termisrn of the kind that, for example, pension funds have been widely accused of. For securitization, in the broad sense in which we have been using it, does take some of the risk out of the markets by providing a wider range of hedging possibilities, and therefore might be said to encourage speculation. And after all, the sup- posed benefits of price sensitivity lie precisely in the way that it enables decisions to be taken more and more quickly. Will, as Keynes argued, globalization and concentration merely crowd out long-term investment - especially 'productive' investment in the 'real economy?' Will it increase profitability at the expense of manufacturing production, real standards of living, and jobs? Will it open the way to more booms and slumps, more financial bubbles and panics? And if governments can no longer control this process in an effective, strategic way, will it not lead to an increasing 'democratic deficit" in which the interests of the people do not seem to exist because there is no way to trans- late their expression through existing political systems into government action? The answers to these and other questions are as yet unclear, but indi- cations are that these trends are both strong and growing.

Some believe that globalization is not yet sufficiently comprehensive and inexorable to prevent governments from taking back control, at least to the extent of mitigating the worst possibilities. The cooperation between finance ministers of the developed work in keeping the financial markets liquid after the October 1987 crash is often cited, as is the 1988 Basle Agreement mentioned earlier in this article. However, in the view taken here, such international cooperation is both too little and too limited. The Basle Agreement has not been followed up by significant further international regulatory cooperation of such a basic kind, and the disagreements between governments on capital adequacy regulations for securities markets demonstrates the limited scope for further progress in this area. With the exception of Basle, most international - intergovernmental - cooperation has been in the form of crisis management, often following the most egregious regulatory failure, as in the case of the Bank of Credit and Commerce International (Beaty and Gwynne, 1993), rather than in terms of effective a priori regulatory control. Of course, governments are still sovereign, and may still be able to use legal restrictions, as Martin Mayer writes, to increase the 'friction' between different markets (Mayer, 1992). It is difficult to see how this can be done in practice, however.

The high costs of new regulatory barriers and enforcement procedures are likely to be prohibitive in a world where so-called 'footloose' capital, epitomized by financial capital, can relocate so freely. At the same time, German- style universal banks, although representing concentrated financial power, have tended over time to use their equity ownership of non-financial firms in

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the way that some pension funds may be starting to discover, i.e., to supervise and improve the performance of the firms. However, even the universal banks are themselves increasingly charged with short-termism as they 'go global" Governments can try to manipulate global capital flows, of course, for example by the creative use of deficit financing and some limited manipulation of industrial policy, education policy, etc. But this is a question of attempting to ride the tiger, with the distinct possibility - and increasing reality - of states ending up inside] And finally, what of size? The question of economies of scale is double-edged. Although big financial supermarkets have some comparative advantages, so do small financial 'boutiques' - although how significant the advantages are in terms of capital allocation and price-setting in the overall system is still unclear. Can boutiques, by continuing to enter the market, make it more responsive, or will they simply be price-takers with a limited role? Another major question concerns the role of transaction costs. Will the kind of computerized networks required for effective global trading lead to oligopolies and cartels, as they seem to have done for airline reservations systems? Or will the financial markets evolve towards the 'personal computer' model, where everyone can play?

Conclusions

In any case, I believe that these questions will be increasingly determined by competitive forces in the global marketplace, and that governments will have either to adjust or see their options narrow even more. A country without efficient and profitable financial markets and institutions will suffer multiple disadvantages in a more open world. It will lose yet more investment, it will suffer worse real interest rates in the attempt to attract capital, and its government will not only be limited in its general economic policy by the threat of capital flight but will also see a long-term erosion of its tax base. In today's world, the global markets and the big institutions are 'where the money is' - as 19th-century bank robber Willie Sutton said of banks - and there is no government with the 'extraterritorial' power to control its allocation. Driven by both defensive reactions and new strategies intended to shape outcomes, the globalization of markets is moving forward more and more quickly - driven by technological change, market structure, and political and policy processes. Indeed, the very nature of the 'competition state' (Cerny, 1990) drives this process forward as state actors attempt to free-ride on financial globalization through increasing market liberalization (Andrews, 1994).

To summarize, then, the structural changes embedded in the Third Industrial Revolution have turned the convergence of and synergy between political and economic structures characteristic of the Second Industrial Revolution into a rapidly expanding process of structural differentiation, leading to a structural dissonance to which states are attempting to adapt in an awkward and piece- meal way. To take this point several steps further, it can be argued that the

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economic and political world of the Third Industrial Revolution increasingly revolves around a central paradox. On the one hand, globalization would seem at first glance to entail the shift of the world economy to an even larger structural scale. This perception of globalization was what misled observers a decade or two ago to misinterpret the significance of multinational corporations, which were seen as involving the worldwide integration of specific assets, s While some firms in some sectors, and some problems like environ- mental pollution, do partially approximate this model of a relatively homogeneous 'upward' shift in scale, for the most part economic restructuring has involved a more complex process, leading in a very different direction. For the second face of globalization entails the undermining of the public character of public goods and of the specific character of specific assets, i.e. the privatization and marketization of the political-economic structure - of the 'state' as we have known it - itself. These processes, in turn, especially as represented in the globalization of financial markets, will lead to the increased whipsawing of states - and the relatively weak regimes which states spawn - between structural pressures and organizational levels which they cannot control. Financial markets, not states, represent the closest thing to a new hegemony in the contemporary international system. Polanyi's 'Great Transformation' is over, and a new Great Transformation will be required at a global, supranational level if values other than the establishment of a global self-regulating market are to be realized.

Notes

1. For an attempt to look at the role of finance in this context more widely, see Cerny, ed., 1993, especially Chapters 3 and 6 by the editor. For two case studies, see Cerny, 1989 and 1994c. For an attempt to characterize the emerging structure of a post-realist world (and the role of the competition state in that context), see Cerny, 1990 and 1993.

2. Moran (1991), for example, seems to regard the transnationalization of finance as the ulti- mate cause of regulatory change, but has relatively little to say about it, in contrast with his emphasis on the changing character of corporatist structures.

3. The annual reports of the Bank for International Settlements provide a rich seam of empiri- cal material on a regular basis, as do their quarterly reports on International Banking and Financial Market Developments.

4. A more detailed analysis which I am developing elsewhere will go into the differences between goods and assets, i.e. that goods are what are used, produced, exchanged, and consumed whereas assets are a part of the production process (Cerny, 1994a). Of course, there is a wide area of overlap between the two categories.

5. The collapse over two years ago of the Bank of Credit and Commerce International and the conviction of leading traders like Ivan Boesky and Michael Milken show, however, that the temptation to fraud, and the capability of keeping it hidden for a long time, still exists.

6. This term is also used, including in this article, in a wider sense, to mean the general decline in recourse to traditional bank loan financing ('intermediated' financing) and the increasing predominance in finance of both securities trading and financial innovation in securities markets (see below).

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7. 'There was a young lady from Niger Who smiled as she rode on a tiger. They returned from the ride With the lady inside, And the smile on the face of the tiger.'

8. A more complex and sophisticated analysis of multinational corporations - how they work, how they interact with each other, and how they interact with states - can be found in Stop- ford and Strange (1991).

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The dynamics of financial globalization: Technology, market structure, and policy response

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