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The Global Financial Crisis: Foreign and
Trade Policy Effects
Dick K. Nanto, Coordinator
Specialist in Industry and Trade
April 7, 2009

Congressional Research Service
7-5700
www.crs.gov
R40496

CRS Report for Congress
Prepared for Members and Committees of Congress

The Global Financial Crisis: Foreign and Trade Policy Effects

Summary
The global financial and economic crisis affects all three of the essential national interests of the
United States: national security, economic well being, and value projection. Only occasionally
does an event of this magnitude occur that generates such daunting challenges yet also
opportunities for U.S. policy. The effects of the crisis on foreign policy, trade, and security are so
diverse and widespread that, out of necessity, policy responses must range from the highly
specific to the broad and ethereal.
This report provides an overview of the major non-financial effects of the global crisis. In some
countries, incumbent governments have lost support or authoritarian governments are
consolidating power. In certain countries, conditions for citizen discontent or even radicalism are
being augmented and market capitalism is being questioned. On the world stage, U.S. leadership
is being challenged; money to lend is becoming a critical component of soft power; budgets are
tightening and threatening funds for economic assistance and national security; international
financial institutions are assuming a higher profile relative to national governments; and shifts in
trade flows are raising forces for protectionism. As seen in the G-20 London Summit, the
financial crisis also has become a rallying point for anti-globalization groups and anti-government
activists. The U.S. Director of National Intelligence, Dennis Blair, has told Congress that
instability in countries around the world caused by the global economic crisis and its geopolitical
implications, rather than terrorism, is the primary near-term security threat to the United States.
The political and foreign policy effects of the global financial crisis can be divided roughly into
the following categories: effects on political leadership, regimes, stability, and spheres of
influence; effects on economic philosophies, state capitalism, and trade protectionism; effects on
U.S. international leadership and attitudes toward the United States; effects on supranational
financial and economic organizations; effects on poverty; and budgetary effects on resources for
aid, diplomacy, and defense.
Congress has been active in recognizing and moving toward dealing with the longer-term effects
of the crisis, but most of the long-term effects are just developing, and it is yet not clear whether
they are temporary jogs in a path or a permanent deviation from post-World War II trends. The
response to the effects depends both on “more of the same” (working through existing institutions
for diplomacy, aid, trade policy, and security) with incremental changes and at a higher level of
intensity, and on new and innovative approaches to cope with problems laid bare by the crisis. As
the dust from the onset of the crisis has begun to clear, it is apparent that the world has become
more unstable, that much of the blame for the turmoil is being aimed at the United States, that
attempted solutions are taking enormous amounts of budgetary resources, and that, if the crisis
worsens, it may cause wrenching changes both within the countries most vulnerable and among
the big power nations of the world.

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The Global Financial Crisis: Foreign and Trade Policy Effects

Contents
The Issue and Role of Congress ..................................................................................................1
Two Indicators of the Severity of the Crisis: Growth and Trade ...................................................4
Political and Foreign Policy Effects of the Crisis .........................................................................6
Effects on Political Leadership; Regimes; Perceived Countries of Influence; and
Stability, Violence, and Terrorism.......................................................................................7
Political Leadership ........................................................................................................7
Perceived Countries of Influence................................................................................... 10
Stability, Violence, and Terrorism.................................................................................. 12
Effects on Economic Philosophies, State Capitalism, and Protectionism .............................. 15
Economic Philosophies ................................................................................................. 15
State Capitalism ............................................................................................................ 16
Trade Protectionism ...................................................................................................... 18
Effects on U.S. Leadership and Attitudes Toward the United States ..................................... 21
Effects on Supranational Financial and Economic Organizations ......................................... 24
Effects on Poverty............................................................................................................... 25
Budgetary Effects on Resources for Aid, Diplomacy, and Defense....................................... 27

Figures
Figure 1. Actual and Potential Foreign Policy Related Effects of the Global Financial
Crisis .......................................................................................................................................2
Figure 2. Actual and Forecasted Economic Growth Rates for Country Groups and the
United States, Japan, and Ukraine (Annualized Quarterly Changes)..........................................5
Figure 3. Change in Merchandise Export Levels for Selected Regions and Countries,
February 2008-February 2009 ..................................................................................................6

Tables
Table 1. Actual and Potential Foreign Policy and Security Changes Caused or
Exacerbated by the Global Financial Crisis ..............................................................................3

Contacts
Author Contact Information ...................................................................................................... 29

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The Global Financial Crisis: Foreign and Trade Policy Effects

The Issue and Role of Congress
The world now faces the worst financial and economic crisis since the Great Depression. The
bursting of the U.S. housing market bubble has sparked a ripple effect that has grown to major
proportions and is wreaking havoc on market after market and country after country as it works
its way around the world. The sudden loss of trillions of dollars in wealth, the addition of tens of
millions of people to the ranks of the unemployed, and historic drops in economic activity have
combined to create new challenges for policymakers. While the current focus is on measures to
recover from the financial and economic turmoil, the uncertainty and socio-political forces being
generated are creating political instability, heightening security risks, and affecting U.S. interests
in ways that could hardly have been imagined just a year ago.
This report provides an overview of the major non-financial impact of the global financial and
economic crisis—both actual and potential. Although the eventual effects of the crisis are yet to
be determined, looking back at the Great Depression, it is clear that a prolonged and widespread
economic contraction can lead to major shifts in governments and acts of desperation that can be
catastrophic in nature and far reaching in effect. International Monetary Fund Managing Director
Dominique Strauss-Kahn recently stated that as the crisis spills over into developing countries,
millions will be pushed into poverty and unemployment, and, for many countries, this will be at
the roots of social unrest, some threat to democracy, and for some cases may also end in armed
conflict.1
The forces that determine foreign policy and provide a foundation for the basic paradigms that
underlie policy initiatives tend to have a long history and a momentum of their own. Therefore,
the ultimate effects of the global financial crisis likely will depend on the length and severity of
the global recession. If, as many economic forecasts indicate, the global downturn is U-shaped
with a recession that lasts for about two years and recovery beginning in late 2009 or in 2010, the
long-term effects are likely to be more of an exacerbation of previously existing trends rather than
revolutionary direction-changing events except in particularly dire situations. However, if the
global recession takes an L-shape with prolonged contraction and stagnation, much like the Great
Depression, the probability rises that changes will be more than mere blips in a continuum but
significant turns in the road.
As the crisis has progressed, policymakers have moved from rescues of financial institutions and
loosened monetary measures to shoring up manufacturers in the real economy and expansionary
fiscal policy. Now the crisis is extending into political and security concerns and is affecting
fundamental issues such as basic economic philosophy or the underlying assumptions about the
workings of market based economies. Some wonder if a statement by Albert Einstein may not
apply here:
The significant problems we face today cannot be solved at the same level of thinking we
were at when we created them.

As indicated in Figure 1, the financial crisis began with a rising default level in subprime
mortgages, bankruptcies, an overextension of credit and then a freezing of credit markets, and
1

Jonathan Lynn, "IMF says clean up banks to tackle dire world crisis," Reuters, March 23, 20009, Reuters.com.

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The Global Financial Crisis: Foreign and Trade Policy Effects

excessive financial bets on securitized debt obligations mainly in the United States but also in
Europe. This has now grown into a global financial crisis with wildly diverse effects. At first, the
crisis was transmitted through the globally interconnected financial system primarily among
industrialized countries. As the economies of North America, Europe, and East Asia slowed or
dropped into recession, the concomitant drops in commodity prices, international trade flows, and
remittances along with tightening credit, and depreciating currencies (relative to the dollar and, in
cases, the euro) caused similar contraction in growth in developing and emerging market
countries.2 This, in turn, has caused social and economic effects that pose the foreign policy
challenges discussed in this report, and which ultimately can lead to a greater role for
international financial institutions and a weakening of pro-United States and pro-Western
sentiments and ties.
Figure 1. Actual and Potential Foreign Policy Related Effects of the Global Financial
Crisis

Bursting of
housing bubble
Bankruptcies
Credit crisis

Corporations
Facing
Bankruptcy

Rise of
State
Capitalism

Expensive
Rescue
Packages

Citizen
Discontent

Increased
Protectionism

Consolidation
of Pow er by
Autocrats

Global
Financial
Crisis

Rise of
Opposition
Parties

Fall in Capital
Flow s &
Remittances

Global
Recession

Political
Instability

Anti-establishment
and Anti-globalization
Sentiments Rise

Fall in Exports
Rising
Unemployemnt
Increased
Poverty

Constrained
Government
Budgets

Developing Country Issues
Starvation
Desperation
Poor Health
Easier Recruitment
of Extremists

Constrained
Expenditures for
Security

Less Funding
of Aid

Return of Migrant
Laborers

Greater Role for
IMF, World Bank

Appeals for
Assistance
Unmet

Source: Congressional Research Service

Some of the specific effects being created or exacerbated by the financial crisis are shown in
Table 1. These include changes in the U.S. leadership role and in international relations both
among countries and between the United States and other nations. The enhanced role of the
International Monetary Fund both as a lender of last resort and coordinator (along with the
2

For details, see CRS Report RL34742, The Global Financial Crisis: Analysis and Policy Implications, coordinated by
Dick K. Nanto.

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The Global Financial Crisis: Foreign and Trade Policy Effects

Financial Stability Board) of international financial regulatory reform is particularly notable.
Among the fundamental philosophies being affected are the rise of state capitalism, trade
protectionism, and doubts about what has been seen as the Western economic model of marketbased capitalism. Security issues include rising poverty and conditions that could provide ready
recruits for religious extremism in certain countries of Africa and South Asia and budgetary
pressures that could constrain security related expenditures. Among the challenges stemming
from the economic and financial fallout from the crisis are questions about the primacy of the
United States and the role of the dollar as a reserve currency, problems for developing nations
caused by diminished inflows of capital and remittances and declining exports and prices for
commodities.
Table 1. Actual and Potential Foreign Policy and Security Changes Caused or
Exacerbated by the Global Financial Crisis
Category of Change

Actual or Potential Changes

International Relations

Potential effects on the U.S. leadership position in the world
Enhanced role for the International Monetary Fund, Financial
Stability Board, and Multilateral Development Banks
The rise of China as a player in international financial issues
and the co-mingling of U.S. and Chinese financial interests
Additional pressures on European unity and policy discord
between the United States and Germany/France
Economic and political crises in Eastern Europe and tug-ofwar for influence there between Russia and the EU/U.S.

Fundamental Philosophies

Rise of state capitalism and questioning of the Western
economic model of deregulated, market-based
decisionmaking
Risk of rising trade protectionism and intensified antiglobalization efforts
Potential for more authoritarianism in countries such as
China and Russia and/or rise in authoritarian models of
governance in the developing world

Security

Rising poverty and potential political instability in developing
nations providing fertile ground for recruits for religious
extremism
Budgetary pressures in Western nations that could
constrain international security and diplomatic efforts

Financial and Economic Fallout

Possible reduced U.S. financial primacy in the world and
importance of the dollar as a reserve currency
Diminished flows of economic assistance, capital, and
remittances to developing nations
For developing nations, declines in export earnings from low
prices for commodities and from shrinking world trade

Source: Congressional Research Service.

The role of Congress in this aspect of the crisis is multifaceted and broad based. As of early 2009,
the major policy focus has been on containing the crisis and doing what is necessary to promote
recovery and reform in financial markets both in the United States and abroad. Congress has a

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The Global Financial Crisis: Foreign and Trade Policy Effects

particular role to play in protecting the national interest; informing the public and managing
public expectations; budgeting for economic assistance, diplomacy, and defense; determining
trade policy; providing capital for the International Monetary Fund and Multilateral Development
Banks and determining their role relative to the U.S. government; and ensuring that the U.S.
grand strategy in dealing with the world succeeds. Several committees in both the Senate and
House already have held hearings on the foreign policy and security implications of the global
financial crisis. 3

Two Indicators of the Severity of the Crisis: Growth
and Trade
How severe is the global financial crisis? On March 19, 2009, the International Monetary Fund
projected global economic activity to contract by ½ to 1% in 2009—the first such fall in 60 years.
Figure 2 shows projected growth rates by quarter (annualized) by Global Insight, an econometric
forecasting firm. As can be seen, countries of the world are experiencing a simultaneous
downturn with the advanced industrialized countries of North America, Europe, and Japan
dropping into recession and a significant slowdown in economic growth rates in both developing
countries and in emerging markets in Eastern Europe. Particularly noteworthy are the growth
rates for China which still is positive but down considerably, and those for Japan (the second
largest economy in the world) and Ukraine (an example of a particularly hard-hit economy), both
facing severe recessions. These declines in economic activity have combined with trillions of
dollars lost in equity markets and a credit squeeze that not only is affecting households and
businesses world wide but is putting a damper on the financing of activities such as world trade
and oil exploration. The International Labor Organization has noted that after four years of
consecutive declines in world unemployment, the number of unemployed persons had increased
in 2008 by 14 million. As the crisis continues to spread and job losses mount, worldwide
unemployment could increase by at least 38 million by the end of 2009.4

3

U.S. Congress, Senate Committee on Foreign Relations, Foreign Policy Implications of the Global Economic Crisis,
Hearing, 111th Cong., 1st sess., February 11, 2009 and Foreign Policy and the Global Economic Crisis, March 25,
2009. U.S. Congress, Senate Committee on Armed Services, To receive testimony on the current and future worldwide
threats to the national security of the United States, 111th Cong., 1st sess., March 10, 2009. U.S. Congress, House
Committee on Armed Services, Hearing on Security Challenges Arising from the Global Financial Crisis, 111th Cong.,
1st sess., March 11, 2009. U.S. Congress, House Committee on Foreign Affairs, U.S. Foreign Economic Policy in the
Global Crisis, 111th Cong., 1st sess., March 12, 2009.
4
International Labor Organization, International Institute for Labor Studies, The Financial and Economic Crisis: A
Decent Work Response, Preprint edition, March 2009.

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The Global Financial Crisis: Foreign and Trade Policy Effects

Figure 2. Actual and Forecasted Economic Growth Rates for Country Groups and
the United States, Japan, and Ukraine (Annualized Quarterly Changes)
20

Percent Growth in GDP
Actual

15

2001
Recession

Global
Financial
Crisis

China

10
Developing
Econom ies

5

Forecast

Em erging
M arkets

World

0
Advanced Econom ies

U.S.

-5

-10

Japan
Ukraine

-15
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
Year (4th quarter)
Source: Congressional Research Service with data from Global Insight (March 14, 2009, monthly forecast).

Exports of goods and services provide the main vehicle for countries to generate the foreign
exchange necessary to pay for imports and to repay international debt. A deficit in a country’s
balance of trade also tends to depress the value of its currency which then raises the cost of debt
service for governments, businesses, and households that have borrowed in international
currencies. This is a particular problem for Eastern European nations whose public and private
debt often is denominated in euros or Swiss francs. Also, in many less developed countries, the
decline both in volume and price of exports of minerals and agricultural commodities undermines
the basic levels of income for large segments of the working poor.
Figure 3 shows estimates of the change in export levels in February 2009 compared with that a
year previous. For the world, advanced economies, and emerging markets, exports were estimated
to be down about 25% (Japan’s were down 49%). For developing countries, however, exports
were down by more than a third. Exports were down from 9% to 64% for the other countries
indicated. These are historic drops in trade volume. Even though imports also are falling, the
shrinking of international trade is adding to the contraction in global economic growth and
causing unemployment rates to rise and pushing more people into poverty.

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The Global Financial Crisis: Foreign and Trade Policy Effects

Figure 3. Change in Merchandise Export Levels for Selected Regions and Countries,
February 2008-February 2009

Region/Country
World
OECD
Non-OECD
Adv anced Economies
Emerging Markets
Dev eloping Countries
South Af rica
United States
Ireland
Pakistan
South Korea
Philippines
India
Italy
Canada
Sudan
Brazil
China
Israel
United Kingdom
France
Taiwan
Indonesia
Germany
Hungary
Nigeria
Latv ia
Mexico
Mexico
Chile
Czech Republic
Ukraine
Russia
Iceland
Iraq
Poland
Japan
Cambodia
Saudi Arabia
Sy ria
Iran
Venezuela

-26.8
-25.8
-28.4
-24.7
-29.6
-34.3
-9.2
-10.3
-12.5
-15
-16.8
-21.6
-22.4
-22.8
-24.5
-25
-25.1
-25.7
-28.2
-28.3
-29.1
-29.2
-31
-31.1
-32.5
-34.1
-34.1
-34.7
-34.7
-37
-38.2
-39.8
-41.3
-41.9
-42.4
-45.2
-49.4
-50.1
-50.3
-50.4
-62.4
-63.6

-60

-40

-20

0

Percent Change in Exports, 2/2008 - 2/2009
Source: CRS, Forecast data from Global Insight (March 14, 2009 forecast).

As the crisis has spread, the adverse macroeconomic effects are reverberating back to further
weaken financial institutions, currencies, and equity markets. This is working to exacerbate
adverse long-term effects that may affect U.S. foreign policy and, ultimately, U.S. security.

Political and Foreign Policy Effects of the Crisis
Any event of the magnitude of the global financial crisis generates unanticipated effects and this
particular set of events seems to be driving states to adopt policies unprecedented in recent times.
The financial crisis can be divided into four overlapping phases, each with a different focus. The
first has been to contain the contagion and strengthen financial institutions through various
financial packages aimed at restoring balance sheets of financial institutions and confidence in
markets. Although the worst of the credit crunch seems to have subsided, the inventory of legacy
“toxic” assets still has curtailed the ability of banks to lend and, combined with depressed equity
values, is threatening insurance companies, pension funds, and investments held by a large swath
of households and institutions across the world. The second phase of the crisis has been to deal
with the slowdown and recession in world economies through various stimulus packages and

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The Global Financial Crisis: Foreign and Trade Policy Effects

other measures. The third phase has been to change financial regulations and build oversight and
a regulatory architecture designed to prevent future crises and correct past abuses of the system.
The fourth phase has been to deal with political and foreign policy effects of the crisis.
On February 12, 2009, the U.S. Director of National Intelligence, Dennis Blair, told Congress that
instability in countries around the world caused by the global economic crisis and its geopolitical
implications, rather than terrorism, is the primary near-term security threat to the United States. In
his testimony before Congress, Blair stated that the crisis has already “increased questioning of
U.S. stewardship of the global economy” and if it continued to spread and deepen, it would
contribute to unrest and imperil some governments. He said that according to their statistical
modeling, if economic crises persist over a one-to-two year period, they increase the risk of
“regime-threatening instability.”5
Other countries also have recognized that potential political and security effects of the crisis. On
March 6, 2009, the United Kingdom established a new security committee called the National
Security Forum and asked it to assess the security implications of the global financial crisis. The
12-member group is to bring together experts on policing, counter-terrorism, intelligence, finance
and diplomacy to provide analysis to the UK’s national security decision-makers.6
The political and foreign policy effects of the global financial crisis can be divided roughly into
the following categories:
•

effects on political leadership; regimes; perceived countries of influence; and
stability, violence, and terrorism;

•

effects on economic philosophy, state capitalism, and protectionism;

•

effects on U.S. international leadership and attitudes toward the United States;

•

effects on supranational financial and economic organizations;

•

effects on poverty; and

•

budgetary effects on resources for aid, diplomacy, and defense.

Effects on Political Leadership; Regimes; Perceived Countries of
Influence; and Stability, Violence, and Terrorism
Political Leadership
Two of the major mechanisms through which the financial crisis works on political leadership and
regimes within countries are citizen discontent and the consolidation of power by governments.

5

Dennis C. Blair, Annual Threat Assessment of the Intelligence Community for the Senate Select Committee on
Intelligence, Director of National Intelligence, Washington, DC, February 12, 2009. See also, U.S. Senate, Committee
on Foreign Relations, “Foreign Policy Implications Of The Global Economic Crisis,” Roundtable before the Committee
On Foreign Relations, February 11, 2009. Mark Mazzetti, "Global Economy Top Threat to U.S., Spy Chief Says," The
New York Times, February 13, 2009, Internet edition.
6
Luke Baker, "UK forms new security body, weighs financial crisis," Reuters, March 9, 2009.

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Citizen Discontent
The discontent from citizens arises from those who are losing jobs, seeing businesses go
bankrupt, losing wealth both in financial and real assets, and facing declining prices for their
products. This discontent often results in public opposition to the existing establishment or ruling
regime and, in democracies, can lead to their replacement through established electoral processes.
One commentator has called this the “Axis of Upheaval”7 referring to the concept that the
substantial increase in unemployment and a painful decline in incomes are likely to cause, or
contribute to, political upheavals in countries. While financial crises may not be the only cause of
such political instability, they may push conditions to a “tipping point.”
For example, on January 26, 2009, in financially beleaguered Iceland, Prime Minister Geir
Haarde and his cabinet resigned just three months after the collapse of the country's currency,
stock market, and several major banks, and following large outbursts of public protest. 8 On
February 20, 2009, Latvia's center-right coalition government collapsed, a victim of the country's
growing economic and political turmoil.9 In Hungary, the country’s economic crisis has provided
an opportunity for a political comeback for Viktor Orban, the long-standing leader of Hungary’s
conservative opposition. 10 A similar situation has developed in Japan where Prime Minister Taro
Aso’s approval rating has dropped to about 10% (in February 2009) apparently because of public
discontent with his efforts to rekindle economic growth.11 His conservative Liberal Democratic
Party could well lose control of the government in the next election to an emboldened
opposition.12 Ukraine and Georgia also have been moving into a period of political uncertainty as
they sink deeper into economic recession.13 Public discontent over the adverse effects of the
financial crisis also is rising in countries such as Greece, France, the United Kingdom, Ireland,
Thailand, Haiti, and China. Some have called this the “European winter of discontent”14 even
though the impact extends far beyond the European continent. This illustrates how the global
financial crisis can create chances for opposition leaders, regardless of political philosophy, to put
pressure on incumbent governments.
In some cases public discontent may be manifest in extremist movements, particularly in poorer
countries where large numbers of unemployed young people may become susceptible to religious
radicalism that demonizes Western industrialized society and encourages terrorist activity. (See
section on Stability and Violence below.) Although not completely related to the financial crisis,
in March 2009 in El Salvador, the left-wing FMLN party of former Marxist guerrillas claimed
victory in a hotly contested election. 15 If governments change, moreover, the rising new
7
This is a reference to G.W. Bush Administration’s use of “Axis of Evil” referring to Iran, Iraq, and North Korea. Niall
Ferguson, "Introducing the axis of upheaval; The financial crisis is bad enough; but combined with empires in decline
and ethnic disintegration, it is a recipe for disaster," The Times (London), March 14, 2009, Internet edition.
8
"Icelandic government falls; asked to stay on," CNN.com/Europe, January 26, 2009.
9
David L. Stern, "Latvia's government collapses," International Herald Tribune, February 20, Internet edition.
10
Stefan Wagstyl, "Crisis opens door for Hungrian conservatives," Financial Times, February 3, 2009, p. 4.
11
Kanoko Matsuyama and Toko Sekiguchi, "Aso Approval Plunges as Japan’s Economy Shrinks 12.7%,"
Bloomberg.com, February 16, 2009, Internet edition.
12
Toko Sekiguchi and Sachiko Sakamaki, "Aso’s Obama Summit May Be Last as Calls to Quit Grow ,"
Bloomberg.com, February 23, 2009.
13
"Eastern Europe gripped by political instability," EuActive.com, February 17, 2009.
14
Adrian Michaels, "Europe's winter of discontent," The Telegraph, January 29, 2009, Telegraph.co.uk.
15
Adam Thomson, "El Salvador's left claims victory in historic poll," FT.com (Financial Times), March 16, 2009,
Internet edition.

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government may play on nationalistic sentiments, particularly if the previous regime is seen as
having been too oriented toward international considerations.
Some members of the European Union initially viewed the financial crisis as primarily an
American phenomenon. That view has changed as economic activity in the EU has declined at a
faster pace than in the United States and public protests against the growing financial and
economic turmoil have increased the political stakes for EU governments and their leaders. As
one commentator has put it, “As panic grips Cabinet rooms across the Continent, the public is
driven to fury.”16 Of growing concern is the impact the financial crisis and the economic
recession are having on the economies of Eastern Europe and prospects for political instability as
well as the future course for market reforms. Western European banks are heavily involved in
Eastern Europe, and worsening economic conditions there could compound the current problems
facing financial institutions in EU member nations.17

Consolidating Government Power
The second way that the crisis works on ruling regimes is through the actions of existing
governments both to stay in power and to deal with the adverse effects of the crisis. Any crisis
generates centrifugal forces that tend to strengthen central government power. Most nations view
the current financial crisis as having been created by the financial elite in New York and London
in cooperation with increasingly laissez faire governments in the United States and the United
Kingdom. During the January 2009 World Economic Forum in Davos, Switzerland, for example,
Chinese Premier Wen Jiabao charged that America's voracious appetite for debt and “blind pursuit
of profit” had led to the worst recession since the Great Depression.18 By blaming the
industrialized West, particularly the United States, for their economic woes, governments can
stoke the fires of nationalism and seek support for themselves.
As nationalist sentiments rise and economic conditions worsen, citizens look to governments as a
rescuer of last resort. Political authorities can take actions, ostensibly to counter the effects of the
crisis, but often with the result of consolidating their power and preserving their own positions.
Authoritarian regimes, in particular, can take even more extreme actions to deal with financial
and economic challenges.
In Venezuela, for instance, President Hugo Chavez won a referendum on February 15, 2009,
ending the two-term limit on presidential elections, a battle he had previously lost in December
2007. Although the result of a democratic process and not completely attributable to the global
financial crisis, this does point to the tightening of Chavez’s power in Venezuela. On February 28,
he sent troops to temporarily take over rice processing plants including one owned by the
American company Cargill. Falling oil prices have limited the government’s ability to provide
compensation for takeovers of private businesses.19
16

Peter Popham, "The Big Question: How serious is the political unrest on the Continent, and can it be calmed?," The
Independent, January 30, 2009, Internet edition.
17
The International Monetary Fund has issued emergency loans to Hungary and Ukraine. The World Bank in a joint
effort with the European Bank for Reconstruction and Development and the European Investment Bank announced on
February 27, 2009 that they were providing $31 billion over two years to assist ailing banks and businesses in Eastern
and Central Europe.
18
"Furious leaders lash US over economic crisis," ABC News, January 29, 2009.
19
"Chavez orders army to seize Venezuela rice mills," Reuters as reported by MSNBC.com, February 28, 2009. Deisy
(continued...)

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In Russia, the impact of the financial crisis has been particularly severe as it faces a decline in
global demand for its exports of oil and natural gas and a 71% drop in the price of its petroleum.
The crisis has exposed Russia’s significant dependence on oil, natural gas, and other
commodities. In 2008, oil, natural gas, and other fuels accounted for about 65% of Russia’s
export revenues. In addition, the Russian government is dependent on taxes on sales of oil and
natural gas for more than half of its revenues; Russia has generated budget surpluses since 1998,
but it is expected to have a budget deficit in 2009, primarily because of the fall in oil prices.
The fall in world demand for oil also has hit other parts of the Russian economy. As of April 6,
2009, Russia’s RTS stock market index had lost nearly 70% of its value from the peak reached on
May 19, 2008. From June 2008 to the end of January 2009, the ruble had depreciated by 52% in
terms of the dollar and 22% in terms of the euro. This compelled the Central Bank of Russia to
intervene to bolster the value of its currency by selling foreign exchange and buying rubles. This
caused Russia’s official foreign exchange reserves to decline accordingly.
These increasingly difficult economic circumstances in Russia are proving to be a factor in rising
nationalism and spreading state capitalism there. Some feel, for example, that Russia has taken
advantage of the need to intervene in the economy to counter effects of the financial crisis to
make the country a harder, more vertically managed power with state capitalism as the foundation
of its industrial sector. This reversing or slowing down of many of the structural economic
reforms had been pursued under then President Putin, but as the financial crisis and drop in the
price of energy has hit Russia, the Kremlin and now Prime Minister Putin have increased the
government’s control over critical sectors such as oil, natural gas, and other commodities.

Perceived Countries of Influence
As the financial crisis spreads to emerging and developing nations, many of these countries are
facing gargantuan financial problems that they are unable to resolve themselves. They have
turned to outside assistance from sources such as Russia, the European Union, China, and the
International Monetary Fund. Whether such assistance is extended or not may affect strategic and
political relations with the nations in question. In Eastern Europe, in particular, there appears to
be a tug of war developing between the European Union and Russia for the long-term allegiances
of Eastern European states.20 The situation in Ukraine illustrates the problem. After being
rebuffed by the IMF for additional financing, Ukraine Prime Minister Yulia Tymoshenko said that
she had sent letters requesting financial aid to the United States, the European Union, China,
Japan, and Russia. She also noted that Russia had responded with a positive reply, although
Moscow has yet to announce a decision.21 (Eventually, Ukraine accepted an IMF loan and has
agreed to its rather stringent conditions [such as increasing its retirement age].)

(...continued)
Buitrago, "Venezuela sees no further Cargill takeovers," Reuters, March 6, 2009.
20
"EU, Russia quietly battle for Eastern Europe influence," EurActiv.com, February 11, 2009.
21
Office of mass media relations of the Cabinet of Ministers of Ukraine Secretariat , Yulia Tymoshenko: Ukraine
carries on successful negotiations with many countries of the world on giving credit to cover deficit of State Budget,
Government Portal, Riga, Ukraine, February 7, 2009. Yekaterina Trofimova, "Russia Seen as Cash Cow," Utro.ru (in
Russian), March 4, 2009, Translated by Open Source Center, document CEP20090304009003 . "Ukrainian Speaker
Says Borrowing From Russia Would Be Advisable," ITAR-TASS, March 11, 2009.

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In April 2009, OAO Surgutneftegaz, a Russian oil company close to the Kremlin, announced that
it had acquired a 21% stake in Hungary's national energy company. This sparked criticism that
Moscow was exploiting the financial crisis by parlaying its energy resources into greater
economic influence in Eastern Europe.22
In one case, the financial crisis may help in moving a country away from Russia and toward the
West. On January 12, 2009, the IMF approved a 15-month Stand-By Arrangement of $2.46
billion for Belarus. Belarus also had unsuccessfully approached Russia for a $3 billion currency
swap arrangement and then asked for a $2 billion bank loan guaranteed by the Russian
government. Some assert that Belarus has set up a “bidding war” between the East and West for
influence there. 23
“Checkbook diplomacy” (using economic assistance to gain political advantage), in many cases
has returned only mixed results. However, public memories of events during times of crisis tend
to linger. In Thailand and other Southeast Asian countries, perceptions persisted that the United
States had been slow in lending support during the 1997-98 Asian financial crisis and were only
partly assuaged years later through the outpouring of U.S. assistance to Southeast Asian nations
following the 2004 Indian Ocean Tsunami.24
A Dutch think-tank also has been following the security impact of the financial crisis. It has been
particularly interested in a possible power shift from the West to the East because of China's
rising financial power.25 The London Economist puts the situation in these terms:
China’s prime minister, Wen Jiabao, no longer sticks to the script that China is a humble
player in world affairs that wants to focus on it own economic development. He talks of
China as a “great power” and worries about America’s profligate spending endangering his
$1 trillion nest egg there. ...Already a big idea has spread far beyond China: that geopolitics
is now a bipolar affair, with America and China the only two that matter.26

The financial crisis also is providing an opportunity for cash-rich China to secure critical supplies
of minerals and raw materials.27 Although China’s quest for food, fuel, and ores is not new and
Chinese companies are backing out of some deals, Chinese companies are among the few with
cash on hand to do deals in the current recessionary economic conditions. In February 2009,
China reached a long-term deal to lend $25 billion to two Russian energy companies in exchange
for an expanded supply of Russian oil. China Minmetals Corporation also had offered roughly
$1.7 billion to buy Australia's OZ Minerals Ltd., and Aluminum Corp. of China announced a
planned $19.5 billion investment in Australia’s mining giant Rio Tinto. 28 The financial crisis
22
Guy Chazan and Gregory L. White, "Russian oil company buys stake in Hungary's MOL—Purchase reinforces
concerns Kremlin is extending reach," The Wall Street Journal Asia, April 1, 2009, p. M2.
23
Yuriy Humber, "Lukashenko Eases Grip on Belarus Amid Crisis," The St. Petersburg Times (Russia), April 3, 2009,
Reproduced in Dow Jones Factiva.
24
Meetings with opinion leaders in Indonesia by Dick Nanto in February 2008.
25
Valentina Pop, "European NATO members at odds over strategic priorities," EUuobserver.com, March 27, 2009.
26
"How China sees the world," The Economist, March 21, 2009, pp. 13, 27-29.
27
For an analysis of China’s trade and investments as part of its soft power, see CRS Report RL34620, Comparing
Global Influence: China’s and U.S. Diplomacy, Foreign Aid, Trade, and Investment in the Developing World,
coordinated by Thomas Lum.
28
David Winning, Shai Oster, and Alex Wilson, "China, Russia Strike $25 Billion Oil Pact ," The Wall Street Journal,
Asia, Internet Edition, February 18, 2009.

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apparently has made companies facing falling demand eager to secure cash and more amenable to
overtures by Chinese companies. While locking up such supplies of raw materials may not
translate into political allegiances, they constitute a strong link in supply chain ties that tend to
bind economies together. 29
China also has entered into currency swap arrangements totaling 650 billion Chinese yuan ($95
billion) with South Korea, Hong Kong, Malaysia, Indonesia, Belarus and Argentina. Under the
swap arrangements, those countries could swap a foreign currency for yuan that can be used to
settle trade with China.30
The financial crisis also has been buffeting the sense of unity among the eurozone nations. There
has been some speculation on a potential break-up of the eurozone, a development that could
affect European security. The issue revolves around the troubles that Ireland and southern
members of the single currency arrangement (Portugal, Spain, Italy, and Greece) have had in
selling bonds and stabilizing their growing budget deficits.31 At the same time, the financial crisis
and the accompanying economic downturn have battered the currencies of many of the noneurozone countries, especially in Central and Eastern Europe. As a result, many of these countries
have become more interested in joining the perceived safety of the eurozone and have pressed the
eurozone members to relax the rules on entry into the euro area. These actions are straining
relations with the larger, more prosperous economies of the eurozone and the European Union
who hold a skeptical view of any rapid expansion in eurozone membership. For some of the
aspiring economies, however, opposition within the euro area to their membership is especially
embittering, because the recession is undermining their ability to meet the rigid requirements for
membership in the eurozone set by the more prosperous economies, who, they argue, are to blame
for originating the crisis.

Stability, Violence, and Terrorism
Citizen discontent, the consolidation of government power, and effects on international relations
relate to economic and political stability both within and among countries. Stability, in and of
itself, is not an overriding foreign policy goal, 32 but no one likes to deal with surprises,
particularly those that can threaten U.S. interests. If change happens, U.S. foreign policy analysts
would like to be able to predict it and prepare for the consequences. The National Intelligence
Council in its November 2008 report forecasting global trends to 2025, noted that economic
volatility introduces a major risk factor to political stability. Historians and social scientists have
discovered a strong correlation between rapid economic change—both positive and negative—
and political instability. The Council cited the massive dislocation and economic volatility
introduced by the end of the “first” globalization in 1914-1918 that helped lay the groundwork for
the rise of protectionism in the 1920s and 1930, and then to World War II that, in turn, unleashed

29

Valentina Pop, "European NATO members at odds over strategic priorities," Euobserver.com , March 27, 2009,
Open Source Center article No. EUP20090327319002.
30
Denis McMahon and Aaron Back, "PBOC Eyes More Currency Swaps To Up Trade In Crisis," Wall Street Journal,
March 31, 2009, Mobile edition.
31
Valentina Pop, "European NATO members at odds over strategic priorities," Euobserver.com , March 27, 2009,
Open Source Center article No. EUP20090327319002.
32
For a discussion of stability as a goal, see Ralph Peters, "Stability, America's Enemy," Parameters, 2001/2002,
Winter, pp. 5-20.

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a long series of national and ethnic conflicts that reverberates today. 33 One thing that could be
said about stability, is that instability generally favors a rising power or opposition forces. For a
dominant power, instability may pose a risk to its hegemony.
For U.S. businesses operating overseas, stability is essential for smooth operations. Obtaining
government approvals, building manufacturing facilities, expanding service networks,
maintaining a labor force, and shipping components and final products all are threatened by
political, financial, and economic instability. Also, political instability may bring a rise in crime,
traffic in illegal drugs and counterfeit products, kidnappings, and other illicit activity.
The financial crisis also may worsen problems that already have escalated in recent years. In
particular, violence by drug cartels and crime syndicates seems to be on the rise in various
countries. Mexico is a case in point. Rising violence in Mexico is forcing American companies to
change their operating procedures and shipping routes, and to tighten security for their
employees.34 Mexican President Felipe Calderon has rejected U.S. concerns that Mexico is losing
control of its territory to drug cartels and called “absolutely false” the idea that Mexico is in
danger of becoming a failed state if the violence continues. However, in 2008, 6,290 people were
killed in drug violence35 and government officials say the drug war and economic crisis are
starting to feed off each other. The violence discourages foreign investment and tourism while
rising unemployment could nudge more youths to join the drug cartels. Lower growth also could
leave Mexico with less cash to spend on the drug war, which cost $6.4 billion over 2007 and
2008.36
Even in China, where rates of violent crime have traditionally been low, there reportedly has been
an increase in kidnappings for ransom since the onset of the economic slowdown and an overall
rise in security issues for multinational companies, particularly from laid-off workers.
Desperation over unemployment seems to be the primary cause of this increasing threat.37
Political instability and poverty also can provide an incubator for extremism. The financial crisis
may not be the primary cause of ideologically driven terrorism, but the worsening of economic
conditions and rising joblessness among young people provide better recruitment opportunities
for extremist terrorist groups. Militants thrive in places of political instability and lack of strong
central governmental control. The global financial crisis threatens to create more such places.
Countries of concern may include Pakistan, Bangladesh, Yemen, Nigeria, Sudan, Somalia, and
Egypt. As one analyst has stated,
No matter how cohesive and determined a terrorist organization, it needs a supportive
environment in which to flourish. That means a location that provides a steady stream of
funds and recruits and the support (or at least acceptance) of the local population. ... As more
people lose their jobs, their homes, and opportunities for prosperity—in emerging market

33

National Intelligence Council, Global Trends 2025: A Transformed World, NIC 2008-003, Washington, DC,
November 2008, p. 5.
34
"Foreign Companies React To Mexico Violence," Associated Press, reported by CBS News, February 24, 2009,
Internet edition.
35
"Mexico Drug Violence May Be Reaching Peak," CBS/Associated Press, February 26, 2009, Internet edition.
36
Catherine Bremer, "ANALYSIS-Mexico drug war, economy hobble Calderon's ambitions," Reuters, April 6, 2009.
37
Stratfor Global Intelligence, An Uptick in Violent Crime, China Security Memo, February 19, 2009.

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countries or even within minority communities inside developed states—it becomes easier
for local militants to find volunteers.38

The global financial crisis also is causing mass deportations or voluntary exodus by many
immigrant workers who no longer can find employment abroad. As these workers return to their
home countries, they may join the many already unemployed and become targets for recruitment
by militant groups and insurgent movements. For example, most of the Gulf Cooperation Council
states rely heavily on foreign labor in their construction and oil industries. Many of these workers
are from Pakistan, India, Bangladesh, and the Philippines. Dubai’s labor ministry reportedly has
been cancelling 1,500 work permits per day since late October 2008.39
In February 2009, the Chairman of the Joint Chiefs of Staff, Admiral Mike Mullen outlined what
he thinks about the future and evolution of the U.S. military stated that the world's financial crisis
has to be taken into consideration as well. Mullen noted that poor economic states may become
future targets for terrorism. He also added that U.S. defense may be affected by budget cuts,
possibly shifting mission focuses. 40 As noted above, on March 23, 2009, IMF Managing Director
Dominique Strauss-Kahn said the world is in a dire economic crisis that will push millions into
poverty and unemployment, risking social unrest and even war and that urgent action is
required.41
The rising unemployment problem is exacerbated by declining remittances from workers
overseas, a critical component of household income in many poorer countries. The global
financial crisis not only has reduced export income and inflows of investment capital in many
developing nations, but as demand shrinks for foreign labor in more industrialized economies, the
money sent to home countries also may decline. In 2008, remittances from foreign workers
accounted for an estimated $305 billion in flows to developing countries.42 For many countries,
this is greater than inflows of aid and foreign investment funds combined. The countries that rely
on remittances for at least one-fifth of their income include such post-conflict and conflict-prone
nations as Lebanon, Burundi, Liberia, Kyrgyzstan, Tajikistan, Afghanistan, Bosnia, Moldova and
Haiti.43
In Latin America, currencies, stock markets, and output are down broadly by one-third to one-half
from a year earlier. Unemployment is also on the rise. While most countries in the region are
likely to ride out the economic contraction, many are watching Argentina to see if it again ends up
defaulting on its foreign debts, thereby raising the specter of a social breakdown. Financially, the
country is extremely fragile and already is experiencing protests. This could present a challenge
to U.S. policy and status, given that Argentines often blame the United States for many of their
economic problems.

38

Ian Bremmer, "Call: Global recession = more terrorism," Foreign Policy, March 4, 2009, pp. Internet edition,
ForeignPolicy.com.
39
Stratfor, Gulf States: Labor Policies, Financial Crisis and Security Concerns, Analysis, February 24, 2009.
40
Michael J. Carden, Military Adapts to Special Operations Mission, Mullen Says , American Forces Press Service,
February 12, 2009.
41
IMF says clean up banks to tackle dire world crisis, Reuters, March 23, 2009.
42
"Remittances, Trickle-down economics," The Economist (London), February 21, 2009, p. 76.
43
Donald Steinberg, "First Lehman Brothers, Next Liberia?," The Globalist, by the International Crisis Group, January
26, 2009. Stratfor, Watch List for Remittance Flows, Analysis, February 4, 2009.

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The precipitous drop in the price of oil, moreover, holds important implications for countries such
as Mexico, Venezuela, and other petroleum exporters, who were counting on oil revenues to fund
activities considered to be essential to their interests. The oil-producing Andean countries of
Ecuador and Bolivia also tend to be financially fragile and have left-leaning governments. While
moderating oil prices may be a positive development for the U.S. consumer and for the U.S.
balance of trade, such price declines also may cause political instability in certain of these
petroleum exporting countries. The concomitant drop in prices of commodities such as rubber,
copper ore, iron ore, beef, rice, coffee, and tea also carries serious consequences for exporter
countries in Africa, Latin America, and Asia.44
The decline in oil prices may be particularly troubling in oil-dependent Yemen, a country with a
large population of unemployed young people and a history of support for militant Islamic
groups. Also, in Pakistan, a particular security problem exacerbated by the financial crisis could
be developing. The IMF has approved a $7.6 billion loan package for Pakistan, but the country
faces serious economic problems at a time when it is dealing with challenges from suspected Al
Qaeda and Taliban sympathizers, when citizen objections are rising to U.S. missile strikes on
suspected terrorist targets in Pakistan and the country faces a budget shortfall that may curtail the
ability of the government to continue its counterterror operations.45 The Iraqi government also
depends heavily on revenues from exports of oil. Such revenues finance about 95% of the
government’s budget.

Effects on Economic Philosophies, State Capitalism, and
Protectionism
Economic Philosophies
The global financial crisis may have ended what some call the period of economic neoliberalism
that began with President Ronald Reagan and British Prime Minister Margaret Thatcher. This
economic philosophy already was being disparaged in many Latin American countries. Some also
have asserted that the crisis has effectually ended the Washington Consensus, the economic
strictures often prescribed for Latin American countries in financial trouble. 46 The Washington
Consensus included fiscal discipline, liberalization of trade and direct investment flows,
privatization, deregulation, and flexible exchange rates.47 While the elements of the Washington
Consensus and neoliberalism do not overlap completely, the underlying premise of each was that
market-based, rather than government-based, economic decisionmaking along with fiscal
discipline can lead to higher rates of economic growth and greater prosperity for nations. Budget
deficits and their borrowing requirements, in particular, had to be controlled because they caused
inflation and economic instability and crowded out private economic activity.
44
Johnston, Tim. “Asia Nations Join to Prop Up Prices,” Washington Post, November 1, 2008, p. A10. “Record Fall in
NZ Commodity Price Gauge,” The National Business Review, November 5, 2008.
45
Joby Warrick, “Experts See Security Risks in Downturn, Global Financial Crisis May Fuel Instability and Weaken
U.S. Defenses,” Washington Post, November 15, 2008. p. A01. Bokhari, Farhan, “Pakistan’s War On Terror Hits
Roadblock, Global Economic Crisis Prompts Military To Consider Spending Cutbacks,” CBS News (online version),
October 28, 2008.
46
Kevin Gallagher , "The death of the Washington consensus?," Guardian.co.uk, October 13, 2008.
47
Center for International Development at Harvard University, Global Trade Negotiations Home Page, Washington
Consensus, Updated April 2003.

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Now, however, many countries (including the United States in some respects) seem to be turning
toward large budget deficits, increased trade protectionism, restrictions on capital flows,
government ownership of companies, and tighter regulation of financial markets and players.
After the global financial crisis has passed, the basic structure of market-based capitalism and
liberalized international trade are likely to survive, but countries today seem to be turning more
toward viewing economic policies through a strategic lens and some question whether the costs of
neoliberal economic policies being manifest by the financial crisis are worth their benefits. Of
course, coping with the crisis can be viewed as a case of expediency overriding values rather than
a shift in philosophy. As one analyst has noted about financial crises: as each crisis arrives, policy
makers express ritual shock, then proceed to break every rule in the book. The alternative is
unthinkable. When the worst is passed, participants renounce crisis apostasy and pledge to hold
firm next time. 48
At the January 2009 World Economic Forum in Davos, Switzerland, the question was raised
whether the rules and values that were in place to safeguard the capitalist system have failed or
whether the system itself is in need of an overhaul. Most Forum panelists agreed that, while the
financial system needs to be fixed, the solution is not excessive regulation that stifles innovation
and free enterprise. Former British Prime Minister Tony Blair, for example, argued that “the free
enterprise system as a whole has not failed. The financial system has failed.” He noted that the
financial system was originally there to serve the wider economy and the wider economy to serve
the wider society. According to him, the financial system was not meant to be an end in itself. 49
One commentator may have captured the essence of the issue with this comment, “Capitalism
isn’t the enemy, and it isn’t the savior. It is simply a system fueled by human creativity but
vulnerable to human weaknesses such as greed.”50

State Capitalism
Increased government ownership and direction of enterprises and investment funds has been
called state capitalism51 or public-sector capitalism. The formal term for government takeovers of
companies or assets is “nationalization,” although in most cases, the current cases differ from past
cases of nationalizations by communist or socialist governments. Those essentially amounted to
expropriation in which governments would seize private sector assets without fully compensating
owners. Most industrialized market-oriented economies of the world are taking over firms as part
of rescue packages (out of expediency) with the major goal of providing support to the financial
or other sectors of the economy and not to shift the basic structure of the economy away from
capitalism. It is probably not the case, as some have postulated, that “we are all socialists now,”52
but increased government ownership and management of business assets brings a new dimension
to the interaction between policy and business activity.

48

Gelpern, Anna. “Emergency Rules,” The Record (Bergen-Hackensack, NJ), September 26, 2008.
Tony Blair , Stephen Green , Indra Nooyi , and Shimon Peres , The Values behind Market Capitalism, The World
Economic Forum, January 28, 2009.
50
Cynthia Tucker, "Capitalism no foe; just keep an eye on it," Atlanta Journal Constitution, March 29, 2009, Internet
edition.
51
State capitalism also may refer to economic activities by states (e.g., New York) within the United States. Most state
investment, however, tends to be unrelated to foreign policy (except for state pension funds that may eschew investing
in certain countries because of human rights considerations).
52
E.J. Dionne, Jr, "Stuck Between Stations," The New Republic, March 30, 2009, Internet edition.
49

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A challenge for the United States is to balance its own free-market economic philosophy with the
fact that it is now a major owner or player in businesses that it has rescued because of the
financial crisis. Compared with formerly socialist countries, U.S. state capitalism is small in
scale, but the challenges of government management and the potential to sway business decisions
because of political considerations are similar.
With respect to foreign policy, one danger of state ownership of businesses is that governments
may exploit state-owned or state-invested enterprises for international political gains.53
Nationalizations also pose risks for businesses that have invested in foreign countries.
Governments could take over their operations without sufficient compensation. A related issue is
that government ownership may cause companies to become less efficient and unable to compete
as well in the global marketplace over the long-term. Governments may not have the expertise or
manpower to successfully manage or make quick decisions at nationalized firms. Government
ownership of companies, moreover, may induce companies to take actions in response to popular
pressure rather than to market forces. This may lead to inefficiencies and further uncertainties
about economies.
Some examples of increasing state capitalism include the following. Iceland has nationalized all
its major banks, and the UK has taken a 68% share of the Royal Bank of Scotland.54 The United
States has taken control over Fannie Mae and Freddie Mac and has substantial input into the
operations of AIG, Citigroup, General Motors, and Chrysler.55 Germany has approved a law
letting the government nationalize banks.56 Loans being extended to private businesses as well as
capital injections into financial institutions also are coming with strings attached. Whether the
strings are limits on executive compensation, fuel economy standards, pressures on banks to lend
more domestically, or other specific performance requirements, governments now have greater
voice in the operation of many corporations.
In countries such as Russia, where histories of command economics predispose the government
toward state ownership of the means of production, the shift toward state capitalism already was
developing before the financial crisis and has continued to develop. National oil companies, other
state-owned enterprises, and sovereign wealth funds have brought politicians and political
bureaucrats into economic decision-making on a scale not seen since the before the market
reforms that followed the end of the Cold War.57 Although not totally attributable to the financial
crisis, the line between the state-owned Gazprom and the Russian state can be quite thin. Under
former President Putin, Gazprom reportedly became an instrument for centralizing authority,
buying up opposition television stations and newspapers.58 In a poll taken in Russia asking what
socio-economic system the respondent favors, 58% favored the old Soviet system of state
planning and distribution, while 28% favored one based on private property and market relations,
53

Douglas Rediker and Heidi Crebo-Rediker, "Don't Pick on Sovereign Wealth," The Wall Street Journal Europe, July
17, 2008, p. 12.
54
Landon Thomas Jr., "Nationalized in all but name: U.S. move echoes U.K. share of RBS ," International Herald
Tribune, February 24, 2009, Internet edition.
55
CRS Report RS22950, Fannie Mae and Freddie Mac in Conservatorship, by Mark Jickling; CRS Report RL34730,
Troubled Asset Relief Program: Legislation and Treasury Implementation, by Baird Webel and Edward V. Murphy;
Binyamin Appelbaum, "Government to Take Bigger Stake in Citigroup," Washington Post, February 27, 2009.
56
"Germany approves law on bank nationalization," Welt Online, February 18, 2009.
57

Ian Bremmer and Nouriel Roubini, "Expect the World Economy to Suffer Through 2009 ," The Wall Street Journal,
January 23, 2009, p. A15.
58
Andrew E. Kramer, "Gazprom," The New York Times, January 20, 2009.

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and 14% responded that it was hard to say. The polling center indicated that the growth of “antibourgeois” sentiments can be explained by the financial crisis.59

Trade Protectionism
For many, the global financial and economic crisis has confirmed existing anti-globalization
sentiments and is being reflected in opposition to more liberalized trade. 60 Under the dislocation
caused by the financial crisis, many countries are attempting to curtail imports or impose other
restrictions on trade. At both the G-20 Leaders’ Summit and the meetings of finance ministers and
central bank governors, participants agreed to fight all forms of protectionism and maintain open
trade.61 However, in March 2009, World Trade Organization Director-General Pascal Lamy stated
that members of the WTO were showing a “worrying tendency toward increased trade
protectionism as a result of the deepening global economic crisis.” He indicated that the WTO
had identified 85 verified trade measures imposed by 23 countries between September 2008 and
March 2009. The large majority were trade-restrictive, although some were in the direction of
trade liberalization. The largest number of measures were imposed by India, most of them trade
restrictive (duty hikes, import bans introduction of licensing requirements, antidumping actions,
etc.) and some nonrestrictive (removal of export duties). Others that the WTO reported as having
imposed a large number of new trade measures were the EU, China, Indonesia, Argentina, and
Russia. The report also identified a further 14 non-verified trade measures imposed by 12
countries between September 2008 and March 2009 (with the information largely gleaned from
press reports). Lamy stated that a “pattern is beginning to emerge of increases in import licensing,
import tariffs and surcharges, and trade remedies to support industries that have faced difficulties
early on in this crisis.” There also has been an increase in initiations of antidumping
investigations.62
The overt forms of protectionism or beggar-thy-neighbor policies are limited by rules countries
have agreed to as members of the WTO. However, there is ample scope for increases in trade
barriers that are consistent with WTO rules and obligations, including increases in applied tariffs
to higher bound levels. If all WTO members raised their currently applied tariffs to today’s WTO
bound rates, tariffs worldwide would double. The WTO has said that such increases in trade
barriers could cause world trade to shrink by up to 8% and reduce global welfare by up to $350
billion.63
WTO rules also allow countries to impose countervailing duties on unfairly subsidized imports or
to take antidumping measures against imports being sold at less than fair value. Certain sectors
also are excluded from trade agreements for national security or other reasons. Moreover, there
are opportunities to favor domestic producers at the expense of foreign producers through
59
"Russians reject American-style capitalism more than ever," Washington Post paid supplement, Russia Now, March
25, 2009, p. H4.
60
See CRS Report R40461, The Global Economic Downturn and Protectionism, by Raymond J. Ahearn.
61
The Group of Twenty (G-20) Finance Ministers and Central Bank Governors , Declaration and action plan from the
Washington Summit, November 15, 2009, http://www.g20.org. G-20, Meeting of Finance Ministers and Central Bank
Governors, United Kingdom, 14 March 2009, Communiqué, March 14, 2009.
62
"WTO Chief Cites ‘Significant Slippage' Toward Protectionism Since Late January ," International Trade Daily
(The Bureau of National Affairs, Inc.), March 30, 2009.
63
Pascal Lamy, Protectionism cannot be ‘smart’, Lamy tells Australian think-tank, World Trade Organization, WTO
NEWS: SPEECHES—DG PASCAL LAMY, March 2, 2009.

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industry-specific relief or subsidy programs, broad fiscal stimulus programs, buy-domestic
provisions, or currency depreciation.
Almost any government intervention into economic activity affects international trade and capital
flows. Since government intervention generally is influenced by political considerations and may
involve tax dollars, it usually favors domestic constituencies at the expense of foreign
constituencies. A danger in the process of recovering from the global financial crisis is that
countries may try to capture a larger share of a declining volume of international trade rather than
attempt to induce recovery in trade flows by helping their macroeconomies return to health.
Government assistance packages also could result in a form of “creeping protectionism.” At what
point do government loans and assistance become an unfair subsidy under international trade
rules? Also, would a government rescue a company and then stand by while it succumbs later to
import competition? Governments also may turn toward “managed trade” as occurred in the
1980s in response to the oil shock of the 1970s. Managed trade was not an increase of tariff rates
to reduce imports but rather the imposition of import-reducing measures such as “voluntary
export restraints” or local-content requirements.64 Imports also can be restricted through various
other non-tariff measures, such as standards and technical regulations (including sanitary and
phytosanitary measures).
China, for example, has announced plans to provide subsidies to various industries (such as steel
and motor vehicles) and to boost export tax rebates. Also, despite calls for it to allow its currency
to appreciate, the Chinese government has kept its exchange rate relatively stable since mid-2008
arguably to help its export industries. This ended a period beginning in 2005 in which China had
allowed its currency to appreciate by about 20% against the dollar.
A concern among developing nations is that a type of “financial protectionism” may rise. The
combination of the global economic slowdown, fragile banking and securities sectors, tighter
lending standards, increased capital reserve requirements, plus government pressures on banks to
lend more domestically rather than overseas may shrink the amount of capital available for
emerging and developing nations. Some are wondering if the U.S. Treasury, in borrowing to
finance the growing U.S. budget deficit, could crowd out borrowers from countries also seeking
to cover their deficits. Also of concern to countries such as Vietnam, China, and other exporters of
foreign brand name exports is that private flows of investment capital may decline as producers
face rising inventories and excess production capacity. Why build another factory when existing
ones sit idle?
In the United States, Members of Congress are called on to balance constituent pressures for
relief from imports against the increased integration of the United States in the global economy.
This has combined with increased public skepticism about the benefits of free trade and
globalization. The “Buy American” provision in the February 2009 stimulus package65 has been
characterized by some as a step down the slippery slope leading to protectionism and a sign,
worrying to many, that the United States may not be a leader of the free-trade initiatives in the
64
Fredrik Erixon and Razeen Sally, Protectionism is on the rise, European Centre for International Political Economy,
Brussels, Belgium, February 16, 2009, posted on VoxEU.org.
65
H.R. 1 (P.L. 111-5) Sec. 1605 provides that none of the funds appropriated or otherwise made available by the act
may be used for a project for the construction, alteration, maintenance, or repair of a public building or public work
unless all of the iron, steel, and manufactured goods used in the project are produced in the United States provided that
such action would not be inconsistent with the public interest, such products are not produced in the United States, and
would not increase the cost of the overall project by more than 25%.

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years ahead. The European Union has raised questions about whether its provisions are
compatible with U.S. international trade commitments66 even though the provision applies only to
steel, iron, and manufactured goods used in construction projects and language was included that
the provision “shall be applied in a manner consistent with United States obligations under
international agreements.”67 The criticism from other nations of this provision appears to be based
on both its presumed effects and the fear that even a relatively small “Buy American” provision at
this time could set a precedent that could open the floodgates and provide the excuse for a cycle
of “creeping protectionism” by other nations.
On March 31, 2009, just prior to the G-20 London Leaders’ Summit, the Obama Administration
issued an interim rule implementing the “Buy American” provisions in the economic stimulus
package that was consistent with existing U.S. practice. The interim rule imposed no new
restrictions in terms of the origin of products that are eligible to be purchased by the federal
government for procurement projects. It upheld that the manufacturing of all iron or steel used in
federal projects funded by the stimulus bill must take place in the United States, except for
metallurgical processes involving refinement of steel additives. The new rule also established no
requirements on the origin of components or subcomponents used in construction materials, so
long as the manufacture of the construction material occurs in the United States. It also exempted
from the “Buy American” provision all 38 countries that have signed the World Trade
Organization's Government Procurement Agreement and 47 least-developed countries.68
Many analysts note that the relationship between government procurement and the world trading
system has always been tenuous. The national treatment provisions of the 1947 General
Agreement on Tariffs and Trade (GATT)(Article III(8)) excluded government procurement from
its obligations entirely. However, as the government share of GDP grew in the postwar period,
especially in countries where industry sectors such as airlines and steel were nationalized, some
GATT members came to believe that the trading system needed to place government procurement
practices under certain disciplines. The Tokyo Round negotiations, which concluded in 1979,
contained several plurilateral codes including an Agreement on Government Procurement, which
members could join voluntarily. The Uruguay Round Agreements creating the WTO renegotiated
these codes in areas such as antidumping and subsidies and converted them into mandatory
agreements, which became prerequisites for membership in the WTO. However, the Agreement
on Government Procurement (AGP) remained a plurilateral agreement open to WTO members.
Many developing countries such as China, India, and Brazil have not joined the AGP.69

66

"EU Raises New Questions on Compatibility of U.S. 'Buy America' Provisions with GPA," International Trade
Daily (Bureau of National Affairs, Inc.), March 30, 2009.
67
"Europe Warns against 'Buy American' Clause," Spiegel Online International, February 3, 2009, Internet edition.
68

Department of Defense (DoD), General Services Administration, "Federal Acquisition Regulation; FAR Case 2009008, American Recovery and Reinvestment Act of 2009 (the Recovery Act)—Buy American Requirements for
Construction Material," 74 Federal Register , March 31, 2009, pp. 14623-14633.
69
The Agreement on Government Procurement (AGP) commits signatories to practice the principles of national
treatment and non-discrimination in the laws, regulations, practices, and procedures concerning government
procurement. The agreement provides procedures to ensure transparency, including detailed operating rules on the
procurement process of the signatory, a challenge procedure by which a rejected bid can be independently and
impartially reviewed, and recourse to the World Trade Organization dispute settlement provisions. However, AGP only
applies to the sectors and the procurement agencies that the government includes in its schedule of national
commitments. This schedule lists the national and sub-national agencies as well as other entities that will participate,
exceptions within those units, and the threshold- value for including contracts.

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For the United States to both support the inclusion of government procurement in trade
negotiations yet also place certain “Buy American” restrictions on its own procurement policies
illustrates the ambivalence that it, like many nations, feels toward opening government
procurement policies to the same disciplines that govern other commerce. Alone among the
Tokyo Round codes, the AGP was not converted into a mandatory agreement in the WTO. The
political nature of government procurement may account for this ambivalence. First, the
underlying rationale of the WTO system is to increase economic efficiency through freer trade.
However, government procurement decisions may not depend on economic considerations.
Governments use purchasing decisions to achieve domestic policy goals, such as to provide
economic stimulus or the promotion of specific local industry sectors or social groups. Because
taxpayer dollars are involved, however, for many there is a political imperative that money be
spent locally. As one commentator summed up the dilemma, “Countries that feel themselves to be
competitive in supplying goods have an incentive to improve market access, but few countries
seem willing to give up the ability to discriminate in favor of either domestic providers or
regional partners.”70

Effects on U.S. Leadership and Attitudes Toward the United States
Another issue raised by the global financial crisis has been the role of the United States on the
world stage, the U.S. leadership position relative to other countries, and U.S. credibility. These
are largely intangible qualities that depend partly on the effectiveness of current U.S. leaders but
also depend on a host of other factors such as the relative military and economic might of the
United States (including the role of the U.S. dollar and American market in the global economy),
attitudes and perceptions abroad, actions by other nations, and the skillful use of all aspects of
U.S. power. As the global financial crisis has progressed, a world-wide perception has developed
that the lack of oversight and regulation by the United States was a major contributor to the crisis
and has imposed huge costs both on investors and “innocent bystanders” abroad. This has been
added to existing discontent in many countries with the situation in Iraq and other U.S. policies
and may work to reduce the ability of Washington to lead in finding solutions to both the current
financial crisis and other issues.
The financial crisis appears to have had a dual effect on perceptions of the United States as a
world leader. On one hand, U.S. policy is seen as key to financial and economic recovery and in
reforming the international financial system. The crisis has reminded the world that the United
States is a central node in the network of financial and trade linkages that encircle the globe.
Despite efforts to diversify economic and financial ties, most economies remain closely linked to
the United States. Prospects for recovery from the crisis would be quite dim without U.S. policy
initiatives and U.S. leadership. On the other hand, the crisis itself is perceived by some as
weakening the U.S. position in the world and providing an opportunity for other nations to adjust
the global balance of power away from the United States and toward Europe, China, Russia, and
India. The fact that the G-20, not the G-7, 71 has become the international coordinating body for
resolving the global financial crisis indicates that countries such as China, Russia, India, and
Brazil have taken a seat at the head table along with the advanced industrial nations of North
America, Europe, and Japan.
70

John H. Barton, et. al., Evolution of the Trade Regime (Princeton, NJ: Princeton University Press, c2006), p. 119.

71

The G-7 includes Canada, France, Germany, Italy, Japan, United Kingdom, and the United States. The G-8 is the G-7
plus Russia. The G-20 adds Argentina, Australia, Brazil, China, India, Indonesia, Mexico, Saudi Arabia, South Africa,
South Korea, and Turkey.

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During the early months of the crisis, European leaders (particularly British Prime Minister
Gordon Brown, French President Nicolas Sarkozy, and German Chancellor Angela Merkel)
played a major leadership role in coordinating policies and convening meetings in which
immediate rescue actions as well as principles for solutions and proposed policies were
addressed. The end-of-term status of President George W. Bush may have contributed to this
situation, and President Obama made his international debut at the April 2009 London Leader’s
Summit. It appears that other nations are according the Obama Administration room for a “fresh
start.”
The global financial crisis also has enabled countries with large currency reserves, such as China
and Japan, to assume higher profiles in world financial circles. Americans are unaccustomed to
being lectured to by Chinese officials, but on several occasions Chinese officials have publicly
blamed the United States for causing the current crisis. Many contend that the crisis has
undermined U.S. credibility on economic issues and may make it harder for Washington to induce
China to continue to reform its economy, especially its financial system. In addition, Chinese
officials have expressed strong dissatisfaction over suggestions by some U.S. analysts that
China’s economic policies (such as its large purchases of U.S. debt securities) were a contributing
factor to the U.S. subprime mortgage bubble.72 For the Obama Administration and Congress,
bilateral relations with Beijing are likely to be a challenge and require close attention and skill in
managing communications and relations with the Chinese leadership. At the London Summit,
President Obama accepted an invitation to visit China in the second half of 2009.73
China’s large holdings of U.S. Treasury securities ($696 billion as of December 2008) pose a
dilemma for U.S. policymakers. On one hand, Chinese purchases of U.S. debt have helped fund
the U.S. budget deficit and has helped keep U.S. interest rates relatively low. However, much of
the approximately $2 trillion in stimulus spending, troubled asset recovery, capital injections,
mortgage restructuring and other U.S. programs will likely be financed by additional borrowing.
China, which is the world’s largest holder of foreign exchange reserves (at nearly $2 trillion), will
likely be a major purchaser of this new debt. When Secretary of State Hillary Clinton visited
China in February 2009, she expressed her appreciation for the Chinese government's continuing
confidence in the U.S. Treasury securities.74 Many analysts have warned that increased Chinese
ownership of U.S. debt could enhance its political leverage over the United States. For example,
China could threaten to suspend or limit future purchases of U.S. Treasury securities or threaten
to liquidate its current holdings, which could further undermine the U.S. economy. Such action,
however, could also reduce the value of China’s investments, not only in U.S. Treasury securities,
but in other financial instruments and in the U.S. economy.
China’s presence at the multilateral negotiating table also could complicate the process of
policymaking. China’s policymakers have a strong domestic focus, and the country has a
relatively short history of cooperating with international bodies in consensus decision-making. At
the United Nations, China has used its Security Council veto power to block some U.S. and
72

U.S. Joint Economic Committee, “Chinese FX Interventions Caused international Imbalances, Contributed to U.S.
Housing Bubble,” by Robert O’Quinn. March 2008; Wang Yu, The U.S. is the Cause of the Financial Crisis. China
Cannot Be Blamed , Xinhuanet, China, translated By Eugene Tan, and Edited by Louis Standish, printed in Watching
America, http://watchingamerica.com/News/18092/zhang-jianhua-us-is-cause-of-financial-crisis-putting-responsibilityon-china-cannot-be-justified/.
73
"Obama accepts invitations to visit China, Russia," Associated Press, April 1, 2009.
74
Hillary Rodham Clinton, Toward a Deeper and Broader Relationship With China, Remarks With Chinese Foreign
Minister Yang Jiechi , Beijing, China, U.S. Department of State, February 21, 2009.

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European initiatives. China’s own financial regulatory system is still developing, and its stances
on global financial oversight and regulation are only in the process of being formed. But China
clearly seeks a voice in the discussion. In 2009, Zhou Xiaochuan, the governor of the People's
Bank of China (China’s central bank), proposed reforming the international monetary system by
replacing the dollar as a reserve currency. 75 China’s financial weight could provide the potential
for it to play the United States off against others, including Europe and Japan, in multilateral
discussions of financial regulation. This could make finding a consensus more difficult at the G20 level. China also is actively seeking to take a larger role in activities of the IMF and other
multilateral financial institutions.
As for Japan, it is lending $100 billion to the International Monetary Fund and has been active in
moves to create an Asian Monetary Fund and other monetary arrangements in Asia to counter the
effects of currency crises. 76 This is despite the fact that the Japanese economy is in recession, the
government is deeply indebted, and the country seems to be losing international financial and
political clout to China.
The financial crisis and flight to dollar assets for safety also have revived discussion of the role of
the U.S. dollar as a reserve currency. The international role of the dollar not only allows the
United States to run trade deficits without the currency depreciation faced by most other nations,
but the international role of the dollar is a factor in U.S. global influence. Russia’s Prime Minister
Putin has called over-reliance on the dollar “dangerous” and has proposed the development of
multiple, regional reserve currencies in addition to the dollar.77 Joseph Stiglitz, a Nobel laureate in
economics, has advocated the development of a global reserve currency based on a basket of
currencies to reflect the multi-polar world of today. 78 China also has joined the voices arguing for
a creation of a new currency to eventually replace the dollar as the world's standard.79 Although
such proposals are far from being implemented, a decline in use of the dollar as a reserve
currency could make it more difficult for the United States to finance its budget and trade deficits,
and if the value of the dollar fell, this would reduce the buying power of U.S. companies
investing abroad and the purchasing power in other countries of U.S. budgeted funds for
diplomacy, aid, security operations, and other foreign activities.
The recession in the United States and elsewhere also may hamper efforts to reach agreement on
international issues such as climate change. A new climate change agreement may require
sacrifice, and the willingness of either Americans or others to make sacrifices in the current
environment (and our ability to convince China, India, and others to do so) may limit the range of
possible outcomes.
In addition, U.S. trade and foreign investments are key components of American soft power. At a
time when U.S. policymakers are turning toward the use of soft power (or what is sometimes
termed “smart power”80), if U.S. companies are perceived as reducing their overseas business
75

Zhou Xiaochuan, Reform the International Monetary System, Peoples' Bank of China, March 26, 2009, pbc.gov.cn
available at [http://news.xinhuanet.com/english/2009-03/26/content_11074507.htm].
76
Ulrich Volz, "Asian Monetary Fund, Take Two," Far Eastern Economic Review, June 18, 2008, Internet edition;
"IMF close to finalizing $100 bil. loan from Japan: Strauss-Kahn ," Kyodo News, February 2, 2009.
77
"Putin Speaks at Davos," The Wall Street Journal, January 28, 20009, online version.
78

Joseph Stiglitz, "Europe's leaders can seize this opportunity to fill the leadership gap," The Daily Telegraph,
November 11, 2008, p. 7.
79
Andrew Batson, "China Takes Aim at Dollar ," The Wall Street Journal, March 29, 2009, Internet edition.
80
Luigi R. Einaudi, U.S. Smart Power in the Americas: 2009 and Beyond, Institute for National Strategic Studies,
(continued...)

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activities because of the global financial crisis, this could cause a drop in perceived U.S.
importance in overseas business communities and could also lower U.S. diplomatic interest in
countries of lesser importance to U.S. businesses.

Effects on Supranational Financial and Economic Organizations
The financial crisis has brought international financial organizations and institutions into the
spotlight. The issue here is threefold. First is how much sovereignty to yield to the International
Monetary Fund, Financial Supervisory Board, Bank for International Settlements or other such
organizations in devising macroprudential regulations for the world financial system that would
identify signs of problems that could engulf entire economies. For example, how much authority
should the IMF have to compel countries to implement policies to reduce the risk of a systemic
financial failure? A second aspect of the issue deals with how much additional capital member
countries should provide to the IMF, World Bank, and other global lenders. The third aspect is
governance of the institutions. Given the increasing role of China, India, and other new members
of the G-20 in the financial crisis, should they also have a commensurately larger role in the
governance of the international financial institutions?
The economic crisis has highlighted the inter-connected nature of the global financial system and
the rapidity with which a financial crisis in one country crosses borders and spreads across
manufacturing, retailing, and other sectors. It also has raised the importance of having an
international early warning system and some institution that can assess systemic risk occurring
across countries and across financial sectors and take measures to stem world financial problems
before they become too costly and reach the catastrophic level. It has become apparent that
remedial and recovery measures, both on macroeconomic and microeconomic levels, need to be
coordinated. On the macroeconomic level, one country can “free ride” on a stimulus package by
another economy through increased demand for its exports. On the microeconomic level, the
forces of international competition drive business activity away from overregulated or high-cost
financial centers. If, for example, financial institutions in New York are more restricted than those
in London, financial deals may simply migrate from the United States to the U.K.
The major international organizations dealing with the financial crisis include the International
Monetary Fund, the Financial Stability Forum, the Bank for International Settlements, the World
Bank, and the G-20. Several other organizations also play a role in coordinating policy among
nations. Some leaders have called for a Bretton Woods II agreement that would remake the
international financial architecture that was created in 1944 centered around the IMF and World
Bank. 81 Some of the questions being addressed include whether the major role of the IMF should
be informational, advisory, and technical, or should it have enforcement authority? For example,
if the IMF finds that a country is teetering on the brink of a financial crisis, what can and should it
do proactively to lessen the risk that the crisis actually occurs? Any public action could be the
trigger that would start such a crisis, but quietly discussing the issue with national authorities
without any enforcement authority is rarely sufficient to spur corrective actions that may be
politically unpopular. Also, should any enforcement be done through a dispute resolution process,
through rules similar to those that the European Union requires of its members, or should the IMF
(...continued)
National Defense University, Presented at a conference U.S. Smart Power In The Americas: 2009 And Beyond at the
Center for Strategic and International Studies, Washington, DC, February 11, 2008.
81
Gerstenzang, James. “Bush will Meet with G-20 After Election,” Los Angeles Times, October 23, 2008.

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or other international institution be ceded oversight and regulatory authority by national
governments?82
The IMF, Financial Stability Forum (now Financial Stability Board), and the Bank for
International Settlements already have made recommendations for changes in regulations for
member nations. Each is contributing to the G-20 process to devise policies for nations to adopt.
Countries, however, have been slow to implement regulatory changes previously recommended.
Traditionally, the U.S. Treasury and other financial regulatory agencies, not the State Department,
interface with these international financial organizations. As can be seen with the global financial
crisis, however, financial foreign policy can have as large an impact on international relations and
world stability as traditional political and security policies.
At the London Summit of the G-20, the leaders agreed to boost the IMF's reserves to around $500
billion through bilateral borrowing from members and also from borrowing in world financial
markets (much as the World Bank already does). There appears to be consensus that the IMF
lacks the necessary financial resources to tackle the problems of struggling countries, with
particular concern about Eastern Europe. The G-20 leaders also agreed to provide the World Bank
and other regional development banks with extra funds.

Effects on Poverty
In a February 2009 commentary, Dominique Strauss-Kahn, Managing Director of the IMF, noted
that during the financial turmoil attention has been focused on the advanced and emerging-market
economies that are most immediately affected, but, in his opinion, the impact on poor countries is
far more severe. 83 He pointed out that weak global growth is shrinking export markets, and many
commodity prices are plunging. The combination of tighter credit conditions in the advanced
economies and dimmer economic prospects in low-income countries is reducing investment
flows, while workers' remittances, which now eclipse aid as the largest financial flows to many
low-income countries, also are falling.
Even though the poorest countries in the world, many in sub-Saharan Africa, are less integrated
into global capital markets than the advanced industrial nations or emerging economies in Eastern
Europe, the global economic crisis is affecting standards of living and is expected to lead to
higher levels of global poverty. Many argue that the impact on poverty also may be most felt in
the large, middle-income countries such as China and India, the world’s two most populous
nations, and not just in the least developed countries. Over the past two decades, the largest gains
in raising people out of poverty have been made in these two countries. For several years China
has averaged economic growth rates of 10% or higher, while India has grown at 8% or more per
year. The World Bank estimates each one percentage point drop in world economic growth could
trap another 20 million people in poverty. 84 In 2008, global growth was an estimated 2.5%. For
82

For further information on the IMF, see CRS Report RS22976, The Global Financial Crisis: The Role of the
International Monetary Fund (IMF), by Martin A. Weiss
83
Dominique Strauss-Kahn, The World Must Not Forget Africa During This Crisis, A Commentary by Dominique
Strauss-Kahn, Managing Director, International Monetary Fund, February 10, 2009.
84
“Global Financial Crisis: Responding Today, Securing Tomorrow,” Background Paper prepared by the World Bank
Group, G20 Summit on Financial Markets and the World Economy Washington, D.C., November 15, 2008.
http://web.worldbank.org/WBSITE/EXTERNAL/NEWS/
0,,contentMDK:21972885~pagePK:64257043~piPK:437376~theSitePK:4607,00.html

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2009, growth is expected to drop by three percentage points or more.85 In February 2009, China
reported that about 20 million of the nation’s 130 million migrant workers already had become
unemployed. 86
The impact of the global crisis is transmitted to the poorest countries through several channels.
These include:
•

Declining exports. In Pakistan, for example, textile exports fell by 4.1% year-onyear in December 2008. The textile sector represents approximately two-thirds of
Pakistan’s total export revenues.

•

Declining commodity prices. Because many of the poorest countries are heavily
dependent on a few primary export commodities, rapid swings in commodity
prices can wreak havoc on their domestic economy. Yemen, for example,
announced in January that it would have to decrease public expenditures by 50%
because of the financial crisis and the lower government revenues from its oil
exports.

•

Migration and remittances. The combination of slow growth rates, job losses, and
the rising cost of living in advanced countries has led to fewer economic
migrants from developing countries and lower levels of remittances. This could
have major effects in countries which provide large numbers of migrant workers,
including Mexico, Guatemala, El Salvador, India, Bangladesh, and the
Philippines. The volume of remittances soared over the past decade, but recent
data show significant deceleration since the beginning of the current crisis, with
Latin America and Caribbean the hardest hit. The Inter-American Development
Bank calculates that remittances to the Latin American and Caribbean region
declined by 1.7% between 2007 and 2008.

•

Lower levels of foreign assistance. Research from previous incidences of
economic crisis suggests that foreign aid from developed to poor countries is
likely to decrease.

•

Diminished capital flows. Although some progress has been made in developing
capital markets in poor countries, they are still perceived as risky. Global credit
has tightened across the world, especially among the developing countries. This
has lead to a sharp contraction in capital flows to developing countries as well as
restrictions on the availability of trade finance. The inability of developing
country governments to raise money on international capital markets will likely
have a sharp impact on government budgets, reducing the amount available for
poverty reduction programs.

Once the global recession is past, estimates of declines in long-term poverty are encouraging.
Over the medium term, economic growth rates may still be higher than they were in the 1990s
due to macroeconomic policy improvements and structural reforms such as privatization and

85

International Monetary Fund, Global Economic Slump Challenges Policies, World Economic Outlook Update,
January 28, 2009.
86
Keith Bradsher, "China’s Unemployment Swells as Exports Falter," The New York Times, February 6, 2009, Internet
edition.

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regulatory initiatives within developing countries.87 This depends, however, on how quickly and
fully the world economy can recover.

Budgetary Effects on Resources for Aid, Diplomacy, and Defense
The decline in government tax revenues caused by the slowdown in economic activity and the
stimulus programs and automatic economic stabilizers (increased spending for unemployment
compensation and welfare) are increasing competition within countries for scarce budget funds
and affecting decisions about the allocation of national resources. Budget battles, already intense,
have become even more heated as the global financial crisis has spread.88 This could result in
fewer resources available for foreign assistance, diplomacy, and defense. 89
A policy brief by the United Nations Conference on Trade and Development on flows of official
development assistance (ODA) stated the following:
The current recession, and some of the stimulus measures being introduced to combat it, is
compounding budget deficits and budget reallocations in many donor countries. ODA is a
soft target in such situations; during past banking crises, it has dipped anywhere from 20% to
40%. A recent study found that the crises affecting Finland, Japan, Norway and Sweden in
the 1980s-1990s were all followed by a substantial decline in foreign aid, ranging from 10%
in Norway to 62% in Finland. Furthermore, ODA levels tend to recover very slowly–in
Sweden’s and Norway’s case, six-to-nine years after the trough, according to the same study.
Finnish and Japanese aid flows, meanwhile, have yet to return to their pre-crisis peaks.
Given the depth of today’s crisis, the recovery period is likely to be similarly long.90

In the United States, official development assistance to poorer nations and other programs aimed
at alleviating poverty now are competing for funding in a budget deep in deficit.91 The large
expenditures to provide stimulus to the U.S. economy could clash with some early foreign policy
priorities of the new Administration. President Obama and top officials in his Administration—
including Secretary of State Clinton and Secretary of Defense Gates—have pledged to increase
the capacity of civilian foreign policy institutions and levels of U.S. foreign assistance. Early
pledges have included: a 25% increase in Foreign Service staffing; doubling of U.S. foreign
assistance spending to $50 billion by 2012 (or slower increases if the current economic crisis
continues); and increased funds for global health programs.
Although some efficiencies may be found in revamping foreign policy-related programs and/or
improving policy coordination, one incoming State Department official emphasized outright that
“we will need additional resources” to achieve foreign policy goals.92 Financial constraints could
impose difficult choices between foreign policy priorities—for example, between boosting levels
87

Ibid, p. 49.
Jim Snyder, "Budget battles loom as Obama team heads to Hill," The Hill, March 1, 2009.
89
See, for example, Richard Haass, Statement of Richard N. Haass, President of the Council on Foreign Relations,
Before the Committee on Armed Services, U.S. House of Representatives, Washington, DC, March 11, 2009.
90
United Nations Conference on Trade and Development, Keeping ODA afloat: no stone unturned, UNCTAD Policy
Brief, No. 7, March 2009.
91
For details of the FY2009 appropriation, see CRS Report RL34552, State, Foreign Operations, and Related
Programs: FY2009 Appropriations, by Susan B. Epstein and Kennon H. Nakamura.
92
Testimony of Jacob Lew, U.S. Deputy Secretary of State nominee, U.S. Senate Committee on Foreign Relations,
January 22, 2009.
88

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of non-military aid to Afghanistan and increasing global health programs–or changes to planned
levels of increases across the board. The global reach of the economic downturn further
complicates the resource problem, as it both limits what other countries can do to address
common international challenges and potentially exacerbates the scale of need in conflict areas
and the developing world.
The budget constraint also could affect the resolution of issues such as the North Korean (DPRK)
nuclear threat. Under agreed-upon requirements under the Six Party Talks, if the DPRK complies
with its commitments, the United States is to provide more energy and other assistance. In
addition, Japan and South Korea, two countries hit hard by the financial crisis, would have to
budget funds for aid to North Korea.93
U.S. defense expenditures also face similar budget debates.94 Addressing U.S. security needs
under the financial crisis is beyond the purview of this report, but one analysis indicates that the
security threat from the crisis is likely to manifest itself in several distinctive ways.
•

It will create major pressures on the defense budget, most notably acquisition—
that is, the procurement and research and development accounts.

•

It will likely result in a contraction of defense spending, and therefore operations
as well and modernization, on the part of key allies and friends.

•

It could prompt nations that are ambivalent about their relationship with the
United States, most notably China and Russia, to act in ways that are deleterious
to American interests.

•

It could prompt even more hostile behavior on the part of nations such as Iran
and Venezuela that already bear deep antipathy toward the United States.

•

It could further destabilize states that are already vulnerable to internal unrest.

•

It could spur further international criminal behavior that could undermine internal
American security. 95

93
See CRS Report R40095, Assistance to North Korea, by Mark E. Manyin and Mary Beth Nikitin; CRS Report
RL33567, Korea-U.S. Relations: Issues for Congress, by Larry A. Niksch.
94
For information on the FY2009 defense authorization, see CRS Report RL34473, Defense: FY2009 Authorization
and Appropriations, by Pat Towell, Stephen Daggett, and Amy Belasco.
95
U.S. Congress, House Committee on Armed Services, Hearing on Security Challenges Arising from the Global
Financial Crisis, Statement by Dov S. Zakheim, "Security Challenges Arising From the Global Economic Crisis," 111th
Cong., 1st sess., March 11, 2009.

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The Global Financial Crisis: Foreign and Trade Policy Effects

Author Contact Information
Dick K. Nanto, Coordinator
Specialist in Industry and Trade
dnanto@crs.loc.gov, 7-7754

Martin A. Weiss
Specialist in International Trade and Finance
mweiss@crs.loc.gov, 7-5407

Julie Kim
Section Research Manager
jkim@crs.loc.gov, 7-3692

J. Michael Donnelly
Information Research Specialist
mdonnelly@crs.loc.gov, 7-8722

James K. Jackson
Specialist in International Trade and Finance
jjackson@crs.loc.gov, 7-7751

Raymond J. Ahearn
Specialist in International Trade and Finance
rahearn@crs.loc.gov, 7-7629

J. F. Hornbeck
Specialist in International Trade and Finance
jhornbeck@crs.loc.gov, 7-7782

William H. Cooper
Specialist in International Trade and Finance
wcooper@crs.loc.gov, 7-7749

Wayne M. Morrison
Specialist in Asian Trade and Finance
wmorrison@crs.loc.gov, 7-7767

Ian F. Fergusson
Specialist in International Trade and Finance
ifergusson@crs.loc.gov, 7-4997

Ben Dolven
Section Research Manager
bdolven@crs.loc.gov, 7-7626

Congressional Research Service

29