(Shutterstock)
(Shutterstock)

Imagine you live on one side of a river and work on the opposite bank. Your daily commute takes you several hours because the nearest bridge is miles away. A new bridge built closer to home would save you time, money and considerable aggravation. As unrealistic as it may be, assume that the bridge can be designed such that it will never be congested, regardless of how many people use it.1

Now, if the government proposed to finance the new bridge based on some fraction of the value that individuals put on having a new crossing, what value would you report? Most people, knowing the mapping between valuation and financial assessments, would probably dissemble and say that they don't attach much value to a new bridge. When the government tallies up the financial contributions based on individuals' valuations the bridge looks decidedly un-economic. As a result, the bridge isn't built, despite the fact that it could save everyone all that time, money and aggravation and on pure economic (value of time) grounds should be built.

Public choice theorists refer to this dilemma as the preference revelation problem. It arises because of the incentive to free ride: an individual, thinking that his preference is too small to affect the outcome, believes that if others reveal their true preference, the bridge will be built without the need for his contribution. He opts to free ride on the willingness of others to pay for the new crossing. Of course, all individuals thinking the same way results in the decision not to build the bridge, in which case everyone is worse off than if the bridge were built. In practice, however, public goods are financed through coercion — taxes levied by the state — and not through contributions based on individuals' valuations.

While it may be a bit of stretch, this elementary, albeit somewhat contrived, scenario illustrates an important point regarding the design of international architecture. Rules of the game must be enforced, otherwise there really isn't any point. But "enforcement," which probably conjures up images of gunboat diplomacy, doesn't necessarily entail the use of coercion. It could, equally, be achieved through the capitalization of an international institution together with the periodic provision of preferential trade access, debt forgiveness, loans and subsidies, etc. And, regardless of its form, enforcement broadly defined is costly and the country, or group of countries, providing it must be compensated for these costs.

This is relatively straight forward when there is one clearly dominant player (the "hegemon") with the financial wherewithal to unilaterally enforce the rules of the game. The U.K. in the heyday of the gold standard in the late 19th century, and the U.S. in the Bretton Woods era are examples. In both cases, the costs of enforcing the rules and providing the public good of international financial stability were recouped from growth and trade opportunities that the architecture provided, as well as the seniorage from issuing the global reserve asset.

Unfortunately, things can become more complicated when other countries assume a growing share of global output. Under these conditions, a failure to accept responsibility for enforcing the "rules of the game" can result in the free riding problem associated with the preference revelation problem and the (under)provision of public goods. This, arguably, helps explains the tragic consequences of mis-managed transition from "Pax Britannia" to "Pax America" in the 1920s-1930s. As Charles Kindleberger trenchantly observed, in 1920s the Bank of England couldn't provide the public good of international financial stability, while the Fed wouldn't. The Bank of England "couldn't" because by the 1920s the U.K. had expended vast financial resources in World War I, while it had lost economic ground to the U.S. and the Fed "wouldn't" perhaps because  the U.S. was not prepared to take on obligations and responsibilities commensurate with its enhanced economic position.

Similarly, while the collapse of the Bretton Woods system can be viewed as the natural evolution of the global economy, it could also be attributed to the reluctance of economies that had recovered and regained their place in the global economy to take the responsibilities and obligations of the system.

So, what are the implications of all this on international architecture reform in the 21st century?

The past decade has seen a number of countries "emerge" to assume a larger share of global output. They understandably chaffe under the rules of the game and institutions that they perceive were written and created by and for the major players that dominated the global economy in the mid-20th century. These newly-industrialized countries seek a "voice" in global fora that is proportional to their importance. They should have it, of course. And, in time, they will. But the history of the past century suggests that transitions between regimes can be highly disruptive.

The surest way to ensure that the global economy remains an engine of growth and poverty reduction is for the new dominant players to take on the obligations and responsibilities for making the system work. For this to happen, the former dominant players must be willing to give up the privileged position they currently hold. All of this is underway. But the process is slow and in the meantime big adjustment challenges remain. More progress and a recommitment to the underlying principles on which the architecture rests would provide insurance against the possible "transition shocks" that cloud the outlook in the new age of uncertainty.

1 Economists will recognize that this assumption is required to preserve the formal definition of a public good, as one that is non-rivalrous.

Program
The opinions expressed in this article/multimedia are those of the author(s) and do not necessarily reflect the views of CIGI or its Board of Directors.