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Five years on: The strategic legacy of the financial crisis

Five years on: The strategic legacy of the financial crisis
Published 23 Sep 2013 

Matthew Hill is a doctoral student at Cornell University's Department of Government.

Five years on from the beginning of the global financial crisis, last week’s announcement that the US Federal Reserve would continue it monetary stimulus policy – popularly known as QE3 – has been greeted with almost unanimous enthusiasm across Asian financial markets. Yet this short-term surge obscures widening divisions in economic fortunes for the region’s major powers. A glance at the underlying trends provides cause for concern, not only with respect to the region’s economic trajectory, but its rapid impact on the evolution of the strategic balance over the coming years.

Expectations that Ben Bernanke was preparing to ‘taper’ Washington’s $80 billion-a-month bond-buying spree played a major part in the turmoil observed in emerging Asian markets over the past few months. With the announcement that stimulus will continue, governments and markets are likely to gain some breathing room. Yet the passing of panic does not imply that the region is on track to a return to pre-crisis business as usual.

A glance at the balance sheets reveals substantial structural imbalances in a number of prominent states. A number of them have yet to recover from the damage inflicted over the last five years.

Fiscal balances (%GDP). Source: IMF, World Economic Outlook Update, July 9 2013.


The asymmetry in this picture reflects differences in strength of political leadership. China, Russia, South Korea and Indonesia have all benefited from their higher underlying growth potential, but also from strong political direction.

By contrast, while America’s rebound has graduated from anaemic to underwhelming, its toxic domestic politics have shaped the capacity of the state to deal with underlying fiscal imbalances. Both India and Japan face variations on this challenge: in India, political dysfunction and bureaucratic inertia continues to strangle underlying potential, while in Japan structural economic barriers stubbornly persist despite the heroic aspirations of the Abe Administration. In both cases, increased government expenditures have not served to offset stagnant revenues.

The implications go beyond the domestic economic and political realm. As the chart below suggests, the divergence in the fiscal paths of major regional states is substantially mirrored in their defence spending trajectories. Those states capable of pragmatically adjusting their budgets have also retained scope for increasing defence spending. 

Year-on-year changes in defence expenditure. Source: SIPRI, Military Expenditure Database, 2013.

While the relationship between state finances and military capacity is hardly determinative, it does suggest three blunt insights into the future evolution of the strategic balance in the Asia Pacific.

Firstly, while overall US military expenditure remains substantial, present trends suggest a rapid attrition of its lead. This trajectory is the font of regional scepticism regarding the implications of the Obama Administration’s much-heralded ‘pivot’ to the region. While commentators have obsessed over the impact of the Administration’s handling of Syria on US credibility, the reality is that constant congressional willingness to play chicken with the economy is vastly more damaging to Asia Pacific assessments of Washington’s capacity for strategic commitment.

Second, it is notable that Russia and China dominate the list of beneficiaries of fiscal-military dynamics, while their potential counterweights, Japan and India, look set to lag behind. This complicates the ability of the US to step back from the region towards a role as ‘offshore balancer’, since such a role implies a higher level of strategic engagement by US partners than they appear capable of. 

Third, the evolution of strategic and fiscal dynamics is notable for its outliers. Two major US partners who appear to be in a fiscal position to increase their defence spending (South Korea and Australia) have so far chosen not to. With respect to the latter, the inauguration of the Abbott Government may indicate a shift towards more robust expenditure, but that is far from certain. 

The behaviour of both Canberra and Seoul may reflect a tacit acceptance of the limits of their strategic potential relative to regional behemoths. If so, the scope for strategic engagement in support of regional stability may be rapidly shrinking.

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