From: Susan Ariel Aaronson, Global Policy Innovations Program, More from this Affiliate
Published October 30, 2008 10:35 AM

Financial Crisis Hurts U.S. Soft Power

John Maynard Keynes, the most famous economist of the 20th century, had an evocative image of capitalism. He once said that markets were propelled by animal spirits. These spirits can yield growth, but at times they act out of panic rather than reason. They therefore must be domesticated to ensure that the law of the jungle does not apply.

Today's real world financial crisis provides an opportunity to teach the wisdom of dead economists, and I thought Keynes's insights would resonate with students in my graduate class on trade. I hoped to use the class to explain how the U.S. model of financial capitalism influences global capitalism and why that model has broken down.

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Many of my students come from foreign countries and have strong opinions about America's role in the world. As the discussion continued, I realized that the financial crisis would have an additional unforeseen effect. The United States could lose much of its ability to influence the behavior of other nations without using coercion or force—so-called soft power. Much of that soft power is rooted in U.S. economic prowess.

First, America's global standing is, to a great extent, reflective of how it projects its power, relates to other countries, and keeps its commitments to them. If the global financial meltdown makes life worse for the world's poor, many people may link the U.S. model of democratic capitalism with global misery. They may be less receptive to economic and political strategies presented by U.S. diplomats and NGOs. Meanwhile, the financial crisis will make American taxpayers less able to provide generous levels of foreign aid to help the world's poor.

Second, although many countries will be desperate for investment, U.S. investors could come under considerable pressure to create jobs at home. U.S. tax policy is likely to favor domestic job creation and investment in the U.S. market. Meanwhile, U.S. investors may be less welcome abroad than, for example, Chinese or Indian investors—Americans and Europeans are more likely to demand transparency, accountability, and human rights.

Finally, the United States, like the European Union, has long used the incentive of its large market to prod other nations to change their behavior. With a shrunken economy, America will be less able to use trade policy to advance good governance. For example, the U.S. preference program that benefits some 140 developing countries requires participants to protect labor rights and improve the rule of law. In recent years, the United States used free-trade agreements with Oman, Jordan, and Bahrain to promote democracy and good governance in the Middle East; and used a trade ban with South Africa to encourage the end of apartheid.

As my students and I discussed, this worst-case scenario may not happen. The United States will choose a new president in November. Global markets will likely view the end of the Bush administration as a clean start. If the next president puts forward an effective strategy for regulating capital markets, markets could become more optimistic.

The next U.S. president is also likely to address climate change and adopt a different approach on energy. Both candidates have made development assistance a top priority, in recognition of the connection between human security and conflict. By bringing new ideas to the world stage, America's next president will begin his administration with considerable good will. Over time, such good will could spark a sustainable stock market rally and renewed demand for goods and services.

Our class discussion ended on an optimistic note. Keynes lost a fortune in the Great Depression, but managed to remake his fortune in the years following World War II. In his triumph there may be lessons for the United States. The current crisis may well be the end of America's leadership of the global economy—but not necessarily. By working with other nations and building new institutions of governance, America could reinvigorate its influence.

Susan Ariel Aaronson is Associate Research Professor at George Washington University and author of six books on globalization, including Trade Imbalance: The Struggle to Weigh Human Rights in Trade Policymaking (Cambridge, 2007).

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