The G7 and Concert Governance
in the Global Financial Crisis of 199799

John Kirton, G8 Research Group

Paper prepared for the annual conference of the International Studies Association, March 15-19, 2000, Los Angeles. I gratefully acknowledge the financial support of the Social Science and Humanities Research Council of Canada.

Abstract

Existing explanations of the effectiveness of the G7 as an international institution, based on realist and liberal-institutionalist premises, largely emphasize the role of United States leadership and of established international organizations such as the International Monetary Fund in serving as a lender of last resort and performing other hegemonic functions to stave off systemic crises, and in exercising intellectual, policy and structural leadership to reform and construct international regimes.

Yet an analysis of G7 and IMF behavior during the global financial crisis of 1997-9 reveals that a now vulnerable America and a rules and resource constrained IMF both depended upon the G7 to mount an effective crisis response and regime reconstruction effort. Here the G7 operated as an effective international concert, in which lesser member such as Canada and Britain were able to play leadership roles and assemble fluid coalitions to importantly determine G7 outcomes and thus the shape of the new international financial architecture.

Contents:

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Introdution

The global financial crisis of 1997 to 1999 represented the most severe threat to the international economic order in the second half of the twentieth century. Beginning in Asia in the summer of 1997, the crisis spread a year later to post-Communist Europe, and by the autumn of 1998 to the Americas, both South and North. With remarkable destruction and contagion, it threatened to destroy the hard-won prosperity of the Asian "tiger" economies and with it the world's confidence in the model of an open, export-oriented, market-based approach to economic development that had gained widespread global acceptance in the 1990s. With the devaluation and default of Russia in August 1998, the crisis further imperiled a striking achievement of the international community in the 1990s - the peaceful transformation of once-Communist Russia into a democratic polity and market economy to which real measured growth had at long last returned. Most importantly, with the September 1998 collapse of the US hedge fund Long-Term Capital Management (LTCM) and the imminent freezing of the US credit system, the crisis came to the brink of crippling the world's most powerful economy, at the peak of its most prosperous overall performance ever.

Containing this crisis and constructing a new international financial architecture in its wake were the central challenges the international community faced as the twentieth century closed. Reconstructing the international financial system for a new era of intensifying globalization had first been identified as a priority task, well before the 1997-99 crisis erupted, at the conclusion of the 1994 G7 Summit in Naples. Here US President Bill Clinton proposed, with the support of Canadian Prime Minister Jean Chrétien as 1995 host and other colleagues, that the next Summit focus on meeting these challenges of global governance in the twenty-first century. Within a year, the meltdown of the Mexican currency and economy offered an acute example of the costs that open globalized finance combined with poor national policy could bring. It also brought another instance of the United States leading, with the support of North American partner Canada and more distant G7 partners, to mount a successful response and one that left most participants and observers confident the existing reforms to the international financial system were sufficient for the new age (Kapstein 1996a).

This portrait of a US uniquely willing and able to lead seemed to provide a successful formula for coping with any financial crises to come. The decade-long rise of the United States, in the wake of the European Cold War's end and a globalizing world, as the world's only "superpower", also offered a model for system reconstruction, inspiring President Clinton, at the 1997 Denver Summit, to recommend to his G7 partners and the world that they adopt the American way (Bayne 1997, 2000). Prolonged economic stagnation in Japan and major structural problems in the German and other European economies widened the once steadily narrowing gap in gross domestic product (GDP) between the United States and its leading economic rivals (Kirton 1999a, Fry et al. 1998). And at the bottom of the G7's hierarchy of relative capability and status, Canada, afflicted by recurrent national unity challenges, sluggish productivity growth, and a declining currency, also saw the gap with the neighboring US increase.

The Asian financial crisis, which erupted in Thailand in July 1997 only a few weeks after the Denver Summit, at first appeared ready to unleash the familiar dynamic of American hegemonic leadership. A uniquely powerful and prosperous United States stood able to act as the sole international lender of last resort. A weak and paralyzed Japan formed part of the problem. A self-absorbed Europe seemed unconcerned with a distant regional difficulty. And a relatively small, very open, commodity-intensive and hence vulnerable Canada braced itself for the assault on its markets and currency that the Asian crisis would bring (Kindleberger 1998 Rowlands 1999, IMF 1998).

This portrait proved to have some accuracy as the Asian-turned-global financial crisis unfolded over the following two years. The always formidable capacity of the US for structural leadership was increased as the league-leading growth in the US economy, relative rise in the value of the US dollar (propelled by capital inflows into the safe haven of the US economy), and America's leading role as a globally stimulating "spender-of last resort" proved to be powerful assets for it in the bargaining to come. Indeed, from 1997 to 1998, the US share of G7 GDP in current US dollars rose from 39.9 percent to 42.4 percent. The similarly valued GDP of the major G7 members that could provide the US the "strong second" called for in the modified American leadership model of G7 co-operation all declined relative to the U.S. (Putnam and Bayne 1987, Kirton 1999b). Japan fell from 62.1 percent to 51.6 percent of the US total, Germany from 30.2 percent to 26.8 percent, France from 19.8 percent to 18.5 percent, and Italy from 15.0 percent to 14.7 percent. During the following two years, US leadership and success were, not surprisingly, regularly evident, as the US, at times with the traditional strong seconds, prompted the IMF to lend to the three embattled Asian economies in 1997, to Russia in July 1998, and Brazil in the autumn of 1998. It further appeared in the Americans' initiative in establishing the G22 at the APEC leaders meeting in November 1997, in creating the IMF Supplementary Reserve Facility in December 1997, and in the US role in ensuring private banks rescheduled Korean debt during the Christmas holidays in 1997. The US President and Federal Reserve also moved swiftly with a bold vision and interest rate cuts in the dangerous early autumn of 1998, and succeeded in securing a new IMF-based Contingent Credit Line (CCL) in the following months. The American impact was further felt in transforming the G22 into the G20, beginning with the IMF's endorsement of the concept in October 1999, and on the new ideas and procedures for transparency, regulation, and crisis management.

Yet, as the crisis compounded, this familiar portrait of unique American leadership proved to be incomplete, inaccurate on several important occasions, and inadequate as an account of describing how and why the G7 successfully led the international community and its major international institutions into producing a substantially successful, if often slow, response. From the outset of the crisis, the United States and the multilateral organization it traditionally dominated, the IMF, were at important moments significantly constrained. These constraints on US leadership were due most immediately to the difficulty US policymakers and IMF leaders had in abandoning the deeply held, long-successful neo-liberal model or "Washington consensus" that a contagious globalization was now rendering less effective (Kapstein 1996b). They were due more deeply to the limitation on structural leadership flowing from domestic politics - the reluctance of a suspicious US Congress to authorize the US share of the IMF quota increase that would give the institution the funds needed to combat the burgeoning crisis. Most importantly, as the crisis continued, ultimately to threaten the financial system of the American "Goldilocks" economy itself, the mania of the private markets newly liberated by globalization revealed an equally vulnerable America, genuinely dependent upon the concerted action of the other major market democracies in the G7 (Kirton 2000).

An apparently ascendant America, now rendered vulnerable alongside the other G7 members by intensifying globalization, required collective G7 action through mutual adjustment on zero-sum issues and convergent and common contributions in the larger positive-sum domain. This enabled effective influence and leadership, at different times and on different issues, to come from any, even the least powerful, G7 partner. At a time when Japan was inhibited by an unprecedented decade-long stagnation and acute recession, when a slow-growing Germany was absorbed by the prospect and reality of an historic electoral realignment, and when its continental European neighbors were preoccupied with the launch of the new Euro single currency, it was often left to Britain and Canada to play consequential catalytic and influential roles. Their ability and willingness to do so were underscored by their position, however modest, as the only two G7 members to have their relative capability, conceived as GDP in current US dollars, increase relative to the U.S. from 1997 to 1998 (with Britain's rising from 15.9 percent to 16.0 percent and Canada's from 7.6 percent to 7.7 percent). In the case of Tony Blair's Britain, the legacy of its longstanding role as a global hegemon past, the continuing relevance of London as one of the world's leading financial centers, and Britain's transatlantic orientation, offered natural advantages for a Britain able and willing to lead and to stay the course to a successful conclusion (Kapstein 1994, Fraser 1998). In the case of Canada, however, the very lack of league-leading history and issue-specific financial capabilities highlighted how the institutional character of the G7, as a concert of effective equals, allowed even the least capable country to play, under the new circumstances of the late 1990's, a consequential leadership role.

Specifically, Canada, along with Britain, the United States, and other G7 members, acted successfully as an effectively equal "principal power" within the institutional confines of the G7. Canada displayed intellectual leadership by offering, along with most other G7 members, comprehensive programs and initiatives for coping with the crisis and defining a new international financial architecture (Eichengreen 1999, Council on Foreign Relations 1999, Kaiser, Kirton and Daniels 2000). Canada's leadership, first apparent at the Halifax Summit in 1995, continued with its peer supervision plan and "roadmap" concept in the spring of 1998. It culminated with a Six Point Plan of 29 September 1998 and debt-relief plan of March 1999.

Moreover, Canada, along with its partners, mounted policy leadership by identifying in advance, and consistently pursuing to ultimate success, distinctive positions based on specific Canadian interests, values, and experience. In place of the inflation-fighting, fiscal-consolidating, neo-liberal stance that dominated G7 policy in the previous two decades, Canada individually or jointly pioneered the push for properly sequenced and controlled capital liberalization, financial system surveillance and peer supervision; private sector burden sharing, social sensitivity in adjustment and debt-relief packages, fiscal stimulus, and enhanced Official Development Assistance (ODA).

Finally, Canada displayed structural leadership by contributing more than its proportionate share, as a member of a G7 concert serving as a collective lender of last resort, to contain the crisis of confidence and contribute to debt relief for the poorest. It contributed multilaterally as a leading member of the IMF, the International Bank for Reconstruction and Development (IBRD), the Asian Development Bank (ADB), the Inter-American Development Bank (IDB), the General Arrangements to Borrow (GAB), and the New Arrangements to Borrow (NAB). It also acted plurilaterally by providing national funds to the Republic of Korea in December 1997, to Thailand in April 1997, and to Brazil in November 1998. Moreover, it joined in cutting interest rates in the autumn of 1998, when the resources of a financially and congressionally paralyzed United States were insufficient to stave off the burgeoning global crisis. And Canada stood ready to provide new ODA to ensure a successful debt-relief initiative at the 1999 Cologne G7 Summit.

Throughout the two years of the crisis, Canada pursued its preferences by combining, not only with traditional, geographically proximate, far more powerful partners, but also with a shifting array of G7 allies on different issues and at different times. Moreover, it often opposed the initiatives of both the United States and Britain. Ultimately, through persistence, skilled concert diplomacy within the G7 club, and changes in international context as the crisis compounded and its effects became clear, Canada had a discernible impact in shaping outcomes in the direction of a more socially sensitive form of globalization.

While Canada's contribution most clearly shows the G7 to be a forum for collective management, in which even the weakest member can influentially lead, Britain's diplomacy during the crisis further sustains this case. Britain, with its global financial centre in London and prerogatives as host of the 1998 Summit, took the lead in several areas, notably in pressing for unrestricted capital account liberalization as a new constitutional principle entrenched in the IMF, and in the push for transparency and comprehensive international codes of conduct for national financial systems. It pioneered the quest for debt relief for the poorest, which, when joined by the new German government of Chancellor Gerhard Schroeder, proved to be a major achievement of the 1999 Cologne Summit. While Britain at times worked in tandem with the US, it was often Britain that moved most rapidly, and often joined with other G7 members against the preferences of the US, as on installing principles of good practice in social policy in the World Bank. And its impact was felt at the end on these issues, and on the architecture of the new Financial Stability Forum (FSF).

The ability and willingness of the United States to lead remained important in shaping the G7's agenda, action, agreement, and ultimately successful impact on the global financial crisis and resulting new international financial architecture. Overall structural and specialized capability still counted, and here the Americans enjoyed an impressive and increasing lead (Keohane and Nye 1989). Yet, in the rapidly globalizing world of the 1990s, capability was joined by an ever more acute vulnerability that afflicted all G7 members more equally, as a factor that was felt and that forced a much more genuine form of collective leadership from the G7. The impact of "intervulnerability" was reinforced by a crisis that was new in its content, contagion, and severity, and by the distinctive norms and institutional procedures of the G7 in response. The new intervulnerability and crisis bred by globalization, and the new concert-based approach to global governance embedded in the G7, had come to reinforce and in important respects replace America's unique hegemonic leadership in guiding the international financial system as the twentieth century came to a close.

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Phase 1: The Asian Crisis of 1997-98

The substantial role that the G7, and Canada and Britain within it, played in countering the 1997 Asian crisis began soon after the 1997 Denver Summit. At Denver itself, amidst its aura of American triumphalism and welcoming of Russia as a virtually equal member of the newly christened "Denver Summit of the Eight", the G7 held only a very short, semi-secret session among themselves "at seven" to discuss serious economic matters. They devoted no time to considering the early signs of the crisis already brewing in Asia (Hajnal 1999). Even their G7 Finance Ministers, who debated financial regulation at some length, did so with no sense of urgency, in keeping with the prevailing assumption that the measures identified at Halifax and those invented in response to the Mexican crisis would suffice (Kapstein 1996a).

When Thailand precipitated the crisis by devaluing its currency in early July, there was little sense of a common or systemic threat. European G7 members, and even the US, saw the issue as a regional Asian responsibility. By August 1997, when a US$17 billion package for Thailand had been assembled, regionally affected Japan was the only G7 member to contribute national funds.

By September 1997, however, when G7 Finance Ministers met in Hong Kong at the time of the semi-annual IMF meeting, they moved decisively to authorize an ambitious array of innovative measures to strengthen the international financial system in the face of such crises. They agreed to a 45 per cent increase in IMF core resources, to amend the Articles of Agreement within the year to make the IMF formally responsible for sweeping capital account liberalization, to strengthen IMF involvement in financial sector reform, to improve national governance by reducing corruption, and to expand the allocation of special drawing rights (SDRs).

In the diplomacy behind the Hong Kong reform package, Canada and Britain acted as equal members of the G7 concert. Here different members, including the least capable, led on specific issues, and all ultimately adjusted to create a new and effective consensus. On the IMF quota share increase, all G7 members combined to persuade a resistant and internally divided US, which feared congressional opposition, to accept at the last minute the 45 per cent addition. On capital account liberalization, the British led, with an initiative adopted by IMF Managing Director Michel Camdessus and supported by the US. Yet, this initiative met with strong opposition from Canada, which succeeded in blunting initial enthusiasm for a blanket grant of authority to the IMF for early unrestricted liberalization. Canada, working with the United States and Japan, made progress on its push, begun at the 1996 Lyon Summit, for banking and financial sector reform. The United States, with Canada in strong support, secured an IMF agreement to discuss governance issues. Canada encouraged the IMF to double the SDR equity allocation and to devote the proceeds to the new members of the IMF. With the US in the lead and Canada in support, the G7 also made it clear that the IMF, rather than any regional support fund proposed by Japan, would remain at the centre of the Asian rescue effort.

Britain's approach at Hong Kong, most evident in its leadership on capital account liberalization, flowed naturally from its current position as one of the world's leading financial centers, and its past success over two centuries in periodically creating and flourishing within an open global financial system. Canada's approach, particularly its strong opposition to capital account liberalization, also derived directly from its distinct interests, values, and experience. Canada's position had been recently developed in its program for international financial institution (IFI) reform as host of the 1995 G7 Halifax Summit, and its experience with the financial crisis that erupted in fellow NAFTA member Mexico on 20 December 1994 (Kirton 1995a, Martin 1997). Both cases reinforced in the minds of Prime Minister Jean Chrétien and Minister of Finance Paul Martin a strong skepticism toward unrestricted capital flows, as allegedly rational markets proved prone to panic in ways that could have enormously destructive consequences for individual citizens and the public good. Martin's skepticism was further manifested in 1996, when he led Canada to allow Chile to preserve its system of limiting the outflow of short-term capital during the first year after its investment in the provisions of the bilateral Canada-Chile free trade agreement forged that year. Spurred by the collapse of Barings Bank in 1995, Martin had also developed a proposal for Halifax for improved supervision of national financial institutions. The concept was extended after Martin participated in a meeting of western hemisphere Finance Ministers in Santiago, Chile, in December 1996, where the core of a proposal for peer supervision through a new international supervisory authority was born.

Behind the specific lessons of Halifax and Mexico lay domestic imperatives and international experiences. The first was a continuing concern with national unity and an acute awareness that separatist forces in Quebec could use a fall in the Canadian dollar or denationalization of the federal government's capacity for financial management to further their cause. The second was the domestic value that Canada placed on equalization, through automatic federal fiscal transfers, to guarantee all Canadians a similar, high-standard social safety net. And the third was a long history of international successes, ranging from Canada's pioneering role with flexible exchange rates as an adjustment device, through its position as a de facto permanent member of the IMF executive board and the G7 Finance Ministers forum, to its attachment to the world's poorest states through its leading position in the Commonwealth and la Francophonie.

These factors continued to exert an impact as G7 decisiveness and Canada's role expanded in response to the spreading crisis during the autumn of 1997. When a support package for a beleaguered Indonesia was assembled, the United States joined Japan as a contributor to a "second line of defense" of national funds, to be deployed if those of the IMF and other IFIs proved insufficient. In November, Canada and its G7 colleagues formalized the second line of defense and moved to ensure that all had the legislative authority to contribute to it.

In early December, the G7 agreed to a support package for the Republic of Korea of US$35 billion from the IFIs, to be reinforced, if necessary, by a second line of defense. To this second line, Japan pledged US$10 billion, the United States US$5 billion, each of the European G7 members US$1.25 billion, and Canada US$1 billion. Shortly after, when the Korean won plummeted, G7 members agreed to activate the second line in return for an agreement from their private banks, pushed by the US and others, to roll over and reschedule their Korean loans. This private sector burden sharing agreement was particularly valuable in light of the difficulty the United States government was having in securing congressional authorization for its share of the IMF quota increase. The United States Secretary of the Treasury, Robert Rubin, who had hoped that the mere existence of a large package with a second line would reassure markets, now agreed with his other G7 partners that American dollars would be forthcoming. The 24 December announcement that national funds would indeed flow proved sufficient to stem the market's assault on the won. No national funds actually had to be expended in exchange markets. G7 governments acting together had beaten panicking markets in this new globalized game of financial deterrence.

These actions lessened the pressure on the surrounding Asian economies, although Suharto's Indonesia, resisting IMF prescriptions, suffered further attacks. As its situation deteriorated, the United States, reinforced by Germany and supported by the other G7 members, intervened. On 15 January 1998, the IMF and Indonesia negotiated a letter of intent under which Indonesia accepted revised economic targets and more far-reaching structural reform.

The next threat to Asian economies arose in April 1998, when it became evident that both Korea and Indonesia would be unable to meet their pledges, made in the summer of 1997, to the support package for a still struggling Thailand. Here, Canada displayed structural leadership, by assuming the Indonesian share of $500 million (Kirton 1998c). Canada did so on the grounds that Thailand was honoring its program with the IMF and thus deserved the funds promised in return. Canada was the only country from outside Asia to make a contribution to Indonesia. The American administration, concerned about congressional criticism of a "bail-out" and any use of the Exchange Stabilization Fund (as in the Mexican rescue package of 1994-95), refused to contribute. In giving when the United States would not, Canada became part of a "first line" program. Its disbursements, which started to flow in June, ultimately totaled US$300 million.

The Asian phase of the crisis was thus contained through concerted, if just in time, G7 action. In a clear display of their power over markets, G7 governments often prevailed, and did so at times without actually expending national funds. Instead, they induced the IFIs, banks, and other private sector actors to provide the required liquidity. Moreover, in mobilizing these additional moneys, a congressionally constrained US was led to follow the policy leadership of its G7 colleagues, and often rely on the structural leadership which these partners, from second-ranked Asian Japan through sixth-ranked European Britain to seventh-ranked North American Canada, made available in the form of new national funds. In such a situation, intellectual leadership also flowed freely and effectively from the G7's lesser members. Britain and Canada, on opposite sides, drove the debate over capital account liberalization, and Canada, with relatively few Asian investors of its own to protect, pushed along with a congressionally concerned US, with some success for significant private sector participation.

With the acute phase of the Asian crisis over, G7 leaders and Finance Ministers turned their attention from crisis response to system reform for the Birmingham Summit in May 1998. At Birmingham, British Prime Minister Tony Blair, taking full advantage of the institutional advantages of serving as Summit host, introduced some historic reforms to ensure that the G7 would focus on the central challenge of finance (Kirton and Kokotsis 1997-98, Hodges et al. 1999, Bayne 2000). He chose a highly concentrated rather than comprehensive agenda, with finance and the related issues of employment and crime as the central items. He forced the leaders themselves to focus on them, by having their ministers prepare a thorough set of recommendations immediately prior to the Summit and leaving the leaders alone without attending ministers, for the first time in Summit history, to shape them as they saw fit. To enhance this process and diminish the preoccupation with media messaging, he introduced an informal leaders retreat. Finally, he gave G7 leaders a full half-day immediately prior to the opening of the G8 to deal with finance and economic issues, rather than forcing them, as at Denver, to find a few minutes between G8 sessions to deal with the subjects that had historically been at the G7's core.

At Birmingham the leaders stressed the need for improved transparency, early warning, and private sector burden sharing. Canada secured an endorsement for the concept behind its major initiative of establishing a mechanism for peer review of national banking and financial system supervisory authorities. Its proposal, first unveiled at the April 1998 Washington meetings of the IMF's Interim and Development Committees, included a call for a new international supervisory authority, with a small new secretariat for assembling multinational teams of supervisory experts. Because France preferred to invest the supervisory function in the IMF under its Article 4 consultations, and Britain wanted to use a joint IMF-World Bank mechanism, the decision on how to implement the concept was left to the G7, IMF, and World Bank meetings in the autumn.

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Phase 2: The Global Crisis of 1998

The second phase of the crisis came in the summer and autumn of 1998, when the financial crisis went global. Following further disquieting events in Asia, on August 17 Russia unilaterally devalued its currency and rescheduled its debt, only three weeks after receiving yet another large IMF support package that had mobilized the funds of the GAB for the first time in two decades. Although no one within the G7 had been enthusiastic about the prospects for the July support package, the speed of Russia's collapse and the shock of a default and devaluation brought home the message that no country, even a member of the G8, was too big to fail. It was soon apparent that the IMF, which still lacked the agreed-upon quota share increase as a result of American political stalemate, might not have sufficient funds to cope with crises on this scale.

The contagion, driven by plummeting commodity prices, soon spread to the emerging economies of the Americas, as interest rate spreads ballooned in all emerging markets. Brazil, which had a large fiscal deficit financed at floating interest rates, was particularly hard hit. As its interest rates soared, capital started to flee the country at the rate of up to US$1 billion a day. In early September, Colombia devalued its currency. Moodys downgraded Brazil's foreign currency bonds. Stock markets in the United States, Canada, Mexico, and the rest of the Americas continued the sharp fall begun in mid-summer.

By late August, the most powerful and prosperous US itself came under attack. As even healthy companies in the United States found it difficult to borrow money at reasonable rates, fears of an international credit crunch emerged. The crisis peaked in mid-September with the de facto collapse of LTCM, an American hedge fund, and its rescue by major American financial institutions under the guidance of the Federal Reserve. While the rescue was reassuring, the fear that similar hedge funds might be on the verge of collapse compounded the move toward a freezing of credit markets in the United States. Along with continuing congressional refusal to authorize the United States share of the IMF quota increase, this meant that the world was deprived of its traditional reliable lender of last resort. Indeed, the hitherto vibrant American economy was itself on the verge, in the minds of many, of being engulfed by the cascading crisis.

Throughout, Canada, along with the United States, Britain, France, and others, provided intellectual and policy leadership in the IMF and other fora, by producing and pressing for detailed proposals on many items on an expanding crisis response and system reform agenda. The US offered intellectual leadership on 17 September, when President Clinton publicly outlined a package that emphasized the desirability of interest rate cuts, a new IMF precautionary lending facility, and support for Brazil. Canada's Paul Martin, dissatisfied with the central thrust of the American plan and judging that markets needed a stronger signal that governments were in control, prepared his own package. This he unveiled at the Commonwealth Finance Ministers Meeting in Ottawa on 29 September, just before the 3 October meeting in Washington of G7 Finance Ministers (Canada 1998a).

The Canadian plan began, in congruence with the Americans, with a call for stimulus - a carefully worded admonition to focus on "the risks of an extended global slowdown" through, implicitly, an immediate lowering of interest rates by G7 central banks. But the remainder of its Six Point Plan marked a sharp departure in intellectual conception and policy emphasis from the U.S. plan. The second element in the Canadian plan was social targeting - a call to tailor IMF programs to local conditions, particularly through a less restrictive fiscal policy in some Asian countries than IMF orthodoxy prescribed. The third element, reinforced by the recent experience in Asia and Russia, was to extend international supervision to domestic banking and financial systems. The fourth element was capital control - a plea to adjust the move to capital account liberalization by allowing weak economies to impose transitional, non-distortionary controls on capital, particularly short-term capital inflows. The fifth was the introduction of the Emergency Standstill Clause, negotiated in advance and covering all private sector instruments, including bank deposits. This clause could be invoked by countries suffering a crisis of confidence, so they might preserve capital until payments could be restructured in an orderly fashion. In Canada's view, the failure of markets to differentiate between good and bad risk in the wake of the Russian devaluation underscored the need for an international bank holiday. Finally, the development and debt needs of the world's poorest countries were addressed.

The most urgent Canadian concern - a shift in focus from the threat of inflation to that of recession - was a form of policy leadership with immediate origins and an immediate impact. By September, the Canadian economy had suffered four months of no growth. On 27 August, after the Canadian dollar plummeted to an historic low of just over 63 cents to the United States dollar in the aftermath of the Russian devaluation, the Bank of Canada raised interest rates by a full percentage point. The day of Martin's speech, the United States Federal Reserve and the Bank of Canada immediately lowered interest rates by 25 basis points. In mid-October, the Federal Reserve instituted a further unexpected cut, which Canada again matched. By the end of the month, Britain, Italy, and Japan had followed. By November, the continental European countries did the same. From 1 October to the end of 1998, a total of 34 central banks lowered interest rates on 66 occasions.

Canada's early call was by no means the major cause of the emergency action or of the historic shift in the G7's decade-long macroeconomic focus on fighting inflation. Yet the United States-Canadian-British initiative provided the policy leadership which met the short-term needs of the Canadian economy and proved critical in combating a potentially paralyzing liquidity crisis in the United States that would have brought global collapse.

The second Canadian priority was to tailor IMF programs to the particular situation in each country, with an emphasis on fiscal stimulus within them when necessary. In IMF and G7 discussions over the program for Indonesia during the previous autumn, Canada had repeatedly pressed for greater fiscal flexibility in the IMF adjustment program. This, the Canadians argued, would allow the Indonesian authorities to increase their spending, especially on targeted social programs, development programs, and public infrastructure. Canada also favored a relaxation in the pace of privatization of Indonesian state enterprises.

Canada's other priorities made progress at the 3 October G7 Finance Ministers meeting in Washington. Held amidst what President Clinton called the worst financial crisis in 50 years, the meeting produced a communiqué which reflected several major Canadian concerns (G7 1998b). Notably, it signaled an easing of monetary policy to provide needed liquidity. At the end of the meeting, Canada, the United States, and Britain promised to maintain conditions for sustainable growth.

The communiqué also supported IMF programs and a proactive role for the G7, through the IMF, G22, and elsewhere, on the issues of architectural reform and a consensus on the core principles to guide it. Canada, along with Britain and the United States, pushed successfully for an emphasis on transparency. Although the American and British approach to banking and financial system supervision largely prevailed, Canada made some progress in principle. An emphasis on private sector involvement as a way of avoiding moral hazard reflected one of Martin's concerns, although here a German conviction dominated and no particular mechanism for private sector "bail-in"' was endorsed. Canada's greatest gain was in the crisis-bred diminished enthusiasm for rapid capital account liberalization, as the process for amending the IMF articles of agreement, initially slated for completion at the meeting, was extended another one to two years.

Despite this momentum, the G7 failed to provide the badly needed immediate, co-ordinated macroeconomic management required to stem a still burgeoning crisis in Brazil and in credit and equity markets in the United States and the rest of the developed world. In early October, the IMF (1998) cut its earlier estimate of world growth to a modest 2 per cent. Some relief came when Congress passed the American IMF quota share increase on 14 October, and Japan's Diet passed its banking bill shortly thereafter. But the situation remained unstable.

For Canada, continued deterioration during October posed a particular threat. Its primary fear was that the assault on Brazil would spread to Argentina and other Latin American countries, especially NAFTA partner Mexico. With its credit market still gripped by uncertainty, it was unclear whether the United States would have the will or the ability to contain any threat in Mexico as swiftly and surely as it had in the wake of the 20 December 1994 crisis. Mindful of how the Mexican crisis had threatened the Canadian dollar - of how that dollar, perceived as a commodity currency, was already at an all-time low - and with a looming provincial election in Quebec to reawaken fears of disunity within Canada, the Canadian government concluded that further action was necessary.

With markets clearly not absorbing the G7 message from the 3 October meeting, the British led a campaign to send a stronger collective signal, and to do so at the leaders' level. British Prime Minister Tony Blair, still in the chair of the G7 for 1998, called for a special G7 Summit. He received enthusiastic support only from the French, who also demanded that such a special summit involve a broader group of countries. The British Chancellor of the Exchequer, Gordon Brown, returned from the Washington G7 meeting of 3 October convinced of the need for a new G7 statement and one which reflected a deeper degree of consensus than had previously been revealed. Canada, along with the United States and Japan, was initially skeptical about the value of either a statement or a special summit, in the absence of anything new to announce. But when Congress finally approved the IMF quota share increase contribution, Japan passed its banking legislation, Brazil approached the IMF for assistance, and the G7 came to an agreement through conference calls on Clinton's proposed precautionary facility (the CCL that the United States conceived and secured), Canada concluded that a statement that cast these new developments in a positive light would be useful.

Britain, as G7 host, took the initiative in catalyzing the process and drafting the statements, along two tracks. The first was through G7 sherpas and directly among leaders, who were in direct contact with one another by fax and phone. This included calls from Clinton to Canada's Chrétien, Britain's Blair, and, on several occasions, Germany's new Chancellor and incoming summit host Gerhard Schroeder, whose government was strongly opposed to Clinton's call for a new IMF precautionary facility. The second track was among the G7 Finance Ministers, with British Chancellor of the Exchequer Gordon Brown working through the finance deputies. At the last minute, the two statements composed on separate tracks were rendered compatible. Despite the rushed nature of the process, with conference calls until the last minute, the substance of the final statement was genuinely a G7 product, and one which reflected most of Canada's and Britain's core concerns.

On 30 October, the G7 released two statements, the first from the leaders and the second from Finance Ministers and central bankers (G7 1998b). In them, Canada succeeded in its goal of securing collective, proactive G7 leadership in a way that reassured global financial markets, redirected policy from a preoccupation with combating inflation, and directed a far-reaching reform of the IFIs in keeping with its Halifax initiative.

On the issue of capital controls, Martin's call for restrictions on short-term capital outflows, in the form of the Emergency Standstill Clause, received some support. The United States, however, whose own private sector investors would be most harmed by such a proposal, remained adamantly opposed. The 30 October statement included carefully crafted language that amounted to a tacit acceptance of the concept of capital controls. The leaders' statement spoke of the need to minimize the "risk of disruption" for "an orderly and progressive approach to capital account liberalization" and for "measures to ensure the orderly and co-operative resolution of future crises, in particular mechanisms to involve the private sector." G7 officials were directed to work out the mechanisms to give this principle effect over the next year.

A second area of substantial Canadian gain followed from Martin's initiative for stronger banking and financial sector supervision. The Finance Ministers' statement directly endorsed enhanced supervision through "a process of peer review". The IMF, France's preferred forum, also agreed to devote more attention to the quality and capability of such supervision in its annual Article 4 review of members' economies (Canada 1998b).

Canada's influence could also be seen in the emphasis in the leaders' statement on dealing directly with the social dimensions of the financial crisis. The statement began by declaring that all the leaders deliberations and decisions, for the short and longer term, were conducted with a singular concern for their action's "impact on the poor and the most vulnerable". It promised to strengthen the international financial system in ways that better protected the most vulnerable and that would "minimize the human costs of financial crises." It specifically endorsed an emergency facility in the World Bank to offset the social damage caused by financial failure for the most vulnerable groups and called for principles of good practice in social policy to protect the most vulnerable social groups.

The final element of the G7 response was its support package for Brazil, still being negotiated as the 30 October statement was released. When it was unveiled on 13 November, it contained several novel components. Brazil had voluntarily adopted a restraint package prior to the extension of G7 assistance. In addition to IMF and other IFI funds, it would use bilateral national contributions from all G7 members and other countries as part of a first, rather than a second, line of defense. Of the US$41.5 billion total, the IMF provided US$18 billion, the IBRD US$4.5 billion, the IDB US$4.5 billion, and bilateral contributions, funneled through the BIS, US$14.5 billion. For the first time, newly available NAB funds were used to support a non-NAB member. These funds were authorized by phone calls to the G7 Finance Ministers, who provided over 90 per cent of the total. At US$41.1 billion, the package was well in excess of the US$25 billion initially envisaged or the market-rumored US$30 billion. A full US$37 billion of the total would be made available during the first year. The size and early availability of the package, and the willingness of all G7 members to put their national funds on the front line to make it this large, was sufficient to demonstrate resolve and to deter markets from continued attack.

Canada's contribution to the bilateral first line of the Brazilian package, determined at a late stage in the process, was a relatively modest US$500 million, or a deliberate one-tenth of the United States contribution. The contribution was driven by several considerations. The United States had not contributed to the Thai package in the spring, when Canada bore the burden from beyond the region. As a major contributor to the IMF, IBRD, and IBD, Canada was already contributing in excess of US$500 million to the Brazilian package. Canada was unenthusiastic about Brazil's approach to the IMF and the creation of a new precautionary facility for which it was the first test case. Nor was Canada eager to use NAB funds, which became available on 17 November, rather than the United States quota share, which became available only later, for the IMF's multilateral portion of the Brazilian package.

Canada's concern about the prudent use of IMF resources was again evident in a subsequent G7 debate about the speed of repaying the NAB. Because the United States wanted to show a still skeptical congress that the IMF could function as a profit centre, it preferred to rely as long as possible on the NAB, so as to reap its very high interest rates and delay a use of the IMF's regular quota increase. The French agreed. Canada, along with Britain, Germany, and Japan, wanted to pay off the NAB and revert to the lower cost regular IMF quota as soon as possible. Canada's position was driven in part by a desire to free the resources otherwise constrained by their commitment through the NAB to deter and defend against any currency crises to come.

The United States delay in making its IMF quota share increase available in time for Brazil to use it stemmed in part from a provision of the congressional authorizing legislation. It allowed funds to flow only 15 days after the Secretary of the Treasury and the Chair of the Federal Reserve received assurances from the "major shareholders" of the IMF that they were pressing for several conditions as part of IMF programs. So that Rubin could act, the G7 agreed that their executive directors at the IMF would collectively ask the Managing Director to meet such conditions. This unprecedented collective G7 action, which publicly directed the Managing Director of the IMF to take action, proved effective. It indicated that the G7 collectively, and not the United States unilaterally, was the source of effective leadership for the IMF.

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Phase 3: System Reconstruction, 1999

The third stage of Canada and Britain's international financial leadership came during the first half of 1999 as the G7 moved through the final installment of the crisis, in Brazil in early 1999, to the construction of a strengthened system at the Cologne G7 Summit in June. Here, Canada was able to work in close partnership with the new G7 host, German Chancellor Schroeder, and his "red-green" coalition government, to advance its longstanding positions.

Canada's response to the onset of crisis in Brazil was largely channeled through the IMF, using the instruments put in place in the autumn. Canada drew several lessons from the crisis and the particular response of the international community to it. The first was a reinforcement of its belief, based on a close analysis of the Asian crisis, that there were no innocent victims - that Brazil's heavy external debt held in very short-term instruments and the threat of nonpayment by one of its state governments had rendered the country vulnerable and precipitated the crisis. It could not be blamed on any irrational "contagion" at work in a newly globalized economy. The second view, based on the failure of private sector investors to participate in the response to the second Brazilian crisis, was that much stronger measures for private sector burden sharing were required. The third judgement, shared by Schroeder, was that Clinton's preferred precautionary mechanism, the CCL, was a relatively ineffective instrument for dealing with the crises likely to emerge.

Canada took these lessons into the G7 Finance Ministers Meeting in Berlin on 20 February, in Washington on 26 April, and in Frankfurt on 11-12 June, and to the G7 Summit in Cologne on 18-20 June. Canada made some advances in the early meetings. Most notably, the new Financial Stability Forum (FSF), a German initiative, contained a mechanism for peer supervision of national financial systems that gave life to the earlier Canadian proposal - if in a different institutional form. The architecture of the FSF reflected Britain's own proposals for financial regulation supervision even more than the Canadian ones. The British national who headed the BIS, Andrew Crockett, was appointed the FSF's first chair. Yet, as Cologne approached, significant differences remained on the core architectural issues: private sector involvement, moral hazard and the Emergency Standstill Mechanism, crisis prevention and resolution, international institutions and the role of the IMF, membership in the FSF, debt relief for the poorest, and the overall approach to globalization.

On private sector involvement, Canada took its lead from the Prime Minister, who retained a strong aversion, evident from Halifax onward, to privatizing profits and nationalizing losses. Canada thus remained wedded to its Standstill proposal, the option that would force the greatest degree of private sector involvement. The proposal initially evoked strong opposition from the government and leading intellectuals in the United States, whose lenders would be the primary private sector actors called upon to contribute. Yet in the lead-up to Cologne, Canada continued to set private sector participation and the related issues of transparency and disclosure as its three priorities among the six architectural items on which the G7 would focus.

On Standstill, the leading element of Canada's thrust for private sector participation, Canada received support from Britain. However, the continental Europeans remained unconvinced and the Japanese offered no reaction. Rubin, while continuing to see problems with Standstill, began to refer to the concept in his speeches. On the broader principle of private sector participation, Canada took real pleasure from an agreement at Cologne to send a clear message to private sector lenders into emerging markets that they could no longer assume that the G7 or IMF would bail them out of all difficulties.

The views of the Prime Minister were also evident in crisis prevention and resolution. Here again, Canada had a strong aversion to relying on public funds to compensate private sector actors for imprudent lending. It thus worked, along with others and with considerable success, to narrow dramatically the conditions under which the US-inspired CCL - with its antithetical approach of lending public money first - could be activated.

On international institutional reform, Canada faced strong demands from France and from the IMF's Camdessus, who wanted primacy for the IMF. Canada had reservations about transforming the Interim Committee of the IMF into what it saw as a de facto directoire. On the FSF, the earlier agreement of the G7 Finance Ministers had left to the leaders the issues of how broad participation in the Forum should be and whether more emerging economies should be included. Canada, in notable contrast to the United States, was in the vanguard of those pressing for broader participation.

It was on debt relief for the poorest that Canada's intellectual, policy, and structural leadership was most fully expressed. Since the Canadian-hosted Toronto Summit of 1998, this had been a leading Canadian and British initiative at the G7 (Bayne 1998, 2000). During the spring, the new German government, despite the reluctance of its Central Bank, reversed Germany's longstanding position and agreed that a "Cologne debt initiative", including the sale of IMF gold, would be the centerpiece "deliverable" of its Cologne G7 summit. As spring proceeded, a G7 agreement on the sale of five million ounces of IMF gold led rapidly to a demand for the sale of ten million ounces, to raise the substantial funds required to make the initiative credible. As Cologne drew near, Canada, Britain, and, now, the German Chancellor and Foreign Ministry encountered strong resistance from France and Japan on a second component of the initiative. Both countries had continued their program of large ODA loans rather than grants and would thus be faced with large costs to their national budgets in a proposed G7 program to write off loans.

Here Prime Minister Chrétien also had strong views. Canada had led the G7 long ago in giving ODA in the form of grants rather than loans. It also led the way in writing off its loans from an earlier era. Moreover, Chrétien, having moved Canada from a $42 billion annual fiscal deficit into sustained surplus, was willing to provide a substantial new amount of ODA as part of a balanced package of debt relief from Cologne, as his 1993 election campaign Red Book had promised. The new contribution, in addition to the full credit that Canada's Finance Ministry demanded for its past action, was contingent upon Japan and France writing off their substantial loans so that a credible Cologne package could be achieved.

A final area of emphasis, and another propelled in part by Chrétien's views, was the social side of globalization. For the Cologne debt initiative, Canada wanted debt relief to lead to sustainable growth rather than recidivist tendencies. Thus, new financial resources should be tightly targeted to social, educational, and human capital spending. Reinforcing an earlier Canadian-driven emphasis at the G7, relief would be denied to countries that persisted in violating norms of good governance and that incurred excessive military and other unproductive expenditures (Gill 1993: 8). Canada had an interest in not surrendering the levers for promoting these values. In particular, it did not want to use funds for the Highly Indebted Poor Countries (HIPC) to reward Myanmar, a country that continued to violate basic human rights. Canada pressed to include Bangladesh, a very poor Commonwealth partner, in the debt relief program.

By the end of the Cologne Summit, Canada had made substantial advances on all of its priorities. On private sector burden sharing, the communiqué bluntly declared that the G7 would shape expectations "so that private sector creditors know they will bear the consequences of the risks they take" (G7 1999). On crisis prevention and resolution, it limited the use of the CCL to countries pursuing (by then strictly defined) "sound and sustainable policies" and emphasized a host of private sector solutions that were at times intrusive. On international institutional reform, a compromise gave the IMF's Interim Committee permanent standing as a new "International Financial and Monetary Committee", but also affirmed other measures, including "an informal mechanism for dialogue among systemically important countries" (a mechanism which soon became the new G20). A clear Canadian victory came on the Financial Stability Forum when the leaders at Cologne agreed to broaden its membership to include emerging economies.

Canada, along with Britain, also enjoyed considerable success on the Cologne debt initiative. G7 leaders affirmed that relief would be "faster, deeper, and broader" through measures to reduce the stock of debt by more than half. The target was for rulings on three-quarters of eligible countries by 2000. To finance the package, the IMF would sell up to 10 million ounces of its gold, creditor countries would forgive most commercial and all ODA debt, and additional contributions would be made on the basis of a burden-sharing formula that took into account Canada's earlier leadership and contributions. Relief was to be directed towards the Canadian priorities of poverty reduction, health education and other social needs, sustainable development, and good governance.

Perhaps Canada's most striking success was in securing an emphasis on a social safety net to offset the negative effects of globalization. Indeed, the G7/G8 at Cologne produced a new Cologne consensus on socially sensitive globalization that contained a potentially far reaching array of new principles, norms and rules. These contrasted sharply with the prevailing market-oriented neo-liberal equivalents ascendant during the past two decades, and were distinct from the consensus of "embedded liberalism" forged in 1994-5 (Ruggie 1982, Kapstein 1996b). The G7 communiqué heralded the principle that "social policies are the cornerstone of a viable international architecture" and instructed the IMF and other IFIs to invest in education, health, and social needs as an essential part of their policies. The subsequent communiqué of the G8 (now that Russia was included) spoke even more broadly and ambitiously of the need to "strengthen the institutional and social infrastructure that can give globalization a 'human face'" (G8 1999). Notably absent from the Cologne communiqués were any references to capital account liberalization as a valuable international constitutional principle, let alone one worthy of entrenchment in the IMF Articles of Agreement (Blinder 1999). Emerging economies were now invited to carry out a "careful and well-sequenced approach to capital account liberalization" and to do so only after they had stronger, better regulated, national financial systems in place.

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Conclusion

The 1997-99 Asian-turned-global financial crisis was ultimately stemmed when the US Treasury Secretary, Central Bank Governor, and Congress acted at the last hour to lower interest rates and authorize the US quota share increase to the IMF, thereby preventing the clear and present danger of a financial meltdown that threatened to engulf even an apparently secure United States. However, in acting in this way the United States, constrained by congressional stalemate at an unprecedentedly dangerous moment, and by the advent of frozen domestic credit markets in the wake of the LTCM collapse, was by no means behaving as the classic, self-confident, capable hegemon of old. Rather, in an era in which financial globalization rendered the most powerful, relatively closed, and vibrantly growing United States vulnerable along with its lesser partners, the US needed the support of its G7 colleagues to mount an effective response to panicking markets simultaneously on three regional fronts. Moreover, with Japan financially fragile and in recession and Germany initially distracted by a government in transition, the least powerful G7 members - Britain, the 1998 host, and Canada, guardian of the 1995 Halifax program of IFI reform - used their institutional assets to play substantial, multi-leveled, leadership roles.

For Britain, the greatest achievement came from the ultimate fulfillment of its October 1998 quest to mobilize the G7 into taking additional collective action to reassure panicking markets in the wake of a congressionally constrained US. It also secured its desired work on codes of good conduct for social policy at the World Bank. It further succeeded, without the additional impulse of crisis, in realizing at Cologne its decade-long quest to obtain large-scale debt relief for the poorest.

Canada's initiatives were driven by a recognition of its broad economic interests and domestic values, and a systemic sense of responsibility as a member of the governing global concert institutionalized in the G7. During the three phases of the crisis, Canada recurrently displayed intellectual, policy, and structural leadership. Intellectually, it did so in its Halifax program, peer supervision, and "roadmap" proposals; its six-point program; its Standstill concept; and its proposal for debt relief for the poorest. In the policy realm, it acted with early interest rate cuts and calls for fiscal stimulus, peer supervision, social sensitivity, controlled capital liberalization, private sector burden sharing, and debt relief for the poorest. Structurally, it often made more than proportional contributions as a G7 member to the supplementary support packages for Korea, Thailand, and Brazil, and provided its share of the GAB/NAB, IMF, IBRD, IDB, and ADB packages. It was also prepared at Cologne in June 1999 to finance debt relief for the poorest (along with prospective financial packages for Mexico and other endangered economies) and a Balkan stability package for the reconstruction of Kosovo and its neighbors.

Canada often acted against American preferences, notably on capital account liberalization, social sensitivity, fiscal stimulus in afflicted economies, private sector burden sharing and the Escape Clause Mechanism, the precautionary CCL facility, and delayed NAB repayment. It assembled issue-specific coalitions from an ever-changing array of G7 partners. Its distinctive positions were substantially reflected in collective outcomes. Above all, its diplomacy was effective, as the action of the G7 and a G7-led IMF ultimately contained the looming Asian and then global financial crisis (Dobson 1999).

The successful leadership offered by Canada and Britain during the 1997-99 global financial crisis suggests the need for important adjustments of, and extensions to, the traditionally dominant interpretations of the causes of effective G7 co-operation, in order to take account of the changed circumstances of the rapidly globalizing, crisis-ridden world of the 1990s. These theories have argued that such co-operation depends upon the unique and necessary role of a United States able and willing to lead, if, in the leading variant, with support from one of the G7's strongest other members (Putnam and Bayne 1984, 1987; Bergsten and Henning 1996). The G7's response to the 1997-99 global financial crisis and reconstruction of the international financial system was not only or even primarily a case of collective action flowing from a United States alone able and willing to lead, and doing so with the support of a second leading G7 power. For the leadership the US had routinely displayed during much of the post world war two period, and in the Bonn Summit of 1978, was notably absent in the years leading up to, and into, the crisis (Kapstein 1996b: 35-6). During the crisis the US was at key moments a hesitant leader, constrained by congressional stalemate, and carried by collective peer pressure from its G7 partners, in the face of compounding crisis, into following a consensus started by others. It shared the intellectual and policy leadership with others, depended on the financial contributions from others, and adjusted to others to produce the "just enough," "just in time" leadership that the G7 brought. In such a situation, effective co-operation came from a G7 in which even the weakest members, Canada and Britain, along with the US and others regularly led, and in which the US, along with Canada, Britain and the others, regularly followed.

Nor did G7 co-operation during the crisis flow importantly from a shared memory of distant market and policy disasters, which provided a divergent or common interpretative frame and impulse for leaders as they approached the unknown events of the present and near future (Putnam and Bayne 1987). The memories of the stock market crash of 1929 and especially the ensuing depression (and the social costs that flowed from the monetary and fiscal policies initially pursued to combat it) were far less important to leaders, in a now globalized world, than the more recent and sufficiently successful responses they had mounted to the 1987 stock market plunge, the Mexican meltdown of 1994, and the Barings Bank collapse of 1995. At the same time, these recent experiences also inhibited swift and sensitive collective action, as the Mexican model induced European members at the outset to first adopt a regionalized view of the world, rather than one in which all members of the transregional G7 coalition had to be involved. However, ultimately, all G7 members were able to cast off such geographic free-riding complacency and learn that a genuinely global response was required. More broadly, the crisis similarly led G7 leaders, at first constrained by a Washington consensus with neo-liberal values at its core, and by the false belief that globalized financial markets would now allow little policy co-ordination (especially if aimed at departures from the neo-liberal orthodoxy), to change significantly to collective action grounded in a new model of socially sensitive and potentially socially safeguarded globalization (Bergsten and Henning 1996). In short, neither the distant memories of the past nor false consensus of the present when the crisis broke did much to determine the G7's effective collective action as the crisis compounded.

Domestic-level factors, whether as domestic cleavages permitting mutually supportive transnational alliances or as traditional differences based on overall national or state-defined interests, were important but ultimately not decisive. Congressional resistance did constrain and delay the American administration's preferred actions, and lead Clinton and Rubin to play a variant of a two-level game (Putnam 1989). Yet, it was more the contagion of a crisis that finally infected the American homeland, rather than a transnational coalition forged with a newly elected German government (with a very different orientation than its predecessor) that prompted the United States and the G7 to produce the effective consensus by the end of October 1998. And traditional differences, based on the interwar-generated US preference for growth and the German preference for anti-inflation, were readily overcome (Bergsten and Henning 1996). The United States remained until the peak of the crisis in September 1998 wedded to fiscal consolidation and monetary restraint. It also ultimately set aside its quest for rapid IMF-entrenched capital account liberalization. Moreover, the new "red-green" German government readily joined those pressing for fiscal and monetary stimulus, and adopted a debt-relief initiative with IMF gold sales as the centrepiece deliverable of its Cologne Summit.

Of some relevance were those factors highlighted by the model of democratic institutionalism (Kokotsis 1999, Ikenberry 1993). At the national level, Finance Ministers, who were most focussed on their country's G7 responsibilities, were largely in the lead, allowing for swift crisis response and continuing system construction efforts in the inter-peak crisis interludes when their heads were personally not engaged. At the international level, the G7 Finance Ministers process, international institutions the G7 controlled, beginning with the IMF, GAB, and NAB, and newer bodies they dominated and created such as the G22 and FSF, allowed for wider legitimacy for G7 leadership, broader burden sharing, and swifter implementation. In addition, the personal commitment of and popular support enjoyed by key leaders, notably Canada's Chrétien, Britain's Blair and even America's Clinton, enabled them to persist in their efforts to keep the Summit focussed on crisis response and system reconstruction until an adequate solution was found.

More specifically, in accordance with the core tenets of liberal-institutionalist theory, the particular procedures, rules, norms, and principles of the G7 empowered the weaker members and thus enabled them to constrain and collectively change the opening perspectives and positions of the most powerful. Canada in 1995, Britain in 1998 and Germany in 1999 skillfully used the prerogatives and legacy of the G7's rotating annual hosting arrangements to advance their issues and interests. The norms of consensus and peer pressure allowed each member, including the smallest, to delay action, and induced even the largest United States, from Hong Kong onward, to adjust to the consensus of the others. Moreover the growing Summit-inculcated sense of systemic vision and responsibility, and the accumulated legacy of trans-regional burden sharing, induced members who were initially instinctive regionalists to contribute to the collective cause.

Above all, effective G7 action to contain the crisis and construct a new financial architecture from 1997-99 was driven primarily by variants of those factors at the core of the G7's essential character as a modern international concert, now operating in the face of the acute inter-vulnerability and new forms of crisis and contagion that a rapidly globalizing system brought. These particular international processes and international institutional provisions critically empowered the other, including the least powerful, members of the G7 to assist the US administration in overcoming domestic constraints on US leadership and adjusting America into the consensus that generated a collective and effective G7 response. G7 capabilities remained collectively dominant in the full system, even as the legitimacy and funds brought by outsiders, and by the G7-led Bretton Woods institutions played important roles. The equalization of capabilities bred by the new rise of Canada and Britain at the bottom helped offset the small rise in the US share in the G7 as a whole and the sharp drop in second-ranked Japan and third-ranked Germany. But far more importantly, it was the rapid equalization of vulnerability brought by the contagion and virulence of the crisis that prompted all G7 members to join together, enabled each to lead, and induced all to commonly search to construct a solution, adjust to arrive at a consensus, and thereby contribute to the collective good.

Constricted participation within the IMF and elsewhere, especially in October 1998 among the US, current G7 host Britain and incoming G7 host Germany, proved critical, even though the G7 also reached out from the start to mobilize the resources and legitimacy of the GAB, NAB, new G22, and, later, FSF and G20. Common principles of major power responsibility, market democracy and the rule of law, induced all G7 members to support democratizing and marketizing countries in distant regions, to do so in ways that sustained the move toward genuine market democracy, and the openness, transparency, and "good governance" that accompanied it. A common core of domestic values ultimately helped all G7 countries, with Canada and Britain in the lead, to recognize that the adjusting countries needed the social safety expenditure that was taken for granted within G7 countries at home. Political control by democratic and popularity elected leaders through the G7 Summit and ministerial was important in helping allow President Clinton's position to prevail vis à vis his Congress, Chancellor Schroeder's vis à vis his central bank, and the Canadian Prime Minister and Finance Minister against the economic orthodoxy of their trade and finance officials.

Above all, it was the intervulnerability created and rendered visible by crisis, the recent "first shock" of the 1994 Mexican crisis, and the learning that had begun at Halifax and was reinforced at each stage of the contagion that led to co-operation, and co-operation on a very different set of premises that those that had reigned, amidst the aura of American triumphalism, at the Denver Summit of 1997.

The experience of the G7 during the global financial crisis of 1997-9 also provides important evidence to assist in arbitrating some of the central debates in the larger literature on the international political economy of global finance (Dombrowski 1998). In the first instance it underscores the central role of crisis as a cause, particularly, in "laying bare" the state as the locus of authority in the modern age and in increasing the willingness of the state to sustain the consequences of defying markets (Pauly 1995: 373)

Furthermore, the ability of states, acting collectively, to play and win the game of financial deterrence with private market players assaulting the Korean won in December 1997 suggests that globalized finance has not acquired sufficient force in itself to elevate it, along with anarchy, to the status of a structural characteristic of the international system, as some have suggested (Keohane and Milner 1996). The success of G7 governments in securing private sector participation in the Korean case, in affirming the principle of private sector participation at the Cologne summit, and in comprehensively constructing a new international financial architecture in the wake of the crisis reinforces the arguments of those many scholars who have emphasized the central role of public authority in shaping the pace, path, and progression of global finance and its liberalization, control and potential reversibility (Underhill 1991, Goodman and Pauly 1993, Porter 1993, Helleiner 1994, Kapstein 1994). Most broadly, the advent of the new Cologne consensus on socially sensitive, and possible socially safeguarding globalization, should it be sustained and strengthened, may suggest that collective state action in an age of globalized finance is not tightly confined by "embedded financial orthodoxy" or "financial and monetary imperatives" (Cerny 1994: 226), but can be moved from the previous condition of Gramscian hegemony (Gill and Law 1989) to a new collective consensus, in a relatively orderly way.

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