Download Trade Globalization, Economic Performance and Social Protection

Trade Globalization, Economic Performance and Social Protection:
19 -century British Laissez-Faire and post-World War II U.S. Embedded Liberalism.
th
Salvatore Pitruzzello
Assistant Professor
Tulane University
Department of Political Science
[email protected]
Tel. 504 862 8307
_________________
I would like to thank the following people for their help and support in developing this project: Mike
Artis, Ilijan Georgiev, Ron Jepperson, Lars-Erik Cederman, Luis Moreno, Martin Rhodes, Mark
Kesselman, Ron King, David Clinton, Tony Pereira, and Benedicta Marzinotto. A Jean Monnet
Fellowship from the Robert Schuman Center for Advanced Studies at the European University Institute
has provided financial support for the project.
Abstract
How have market and state shaped the long-term evolution of economic performance and social
protection during the 19th - and post-World War II waves of globalization associated with laissez-faire
liberalism and embedded liberalism? Under the impulse of a seemingly ever-intensifying globalization,
this question is emerging at the core of a novel body of political economy research that wants to compare
the two waves of globalization to draw useful lessons from the past. The research reflects the concerns
recently voiced in the more popular literature by neo-liberals and neo-interventionists about the long-term
stability and viability of globalization in post-World War II embedded liberalism. This paper argues that
research fails to achieve its core objective, namely, to investigate the long-run evolution of the two
regimes. Cointegration analyses of the evolution for the two hegemonic powers—19th -century Britain and
post-World War II century US—demonstrate that state-steered embedded liberalism exhibits better longterm economic growth as well as social protection.
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1. Introduction
How have market and state shaped the long-term evolution of economic performance and social
protection during the 19th -century and post-World War II waves of globalization associated wit h British
laissez-faire liberalism and U.S. embedded liberalism? 1
In the context of an ever-intensifying globalization, this question is at the core of an emerging body
of political economy research that compares the two waves of globalization to draw lesson from the
past—from the 19th -century wave (James, 2001; Gilpin, 2000; Aghion and Williamson, 1999; Bordo et
al., 1999; O’Rourke and Williamson, 1999; O’Rourke, 1999). This research strongly reflects two major
concerns recently voiced in the popular literature by neoliberals and neointerventionists: the long-term
stability and viability of globalization in post-World War II embedded liberalism; and fears of backlashes
against globalization that are reminiscent of the 19th -century wave (James, 2001; Friedman, 2000; Gilpin,
2000; Rodrik, 1997). Relying on neoclassical views of self-regulating economies, neoliberals privilege
the intensification of unfettered globalization: they lament the inefficiency of state-steered embedded
liberalism, fear politically-driven protectionist backlashes against globalization, praise the efficiency of
19th -century laissez-faire in ensuring superior growth, and favor the reconstitution of market dominance
as the ideal pathway to long-run full-employment growth (Lindsey, 2001; Vasquez, 2000; Lal, 2000;
Micklethwait, 2000). In contrast, viewing the economy as prone to breakdowns, neo-interventionists fear
the intensification of unfettered globalization: they also lament inequalities associated with disembedded
markets, point to the social costs of 19th -century laissez-faire, and privilege political control of markets to
ensure economic growth and social protection (Broad, 2002; Friedman, 1999; Gray, 1998; Greider,
1997). 2 Such concerns are clearly reflected in the political tensions informing recent mass demonstrations
against globalization (Bhagwati, 2002; Broad, 2002; Dollar and Kraay, 2002; Stiglitz, 2002).
Undoubtedly, these seemingly novel debates represent the resurgence of the interwar “ideology
debate”—with Keynes and Polany on one side and Hayek and Von Mises on the other—over the
efficiency of market and state in shaping long-term economic performance and social protection. Then the
debates were about the long-term stability and viability of 19th -century laissez faire and its replacement
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with embedded liberalism (Ruggie, 1982; Keohane, 1984). Today, after half a century of experiments
with embedded liberalism, debates are about its long-term stability and viability and its replacement with
novel forms of laissez faire (Gilpin, 2000; Ruggie, 1998, 1997). Nevertheless, systematic comparisons of
the two regimes that satisfactorily assess the empirical adequacy of the rival neo-laissez faire and neointerventionist claims remain severely lacking. Seemingly, the crucial problem for the political economy
research is its focus of on a variety of related issues that ultimately fails to capture, directly and explicitly,
how market and state shape the long-run coevolution of economic performance and social protection in
the two regimes: e.g., properties of globalization (Baldwin and Martin, 1999); 3 economic and political
determinants of long-run growth (Cornwall and Cornwall, 2001; Hodgson, 1996; Maddison, 1995;
Baumol, 1985); wage and income convergence (Boyer, 1996; Williamson, 1996); inequality and growth
(Aghion and Williamson, 1999; O’Rourke and Williamson, 1999; Williamson, 1998b); causes of
backlash against globalization (O’Rourke, 1999; Williamson, 1998a). Instead, I argue that more
fundamental is an unsettling disjunction between theoretical claims about the long-run dynamics driving
the two regimes and empirical evidence that at best would describe short-run fluctuations.
The utter neglect of nonstationarity, or persistence, of historical processes central to debates—i.e.,
trade and financial flows, GDP, unemployment, and government spending—triggers such disjunction and
results in erroneous inferences about the dynamics of the two regimes as well as in unwarranted policy
lessons.4 Nonstationarity, however, suggests alternative long-run stable dynamics—equilibrium relations
evolving around shared stochastic trends—if the nonstationary processes were cointegrated, or
historically coevolving (Juselius, 1999; Engle and Granger, 1991). This paper adopts the framework of
cointegration to compare how market and state shape long-term coevolution of economic performance
and social protection in the two regimes. Cointegration allows for the examination of three core properties
of persistent dynamics: namely, (i) regime stability captured by common stochastic trends driving the
nonstationary dynamics; (ii) equilibrium relations coevolving around the common trends; and (iii)
adjustment mechanisms that maintain long-run equilibrium (Patterson, 2000). Theoretically, I propose a
model that links the long-run coevolution of four processes that are central in the political economy
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research: namely, trade, GDP, unemployment, and government spending. The comparison focuses on the
two hegemonic powers that spearheaded the two regimes: Britain for 19th -century laissez-faire for the
1865-1913 period; and the U.S. for post-World War II embedded liberalism for the 1955-2000 period.
Cointegration analyses provide four clear findings. First, unit root tests indicate that all four
processes in both regimes exhibit persistent random walk properties. Second, cointegration tests suggest
that both regimes exhibit long-run stability: the four processes coevolve around one common stochastic
trend that drives the nonstationary evolution of the regimes. Third, equilibrium relations reveal that while
markets dominate 19th -century laissez faire, state interventions in post-World War II U.S. embedded
liberalism are associated with higher economic growth and better social protection. Fourth, the adjustment
dynamics indicate that state interventions are as necessary to maintain the market-driven equilibria of
19th -century laissez-faire as they are in maintaining the state-steered equilibria of embedded liberalism.
These findings challenge well established theoretical and policy claims. The stability of the two
regimes challenges any doomsday scenarios of implosion of globalization regimes proposed by neoliberals for embedded liberalism and by neo-interventionists for laissez-faire. The equilibrium relations
refute neoliberal claims about the economic inefficiency of “positive” state interventions and the superior
economic, and welfare, efficiency of unfettered global and domestic markets in laissez-faire liberalism.
The dynamics of adjustment question long-standing beliefs, ironically shared by neointerventionists, that
markets shape the dynamics of 19th -century laissez faire whereas the state shapes the dynamics of
embedded liberalism. Ultimately, these findings doubt the wisdom of the neoliberal political project to
reconstitute market dominance: it may yield newly disembedded worlds with lower economic growth and
weaker social protection. Rather, they support neo-interventionist claims that political control of
markets—both global and domestic —may better ensure long-term growth and social protection.
Section two traces the resurgence of the debates. Section three shows the centrality of long-run
dynamics. Section four sketches the four-dimensional model. Section five justifies the research design.
Section six develops the cointegration models. Section seven presents the empirical findings. Section
eight discusses the implications of the research.
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2. The “resurgence of the ideology debate”: efficiency of market and state
The emerging diachronic debates between neo-liberals and neo-interventionists do represent the
overt “resurgence of the ideology debate” over the efficiency of market and state in shaping economic
performance and social protection in the capitalist world economy. The debates had been intense during
the inter-war period. Then Keynes (1936, 1926) and Polanyi (1944) challenged, against Von Mises (1995)
and Hayek (1933, 1944), the long-run efficiency and viability of 19th -century laissez-faire: markets
unmediated by positive state intervention neither converged endogenously toward full-employment
growth nor provided satisfactory social protection. 5 Thereafter, debates seemed to permanently subside
with the “end of the ideology debate” in the early 1960s. In the context of the Bretton Woods regime, the
dominance of Keynesian-based embedded liberalism, which seemed to successfully ensure global growth
as well as domestic full-employment and social protection, appeared to be irreversibly sanctioned
(Hobswbam, 1994; Marglin and Schor, 1990; Shonfield, 1969; Bell, 1962; Lipset, 1958). 6
Instead, by the early 1980s, following the breakdown of the Bretton Woods system and the
intensification of globalization, the debates reemerged fiercely under the impulse of neo-laissez faire
synchronic attacks that weakened the postwar consensus on the long-run viability of embedded liberalism
(Keohane, 1984; Ruggie, 1982). The first wave of attacks challenged the economic efficiency of
“positive” stabilizing and welfare state interventions: they hamper optimal economic growth (Stein,
1982). 7 A second wave more explicitly challenged the role of the state in globalizing worlds: international
markets inexorably weakened the ability of governments to stabilize the economy and to provide social
protection (Ohmae, 1996, 1990; Mishra, 1999); and state intervention, especially welfare, undermined
international competitiveness (Alesina and Perotti, 1998). Indeed, neo-Hayekean evolutionary imperatives
predicted inevitable convergence toward laissez- faire (Ohmae, 1996, 1990; Fukuyama, 1993). 8
This ‘hyper-globalization’ view of the homogenizing imperatives of globalization toward economic
laissez-faire and disembedding of social life has had wide resonance beyond neoliberal circles (Buchanan,
1998; Strange, 1996; Cerny, 1996; Reich, 1992). Yet, several counter-critiques have reasserted a virtuous
cycle based on complementarity between markets and state rather than on an ineluctable tradeoff. Thus,
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endogenous growth theories reestablish the economic efficiency of selected types of expenditures (Barro,
1997; Barro and Sala -i-Martin, 1995; Aschauer, 1990; Romer, 1990; Lucas, 1988). New theories of
political economy link social justice protection, equity, reduction of poverty and inequality to productive
efficiency that promotes growth (Barro, 2000; Aghion et al., 1999; Rodrik, 1998; Alesina and Perotti,
1996; Benabou, 1996). The globalization-induced retrenchment of welfare states remains dubious
(Pierson, 2001; 1994). The state continues to play a significant role in shaping national adaptation to
globalization (Weiss, 1998; Keohane and Milner, 1996; Boyer, 1996; Boyer and Drache, 1996; Hirst and
Thompson, 1996). Such critiques have informed several neo-interventionist defenses of embedded
liberalism, which attempt to demonstrate its continuing viability in ensur ing long-term growth and social
protection (Boix, 1998; Garrett, 1998; Giddens, 1998; Ruggie, 1998; Esping-Andersen, 1996). 9 Indeed,
social protection may be essential to forestall a backlash against unfettered globalization (Rodrik, 1997).
Against this background, the resurgence of the ideology debate in diachronic form represents a
rupture with embedded liberalism. The neo-laissez faire admiration of once discredited 19th -century
laissez-faire and the neo-interventionist defense of once dominant embedded liberalism have revived the
interwar debates over the efficiency of market and state in ensuring long-term growth and social
protection. Today’s neo-laissez faire claims find their roots in Hayekean theories of political economy
(Lindsey, 2001; Shearmur, 1996; Hayek and Caldwell, 1995). Neo-liberals challenge the long-term
viability of embedded liberalism established at Bretton Woods under U.S. hegemony to replace the by
then discredited 19th -century laissez-faire liberalism best exemplified by imperial Britain. Simultaneously,
they praise the economic efficiency of once discredited 19th -century laissez-faire: the more encompassing
globalization, the greater flexibility of global and domestic markets, and the minimal state ensured
superior growth. Ultimately , they draw a clear policy lesson: “to go back to the future” by reconstituting
novel laissez-faire worlds in which unfettered markets, as in the 19th -century wave of globalization, more
efficiently deliver higher long-term growth. 10 Likewise, neo-interventionist claims are traced to Keynes’
and Polanyi’s critiques of 19th -century laissez-faire (Gray, 1998; Rodrik, 1997; Ruggie, 1998; Mendell
and Salee, 1991). Neo-interventionists fear the reconstitution of unfettered globalization: 19th -century
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markets dominance may have created unprecedented wealth but the social costs may also have triggered a
backlash against globalization (Aghion and Williamson, 1999; Williamson, 1998a). Concerns about a
renewed backlash against unfettered globalization suggests an as clear policy lesson: “to go forward to the
future” by maintaining, and enhancing, political control over global and domestic markets to best ensure
long-term economic growth and social protection (Rodrik, 1997; World Bank, 1997).
3. Centrality of long-run dynamics: stability and viability of international regimes.
At the core, this debate between neo-liberals and neo-interventionists is about the long-run dynamics
of the two regimes. Fundamental disagreements concern the stability, and viability, of such regimes.
International regimes are stable and viable social institutions around which the long-run expectations of
participating actors converge (Ruggie, 1998, 1982; Hasenclever et al. 1997; Keohane, 1989; Krasner,
1983). This basic hypothesis underlies, despite paradigmatic differences, the three major schools of
thought in international relations—realism, neoliberalism and cognitivism. 11 Accordingly, organizing
principles of legitimate order and meaning shape the formation of regimes as well as their transformation
during their entire existence. Specifically, authority relations define the legitimate orderings of state,
market and society. Diametrically opposite organizing principles and authority relations inform the
laissez-faire and embedded liberal regimes. For laissez-faire, its normative structure rests on the
dominance of markets over state and society. Its central objective is economic growth. Growth determines
the dynamics of unemployment as well as of social protection via the higher living standards that
economic growth affords. Its strategy is to achieve growth via markets unfettered by positive state
intervention. Only negative state interventions, which bolster the dominance of unfettered markets in the
domestic and international arenas, are efficient. In contrast, the normative structure of embedded
liberalism rests on the dominance of state and society over markets. Its central objective is state–steered
global growth that ensures domestic full employment and social protection. In the multilateral framework
of the Bretton Wood system, positive state interventions in both the international and domestic arenas
were to efficiently achieve the twin objective of economic growth and social protection.
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Neo-liberals and neo-interventionists clash over whether the organizing principles of the two regimes
ensure their long-term stability and viability. For neo-liberals, relying on Hayekean and neoclassical
tenets, the institutional framework of laissez-faire liberalism generates stable long-run dynamics.
Unfettered markets endogenously adjust to shocks: they systematically clear and quickly converge toward
long-run full-employment growth. State interventions in both the economy and society are inefficient and
unnecessary. Instead, the institutional framework of embedded liberalism generates unstable dynamics:
the inefficiency of state interventions, best captured by the size of the public sector and by inflexible labor
markets, hampers the spontaneous self-adjusting of markets, results in lower long-term growth, high and
sticky unemployment, and weaken adaptation to globalization pressures. In contrast, reflecting Keynes’
and Polanyi’s critiques, neo-interventionists challenge the efficiency of 19th -century laissez faire. Markets
neither clear nor converge quickly toward full-employment growth. Rather, they tend toward long-term
disequilibrium, which is characterized by persistent booms and busts in economic growth as well as in
socially costly unemployment. Positive state intervention is necessary to ensure efficient convergence
toward long-run full-employment growth as well as satisfactory social protection.
4. The basic model: relative efficiency of market and state
A simple yet encompassing model, which informs much of the current political economy research,
captures the basic tensions at the core of the debates between neoliberals and neointerventionists:12
(1)
(2)
(3)
g = f 1 (y, u)
y = f 2 (t, g, tr)
u = f 3 (t, y)
f 1.y > 0, f 1.u > 0
f 2.t > 0, f 2.g ≠ 0, f 2.tr > 0
f 3.t > 0, f 3.y < 0.
y is the level of GDP; u is the unemployment rate; g is government spending as a ratio of GDP; t is trade
also as a ratio of GDP; and tr is a linear trend capturing productivity shocks.13 Equation 1 links the
evolution of government spending to shocks in GDP and unemployment. GDP operates via Wagner, or
wealth, effects: spending increases as a proportion of national income (Wildavsky, 1975). Unemployment
captures risk-minimizing welfare interventions protecting social strata exposed to labor market shocks
(Rodrik, 1998; Garrett, 1998; Esping-Andersen, 1990; Flora and Heidenheimer, 1981). 14 Equation 2 links
the evolution of GDP to trade and spending. As standard, trade has positive effects on economic growth. 15
8
Government spending, which gauges economic and social interventions, captures the tension in the
debates between neo-liberals and neo-interventionists over the efficiency of ‘positive’ interventions. The
linear trend captures technology-driven productivity shocks. Equation 3 links the evolution of
unemployment to trade and GDP. Trade, as in standard Heckscher-Ohlin models, induces socioeconomic
dislocations that are best captured by unemployment.16 GDP, as in business cycle models, describes
tradeoff between economic growth and unemployment.
For the laissez-faire regime, the mode l describes market dominance over the minimal state. In
equation 1, small wealth and welfare effects on spending do not trigger any significant long-run growth of
the public sector. In equation 2, the small public sector does not contribute significantly to the long-run
evolution of GDP. Rather trade and productivity shocks drive such evolution. In equation 3, only markets,
via trade and GDP, shape the evolution of unemployment. For neo-liberals, market dominance generates
stable long-run dynamics: the self-steering markets unencumbered by the state ensure quick convergence
toward long-term full-employment growth. For neo-interventionists, market dominance yields unstable
dynamics: unfettered markets fail to clear and to converge, and indeed generate persistent unemployment.
For embedded liberalism, the model captures the dominance of the state. In equation 1, significant
wealth and welfare effects contribute strongly to the growth of the public sector (Tanzi, 2000). In
equation 2, in addition to trade and productivity shocks, government spending affects the long-run
evolution of GDP. In equation 3, trade and GDP affect the evolution of unemployment. For neointerventionists the institutional framework of embedded liberalism is viable: state interventions
contribute to long-term growth, lower unemployment, and social protection. For neo-liberals, inherently
inefficient state interventions dampen growth and yield persistent unemployment.
5. Research design: hegemony and the hegemonic powers
Theories of international regimes suggest a clear research design to evaluates the empirical adequacy
of the rival neo-liberal and neo-interventionist claims about how market and state shape the long-run
coevolution of economic performance and social protection in the two regimes: namely the comparison of
the normative structure defining the relative dominance of market and state in the hegemonic powers:
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their organizing principles inform the evolution—creation and maintenance—of regimes (Keohane, 1984;
Ruggie, 1982; Krasner, 1981).17 Hence, empirical analyses compare the normative structures of Britain
for 19th -century laissez-faire and of the U.S. for post-World War II embedded liberalism.
5.1 Hegemony and the normative structures of social purpose
The hypothesis that normative structure of the hegemonic powers crucially shapes the identity of the
regimes is central to regime theory. Hegemons shape the evolution of regimes through the fusion of two
principles—concentration of resources and normative structure of social purpose—that project their
political authority in the international system. The principle of concentration of wealth and power, which
informs neorealist theories, is crucial in explaining why a hegemon creates and maintains an international
order based on its self-interest and vision of the world while at the same time enhancing long-term global
welfare (Gilpin, 1987, 1981; Kindleberger, 1981; Waltz, 1978). The hegemon invests its superior
economic and military power in constructing rules and institutions, and make short-term sacrifices in
order to secure long-term collective, or global, benefits. Other powers in the regimes share a basic
consensus for its hegemony as they benefit from the international order. Preponderance of resources,
however, does not account for the distinctiveness of international regimes such as 19th -century laissez
faire and post-World War II embedded liberalism (Ruggie, 1998, 1982; Keohane, 1984).
Legitimate social purpose, which is at the core of neoliberal institutionalism, accounts for such
distinctiveness. The authority relations that define state-society relations in the hegemonic country
provide the legitimate social purpose in pursuit of which state power is employed in both the domestic
and international arenas. The balance of market and state best captures the social purpose and the
authority relations that are instituted in regimes. Thus, the normative structure of social purpose that
reflects authority relations within the hegemon best identifies the distinctiveness of regimes. Such
author ity relations define how market and state shape economic performance and social protection.
Hence, the comparison of the normative structures shaping the authority relations that coordinate market
and state in the hegemonic powers provides the general contours of the dynamics of the regimes.
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5.2 Hegemonic Britain and 19 th-century laissez faire
The normative structure of 19th -century Britain captures the distinctiveness of the laissez-faire
regime. Indeed, Britain is the ideal, or extreme, representative of laissez-faire liberalism. Britain clearly
meets the neoralist principle of resources concentration. Britain was the wealthiest country: under the
impulses of the industrial revolution, colonization, and global trade and finance, it developed the largest,
and most open, economy (Clarence-Smith, 1999; Maddison, 1995; Floud, 1994; Hobswam, 1990;
Keohane, 1984). It was also the paramount military power, which, in a system of interstate hegemony
characterized by non-cooperative relations, enforced its preferred rule s of free trade and Gold Standard by
maintaining freedom of the seas (McKeown, 1983; Gilpin, 1981, 1975). The Pax Britannica did ensure an
international order of relative peace and security (Gilpin, 2000).
Concentration of wealth and power, however, is not sufficient to capture the laissez-faire identity of
the regime: only its fusion with a normative structure of social purpose that privileged the dominance of
unfettered and self-regulating markets uniquely captures such identity (Keohane, 1984; Ruggie, 1982).
The authority relations instituted in the international regime reflected the domestic balance of British
state-society relations characterized by the dominance of market over society, and that projected onto the
regime expressed its collective realit y. Indeed, Britain privileged market forces both domestically and
internationally: it limited the discretion of the state in the self-regulating commodity, currency and labor
markets; and it engage in “negative” interventions to institute and safeguard self-regulating markets.18
Thus, while the fusion of the two principles accounts for British hegemony, its normative structure of
social purpose uniquely identifies the laissez-faire identity of the 19th -century liberal regime.
Britain, however, is not simply the hegemon whose normative structure shapes the evolution of the
laissez-faire regime: it is also the ideal, or most extreme, representative of laissez faire. This ideal status
had long been noted in political economy where Britain exemplified the evolution of 19th -century
capitalism (Taylor, 1972; Polany, 1944). Other powers, such as France and Germany, differed in the
socioeconomic and political structures, but they were integrated in the laissez faire global economy
spearheaded by Britain (Gilpin, 1987). As crucially, this ideal status informs the contemporary ideological
11
debates: for neoliberals, 19th -century Britain exemplifies the world to which to return; for “Polanyi’s neointerventionist children”, the world to escape (Lindsey, 2001). Indeed, the ideological debates focus less
on the neorealist principle of concentration of wealth and power of colonial and imperial Britain and more
on the authority relations that subordinated society to market and domestic economy and society to the
international economy. Hence, the investigation of the normative structure of hegemonic Britain will help
evaluate the empirical adequacy of neoliberal and neointerventionist claims concerning how unfettered
domestic and global markets shaped economic performance and social protection.
5.3 Hegemonic U.S. and embedded liberalism
Hegemonic U.S. shaped the normative structure of post-World War II embedded liberalism (Gilpin,
2000; Ruggie, 1998). The U.S. meets the principle of wealth concentration: its economy is the largest and
drives the world economy, although when considering trade openness as a ratio of GDP, it is not the most
open (Dornbusch, 2000, Krugman, 1995). The U.S. also meets the power criteria of hegemony: e.g.,
world policemen; responsible for setting up and maintaining the international regimes of trade and
currency established at Bretton Woods; providing investment and aid (Pahre, 1999; Gilpin, 1987, 1975;
Kindleberger, 1981). Despite contemporary debates on the weakening of hegemony, the Pax Americana
also ensured an international order of relative peace and security (Gilpin, 2000; Keohane, 1993).
As for Britain, only the fusion of resource concentration with a normative structure that subordinates
markets to society uniquely identifies embedded liberalism. The authority relations instituted in the
regime reflected the domestic balance of state-society relations in the U.S. that were based on the
dominance of state over market and on the subordination of market to society (Ruggie, 1998, 1982). The
state took more direct responsibilities for buffering national economies from external disturbances
without sacrificing the benefits of economic openness. The evolution of this normative structure is traced
to three major historical phases. First is the New Deal: it represented the U.S. version of the worldwide
reaction against the collapse of laissez faire following the Great Depression. It ushered novel forms of
‘positive’ state intervention that were to secure economic growth, employment and social protection.
Second, based on the New Deal platform, is the Bretton Woods regime: the U.S. sought to reconstruct the
12
postwar international economic order to minimize socially disruptive costs to shocks generated by
international economic integration. Third is the Great Society of the 1960s: its programs added several
layers of social protection onto the boundaries of state intervention.
The U.S., however, is the weakest representative of embedded liberalism as its state-society relations
remained most ambivalent. It never had a significant socialist movement or labor party and has remained
the most liberal polity in the world (Lipset, 1996). The social and political reforms of the New Deal
lacked ideological coherence, were modest in scope relative to other countries, and confronted strong
opposition (Brinkely, 1995). Since the New Deal, labor markets have been the most flexible (Ruggie,
1982). The Great Society saw the limitations in the residualistic welfare state and in the small public
sector (Swank, 2002; Tanzi and Schuknecht, 2000; Garrett, 1998; Esping-Andersen, 1990). Moreover, the
attack on the normative structure of embedded liberalism is harshest in the U.S. (Ruggie, 1997; Pierson,
1996). Ultimately, the weakening consensus over the future of embedded liberalism is about the kind of
state that should replace the New Deal state (Gilpin, 2000; Ruggie, 1998, 1997). Yet, despite its weak
representativeness, the normative structure of hegemonic U.S. has shaped the identity of the regime.19
Hence, the investigation of the U.S. will provide the general features of how the relative dominance of
state and market shaped economic performance and social protection in embedded liberalism.
6. The data: nonstationarity and cointegration
How does empirical evidence from the hegemonic powers—19th -century Britain and post-World
War II U.S.—support the rival neoliberal and neointerventionist claims about how market and state shape
the long-run coevolution of economic performance and social protection in the two regimes? Graphs and
unit root tests for Britain and the U.S. indicate that the four processes in the model are nonstationary
random walks (see Appendix 1). Nonstationarity lays bare crucial disjunctions between theoretical claims
about long-run dynamics and established empirical evidence derived from methodologies that at best
capture short-run dynamics. Such disjunctions challenge the rival claims about the evolution of the two
regimes. They also indicate that the framework of cointegration is necessary to capture historical
persistence.
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6.1 Nonstationarity: persistence of historical processes.
Figure 1 shows the time paths of the four processes for the hegemonic Britain and U.S. 20 They
appear to exhibit long-memory, or persistent, dynamics typical of random walk—whether with or without
drift. First, British trade shows long-term waves of openness and implosion. In contrast, a strong drift,
which has fueled the recent concerns about the intensification of globalization, drives U.S. trade (Rodrik,
1997). Second, drifts drive the growth of spending in both countries. As well established, spending grew
in both periods albeit from different initial historical conditions identified by the origin at z0 (Tanzi and
Schuknecht, 2000; Flora and Heidenheimer, 1981). Third, the persistence of U.S. unemployment indicates
rigid labor markets. The higher frequency fluctuations in British unemployment may suggest more
flexible labor markets, as maintained by neo-liberals, yet long-memory swings may also drive its
historical evolution. Fourth GDP exhibits similar drift-driven growth patterns in both countries.
Formal ADF (Augmented Dickey Fuller) unit root tests for nonstationarity lend support to the
qualitative insights that the four processes are long-memory random walks. ADF tests take the form
∆zt = c + βt + γzt-1 + δ 1 ∆zt-1 + δ 2 ∆zt-2 + . . .+ δ p ∆zt-p + εt .
zt is a nonstationary process and ∆zt is its stationary I(0) change; the δ i parameters of lagged ∆zt capture
higher order correlations that whiten ε t ; β describes a time trend (t) (Dickey and Fuller, 1979). The γ
parameter (γ=ρ-1) indicates whether zt is a unit root. The ADF tests evaluate two hypotheses: (i) the null
of unit root (H0 : γ = 0), by which ρ = 1; and (ii) the alternative of stationarity (H1 : γ < 0), by which ρ <
1. The random walk has a drift if c≠0 and no drift if c=0. Table 6.1 shows the findings:21
Table 6.1: ADF unit roots tests
19 th-century Britain
c
β
t(γ)
Post-World War II U.S.
MacKinnon
c
MacKinnon
β
t(γ)
0.7
0
1.7
3.5 / 2.9
0.4
0.004
2.1
4.1 / 3.5
∆tt
1.3
0.004
2.4
4.1 / 3.5
1.4
0.006
2.4
4.1 / 3.5
∆yt
0
0
0.9
2.6 / 1.9
0.0
0
1.0
2.6 / 1.9
∆ut
0.1
0
2.0
3.5 / 2.9
0.2
0
1.6
3.5 / 2.9
∆g t
Notes. Tests are on the logs of variables. c≠0: presence of drift. β≠0: presence of linear trend. t(γ): estimated tstatistics for the null hypothesis H0 : γ=0. MacKinnon: critical values at 1% and 5% for N≈50 (MacKinnon, 1991).
14
MacKinnon’s critical values of the t-statistic for γ , t(γ), fail to reject the null γ =0: the four processes
in both regimes are random walks. Moreover, with the exception of unemployment, they all exhibit a drift
(c>0).22 Clearly, persistent, nonstationary, dynamics drive the long-run evolution of both regimes.
6.2 Disjunctions: theoretical claims and empirical evidence
The ubiquity of nonstationarity lays bare three core disjunctions between theoretical claims about
long-run dynamics and empirical evidence that at best captures short-run stationary dynamics. The
disjunctions require the adoption of the framework of cointegration to examine the rival claims about
long-run dynamics. As for the first disjunction, nonstationarity questions the validity of claims based on
magnitudes, or levels, which are typically captured by algebraic means. Such are the neoliberal claims
about the superiority of 19th -century laissez-faire Britain whereby higher levels of trade and smaller size
of government spending are associated with better economic performance. Algebraic means properly
describe stable levels associated with the inter-temporal equilibria of stationary series. However, as the
means of drift-driven series are time dependent and their inter-temporal equilibria undefined, their use is
mistaken and leads to spurious inference (King, et al., 1991; Nelson and Plosser, 1982).23 Drift from the
historical origin and the memory of shocks better describe the properties of the series (Patterson, 2000).
As for the second disjunction, nonstationarity challenges the validity of causal claims based on OLS
regressions. Such regressions at best capture short-run fluctuations of stationary variables.24 With
nonstationarity, OLS yields spurious findings that invalidate causal inference (Juselius, 1999; King et al.,
1991; Engle and Granger, 1987). While explicit and systematic comparisons of the two regimes remain
lacking, OLS regressions dominate the political economy research within the two regimes.25 Indirect
comparisons of the regimes from such research would yield misleading inferences about the persistence
of historical dynamics. The cointegration framework more appropriately captures historical persistence.26
As for the third disjunction, the nonstationarity of the individual processes also refutes naive claims
about the long-run instability of the two regimes. Neo-liberals tend to associate stability with stationary
converging series and instability with nonstationarity non-converging series. Clearly, for 19th -century
Britain, nonstationarity, especially of unemployment, challenges neo-laissez faire claims, based on
15
neoclassical tenets, of market-driven temporary fluctuations quickly and systematically converging to
inter-temporal equilibria. Instead, it lends support to neo-interventionist claims, inherited from Keynes,
about sticky non-clearing labor markets. Likewise, for post-World War II U.S., the nonstationarity of
unemployment and spending seemingly lends support to neo-laissez faire claims of instability and,
conversely, challenges neo-interventionist claims of state-driven stationary equilibria. However, such
claims of instability based on the nonstationary properties of the single series are mistaken: random walks
may exhibit long-run stochastic equilibria if, as a system, they are cointegrated—that is, historically
coevolving around common, or shared, stochastic trends (Engle and Granger, 1991).
7. Cointegration models: the worlds of laissez-faire and embedded liberalism
Given nonstationarity, the four-dimensional model capturing the neoliberal and neointerventionist
hypotheses needs to be recast in VECM form to capture the core persistent dynamics.
7.1 Cointegration model in VECM form
The standard VECM model takes the form
∆zt = µ + Π zt-1 + Γk∆zt-k + ΨDt + et
e t ~ IN(0, Σ).
zt is a vector of at most I(1) variables in levels and zt-1 is the lagged vector;
∆ zt, a vector of differenced stationary I(0) variables in changes and ∆ zt-k is the k-lagged difference;
Dt , a vector of deterministic, dummy, variables such as policy interventions and regime breaks;
Πzt-1 =αβ′zt-1 , a matrix describing the equilibrium relations (β′zt-1 ) and the adjustment mechanisms (α);
Γ k∆ zt-k, a matrix capturing short-run fluctuations that meander around the long-run equilibrium relations;
ΨDt , a matrix describing deterministic shocks—e.g., policy shifts and regime breaks.
This cointegration model allows the investigation of three dimensions of long-term dynamics: (i)
long-term stability stemming from common stochastic trends that drive the nonstationarity of the system;
(ii) equilibrium relations linking nonstationary, yet historically coevolving, variables; and (ii) dynamics of
adjustment to disequilibrium in the relations (see Appendix 2). The extension of cointegration to the
16
analysis of the regimes requires a reformulation of the four-dimensional model—which links the
evolution of the nonstationary trade, GDP, unemployment, and spending—in terms of long-run dynamics.
7.2 Regime stability and historical coevolution: the rank of Π.
Regime stability necessitates that the four nonstationary processes be cointegrated, or historically
coevolving, around the common stochastic trends driving the nonstationarity of the regimes. Debates
between neoliberals and neointerventionists suggest three equilibrium relations describing the long-run
evolution of GDP, unemployment and government spending around one common trend. The following
four-dimensional VECM model summarizes the three relations and the associated adjustment dynamics:27
∆ t t   0
  
∆ y t = α 21
∆ u  α 31
 t 
∆ g t  α 41
0
0 
α 22
α 23  
α 32
α 42
  ß11
 ß 21
α 33 
  0
α 43 
1
0
ß14
ß15
ß 22
1
0
ß 32
ß 33
1
0 
0 

 t t-1 
 y  e1t 
 t -1 e 2t
 ut -1 +  
  e3t 
 gt-1  
 tr  e 4t
The Π = αβ′ matrix has a rank of three (r=3): hence three cointegrated relations unfolding around
one stochastic trend drive the evolution of the two regimes. The β′ matrix describes the three relations,
which are theoretically normalized, or set to 1, for growth (yt-1 ), unemployment (u t-1 ), and spending (g t-1 ).
The α matrix captures adjustment mechanisms: market adjustments rely on GDP (α 2j ) and unemployment
(α 3j ); state adjustments, on spending (α 4j ). Trade, assumed to be exogenous to the system, does not adjust.
7.3 Distinctiveness of evolutionary paths : hypotheses of equilibrium relations (β ij)
How do market and state shape the evolution of the GDP, unemployment and government spending
relations in the two regimes? Neo-liberals and neo-interventionists agree that markets dominate evolution
in British laissez-faire liberalism whereas the state dominates in U.S. embedded liberalism. However,
they disagree on the relative efficiency of market and state. Table 7.1 summarizes the hypotheses:
17
Table 7.1: Hypotheses of cointegrated equilibrium relations in structural form
Relations
Regime
tt-1
yt-1
ut-1
g t-1
UK_yt-1 =
β 11 >0
β13 =0
β 14 =0
β′ y
US_yt-1 =
β 11 >0
β13 =0
β 14≠0
UK_ut-1 =
β 21 >0
β 22 <0
β24 =0
β′ u
US_ut-1 =
β 21 >0
β 22 <0
β24 =0
UK_gt-1 =
β31 =0
β 32 >0
β 33 >0
β′g
US_gt-1 =
β31 =0
β 32 >0
β 33 >0
Note. Normalized relations are in structural form by setting variables on the left side of equation.
tr
β 15 >0
β 15 >0
β25 =0
β25 =0
β35 =0
β35 =0
Spending relations: β′g. A basic agreement is shared: persistent bursts in GDP and unemployment
are associated with stronger expansions of spending in embedded liberalism than in laissez faire. Larger
wealth (0<β32.uk<β32.us ) and welfare (0<β33.uk<β33.us) effects capture the stronger associations.
Unemployment relations: β′u. A basic agreement is also shared: persistent trade expansions are
associated with long-term increases in unemployment (β21 >0), whereas persistent GDP expansions are
associated with long-term declines (β22 <0). However, given the more flexible labor markets in British
laissez faire, long-term associations are stronger for both trade (β21.uk>β21.us >0) and GDP (β22.uk>β22.us >0).
Growth relations: β′y. Disagreements are sharp. The first concerns the efficiency of spending
(β14≠0) in embedded liberalism. For neo-liberals, persistent spending expansions are negatively associated
with long-term growth (β14.uk<0); for neo-interventionists the association is positive, or growth inducing
(β14.us>0). A basic agreement is shared that in laissez-faire persistent spending increases are not associated
with long-run GDP growth (β14.uk=0). The second concerns the strength of the positive trade-GDP link:
for neo-liberals, persistent bursts in trade openness in laissez-faire are associated with stronger GDP
expansions (β11.uk>β11.us>0); for neo-interventionists, the association is stronger in embedded liberalism
(0<β11.uk<β11.us). The final disagreement concerns productivity shocks: neoliberals claim a higher trend
growth for British laissez faire (β15.uk>β15.us >0); neo-interventionists for U.S. (0<β15.uk<β15.us).
7.4 Hypotheses of adjustments to disequilibria: α ij
How do market and state adjust to disequilibrium shocks in the two regimes? Neo-liberals and neointerventionists share a basic agreement: market adjustments dominate laissez-faire liberalism; state
adjustments, embedded liberalism. Table 7.2 summarizes the hypotheses:
18
Table 7.2: Hypotheses of adjustment dynamics
β′ y
β′ u
β′g
UK
US
UK
US
UK
US
α
t
α11 = 0
α11 = 0
α12 = 0
α12 = 0
α13 = 0
α13 = 0
y
α21 < 0
α21 < 0
α22 > 0
α22 > 0
α23 > 0
α23 > 0
u
α31 < 0
α31 < 0
α32 < 0
α32 < 0
α33 > 0
α33 > 0
g
α41 =0
α41 > 0
α42 = 0
α42 > 0
α43 = 0
α43 < 0
Note. β′y, β′u, and β′g are the equilibrium relations distinctive to each regime. The α1j coefficients are set to zero on
the assumption that trade is weakly exogenous.
GDP relations: β′y. For laissez faire, positive deviations from long-run equilibrium (yt - β11 tt > 0)
indicate that GDP grows faster than, and inconsistently with, trade: trade contractions trigger
disequilibrium growth. Only markets adjust to re-establish equilibrium in the next period: (i) GDP
contracts (α 21<0); and (ii) unemployment declines because of higher growth (α 31 <0). Spending, assumed
to be historically unrelated to GDP, does not adjust (α 41.uk=0). Instead, for embedded liberalism both
markets and state contribute to re-establish equilibrium. Positive deviations (yt - β11 tt - β14g t > 0) indicate
that contractions of trade and spending contribute to disequilibrium. Markets adjust faster in laissez faire
Britain: GDP contracts faster (α 21.uk<α 21.us<0), and unemployment declines faster (α 31.uk<α31.us<0).
Spending instead expands to absorb excess GDP (? wealth) in embedded liberalism (α 41 >0).
Unemployment relations: β′u. Disequilibrium (u t - β21 tt + β22yt > 0) indicates that unemployment
grows inconsistently with trade and GDP. Trade expansions and/or GDP contractions trigger
disequilibrium. Market adjustments to re-establish equilibrium require higher growth (α 22 >0) and lower
unemployment (α 32 <0). Market responses are faster in laissez-faire: GDP expands faster (α 22.uk>α22.us>0),
and unemployment declines faster (α 32.uk<α 32.us<0). State interventions play starkly different roles in the
two regimes: in embedded liberalism, spending increases with higher unemployment (α 42.us>0); in laissez
faire, no adjustments occur, as spending is unrelated to unemployment (α 42.uk=0).
Spending relations: β′g. Disequilibrium (g t - β32 yt - β33u t > 0) ensues either because GDP contracts
and/or because unemployment declines. Market adjustments require higher GDP growth (α 23 >0) and/or
higher unemployment (α 33 <0). Adjustments are faster in laissez-faire Britain: for GDP (α23.u k>α 42.us>0),
19
and for unemployment (0<α 33.us<α 33.uk). For adjustments in spending, the disequilibrium triggers a
contraction of expenditures but the adjustment would be faster in the U.S. (α 43.us<α 43.uk<0).
8. Empirical findings
Cointegration tests yield three major findings. 28 First, both regimes exhibit long-term stability: one
common trend, around which three cointegrating equilibrium relations unfold, drives their nonstationary
evolution. Second, for the equilibrium relations, state dominance in post-World War II U.S., not market
dominance in 19th -century Britain, is associated with higher economic growth and better social protection.
Third, for the adjustment dynamics, the state is crucial in maintaining the unique equilibria in both
regimes. These dynamics challenge neo-liberal claims on the inefficiency of embedded liberalism.
8.1 Regime stability: rank of Π and common trends
Are the two regimes stable over the long run? Regime stability requires that the nonstationary series
be cointegrated—or coevolving around common stochastic trends spanning the history of the regimes.
Tests of the rank of Π, shown in table 8.1, lend no support to rival claims of instability—instability of
embedded liberalism for neoliberals, and instability of laissez-faire liberalism for neointerventionists.
Table 8.1: Eigenvalues of companion matrix
Modulus for Britain
Modulus for U.S.
Unrestricted
Restricted
Unrestricted
Restricted
0.8669
1.0000
0.9057
1.0000
0.4366
0.6702
0.8071
0.8448
0.4336
0.6702
0.8071
0.7376
Notes. ‘Unrestricted’: eigenvalues without initial rank restriction. ‘Restricted’: rank restriction with r=3. Only the
largest three roots are reported. Appendix 3 describes the properties of the initial VAR for cointegration.
With one root at unity, the eigenvalues of the companion matrix indicate that Π has a rank of three
(r=3): hence, one common trend, around which three stationary relations unfold, drives the evolution of
the regimes. Regardless of the dominance of market and state, both regimes are stable over the long run.
8.2 Uniqueness of equilibrium relations: β′zt
Given regime stability, how do market and state uniquely shape the equilibrium relations for GDP,
unemployment and spending in the two regimes? Tests challenge neo-liberal claims about the inefficiency
of state interventions: markets do drive the evolution of 19th -century laissez-faire whereas the state drives
20
the evolution of post-World War II embedded liberalism; yet, “positive” state interventions contribute to
long-term growth and social protection in embedded liberalism. Table 8.2 summarizes the findings:
Table 8.2: Long -run cointegrated equilibrium relations
Relations
tt-1
yt-1
ut-1
g t-1
tr
war
S82
UK_yt-1 =
+0.11
0
0
+1.8
0
-β′ y
US_yt-1 =
+0.12
0
+0.40
+3.1
-0
UK_ut-1 =
-4.5
-1.2
0
0
0
-β′ u
US_ut-1 =
+5.4
-5.1
0
0
-+1.7
UK_g t-1 =
0
+0.40
+0.17
0
+0.95
-β′g
US_g t-1 =
0
+0.20
+0.30
0
-+0.12
Notes. Variables are in logs. war: Boer War (1900-02). S82: step dummy capturing the long-term effects of the
‘Reagan-Volcker legacy’ on the unemployment and spending relations. Coefficients are significant at p=0.01 level.
LR test of restrictions χ2 (8): (i) UK: 6.4 [0.598]; (ii) US: 4.2 [0.524].
β′y: GDP relations. The relations challenge three central neo-laissez faire claims. The first, about
the inefficiency of “positive” state interventions, is unwarranted. Spending in British laissez-faire is
historically unrelated to economic growth (β14.uk=0). However, in post-World War II U.S. persistent
spending expansions are associated with long-term growth (β14.us=0.40). The second, about the
superiority of growth-inducing trade globalization in 19th -century laissez faire, is also unwarranted: the
two hegemonic powers exhibit similar long-run positive trade-growth links (β11.uk=0.11≈ β11.us=0.12). The
third, about the “unrivaled” long-run growth in the 19th century, is indefensible: trend growth is more than
1% higher in post-World War II U.S. (β15.uk=1.8<β15.us=3.1).
β′u: Unemployment relations. Three are the crucial findings. First, the two regimes differ
fundamentally with regard to the role played by trade openness. In 19th -century British laissez-faire,
persistent trade expansions are associated with long-term declines in unemployment (β21.uk -4.5). This
tradeoff suggests the existence of long-term business cycles linking trade and unemployment. In postWorld War II U.S. embedded liberalism, trade expansions are associated with long-term increases in
unemployment (β21.us=+5.4). This positive link is consistent with theories of modernization and
deindustrialization (Cameron, 1978; Iversen, 2001). Second, GDP exhibit long-run business cycle
patterns in both regimes: persistent economic expansions are associated with long-term declines in
unemployment, but the association is stronger in the U.S. (β22.us=-5.1>β22.uk=-1.2). These differences in
21
the unemployment relations reveal two starkly different political-economy regimes. The dependence of
unemployment and GDP, from trade supports the hypothesis of the modulating of the domestic from the
international economy in British laissez-faire (Ruggie, 1982). Finally, the Reagan-Volcker legacy since
the early 1980s shifted upward the equilibrium level of the unemployment relation (β26.us=+1.7), which
captures a shift in the objectives of embedded liberalism.
β′g: Spending relations. The relations challenge neoliberal claims of stronger wealth and welfare
effects in embedded liberalism. Persistent shocks in unemployment are more strongly associated with
long-term increases in spending in the U.S. (β32.uk=0.17<β32.us =0.28). Instead, shocks in GDP are more
strongly associated with spending increases in laissez-faire Britain (β32.uk0.40>β32.us=0.16). Thus, the
positive long-term associations linking government spending to GDP and unemployment are not unique
to embedded liberalism. They were operative already in 19th -century laissez-faire Britain (Flora et al.,
1981). Finally, the Reagan-Volcker legacy shifted upward the equilibrium level of the spending relation
(β36.us=+0.12). This shift is consistent with the upward shift in the unemployment relation, but it hardly
matches the magnitude of the shift in unemployment (β26.us=+1.7). This finding lends corroboration to the
hypothesis of neoliberal retrenchment of the welfare state (Pierson, 1994).
8.3 Adjustment dynamics: α ij
How do market and state contribute to maintain equilibrium in the two regimes? Tests do not support
hypotheses of dominant market adjustments in laissez-faire and dominant state adjustments in embedded
liberalism. State interventions play crucial roles the both regimes. Table 8.3 summarizes the findings:
Table 8.3. Adjustment dynamics
β′y
β′u
β′g
Britain
U.S.
Britain
U.S.
Britain
U.S.
α
t
α11 = 0
α11 = 0
α12 = 0
α12 = 0.05
α13 = 0
α13 = 0
y
α21 = -1.0
α21 = 0
α22 = -0.03
α22 = 0.03
α23 = 0
α23 = 0
u
α31 = +7.8
α31 = 0
α32 = 0
α32 = -0.2
α33 = 0
α33 = +1.7
g
α 41 = +1.4
α 41 = +0.4
α 42 = 0
α 42 = -0.02
α 43 = -0.2
α 43 = -0.3
Notes. The αij are speed of adjustment parameter. Larger αij indicate faster response to disequilibrium. αij = 0 imply
that variables do not contribute to re-establishing equilibrium. All αij ≠ 0 are significant at the p<0.05 level.
22
State adjustments. The last row (α 4j ) reveals the crucial role of the state (g) in maintaining the
long-run equilibria in both regimes. First, in the presence of a one-unit positive deviation of GDP (β′y)
from long-run equilibrium, spending increases to eliminate the disequilibrium growth and restore
equilibrium GDP. However, the form of adjustments differs across the two regimes. The U.S. exhibits a
pattern of gradual convergence that absorbs 40% of disequilibrium within the first year (α41.us>0.4).
Instead, Britain exhibits oscillatory dynamics of convergence (α 41.uk>1.4). Second, the disequilibrium
growth in spending (β′g) is met by comparable slow gradual declines in spending (α 43.uk=-0.2≈α43.us=0.3): respectively for Britain and the U.S., 20% and 30% of the disequilibrium is absorbed after one year.
And third, for the disequilibrium growth of unemployment (β′u), spending adjusts very slowly only in
post-World War II U.S. (α 42.us=-0.02): about 2% of the disequilibrium in unemployment is absorbed after
one year. Spending does not adjust to disequilibrium in unemployment in laissez-faire Britain. Clearly,
however, the widely held belief that the state is absent from the long run evolution of 19th -century laissezfaire is a myth. Government spending contributes to maintain market-driven equilibria in laissez-faire
liberalism as well as state-steered equilibria in embedded liberalism.
Market adjustments. They are distinctive to the regimes. First, only Britain exhibits adjustments to
the disequilibrium growth of GDP (β′y). GDP contracts fast: 100% of disequilibrium is absorbed within
one year (α21 =-1.0). Instead, unemployment, as if foreboding a looming recession with GDP well above
equilibrium, expands very fast (α31 =7.8) and thereafter generates an oscillatory dynamics of convergence.
The U.S. exhibits no market adjustments: only government spending re-establishes the equilibrium of the
GDP relation. Second, the disequilibrium growth in unemployment (β′u) in Britain only shows
adjustment in GDP: the higher than equilibrium unemployment also appears to forebode economic
recessions that result in slow GDP contractions (α 22 =-0.03). Instead, the U.S. meets disequilibrium with
market stabilizations: GDP increases, albeit very slowly (α 22 =0.03), and thus contributes to lower
unemployment; and unemployment declines moderately slowly (α 32 =-0.15). Crucially, trade also adjusts
(α 12.us=0.05), indicating that U.S. trade is not exogenous to domestic conditions (Ruggie, 1982; Keohane,
23
1984). Finally, for the disequilibrium growth of spending (β′g), market adjustments, via unemployment,
appear only in the U.S.: unemployment adjusts with a dynamics of converging oscillations (α 33.us =+1.7).
9. Discussion
Conclusions. Four major conclusions can be drawn about the debates between neo-liberals and neointerventionists concerning how market and state shape the long-run coevolution of economic
performance and social protection during the globalization waves associated with 19th -century British
laissez-faire and post-World War II U.S. embedded liberalism. The first concerns regime stability. The
ubiquity of cointegration—whereby the four random walk processes historically coevolve around a
common stochastic trend—challenges claims about unstable dynamics that inform doomsday scenarios of
disintegration elaborated by neo-liberals and neo-interventionists alike (James, 2000). While the two
regimes differ significantly with regard to the dominance of market and state, they exhibit stable long run
dynamics—at least for the sample period. Both regimes represent two viable historical experiments.
The second conclusion concerns the relative superiority of market and state in generating better longrun economic performance and social protection in the two regimes. The equilibrium relations challenge
core neo-liberal claims about the superior efficiency of markets in laissez-faire while lending support to
neointerventionist claims about the efficiency of “positive” state interventions. Market dominance in
laissez-faire Britain is associated with lower growth, weaker social protection, and, crucially, persistent
unemployment. Instead, state-steered markets in post-World War II U.S. are associated with higher
growth and better social protection—the sticky unemployment notwithstanding. Neoliberal beliefs in the
efficiency of unfettered markets and in the inefficiency of state interventions appear to be a myth.
The third conclusion concerns the role of market and state in maintaining long-term equilibria.
Adjustment dynamics challenge core neo-liberal beliefs, ironically also shared by neo-interventionists,
that markets provide the key mechanisms to reestablish equilibria in 19th -century laissez-faire whereas
‘positive’ state interventions do so in embedded liberalism. The state adjustments are ubiquitous and
24
contribute significantly to maintain the long-run equilibria of both regimes. Hence, the belief that the state
is absent from the long run evolution of 19th -century laissez-faire also appears to be a myth.
Finally, the long-run dynamics challenge the policy lessons neoliberals want to draw from the past.
The equilibrium relations suggest that the political project “to go back to the future”—by re-engineering
novel forms of laissez-faire akin to those of 19th -century Britain—would mean a reversion to a world with
lower long-run economic growth, sticky unemployment and weak social protection. Yet, the adjustment
dynamics reveal that this laissez-faire world would still require “negative” state interventions to maintain
the market-driven equilibria. They also reveal that unemployment bears the brunt of adjustments during
protracted periods of depressions. Instead, the neo-interventionist project “to go forward to the future”—
by maintaining political control of domestic and global markets that thus far seems to have served well
the post-World War II embedded liberalism in the U.S.—promises superior growth and social protection.
Persistent unemployment remains as puzzling for embedded liberalism as for laissez faire liberalism.
Extensions. Four main extensions would further enhance comparisons of the two regimes. The first,
beyond trade openness, would consider two additional dimensions of globalization—finance and
migration—that have significantly shaped the evolution of the two regimes. Globalization of finance
draws a clear wedge between the 19th -century Gold Standard monetary regime and the post-World War II
sequences of fixed and flexible monetary regimes (Baldwin and Martin, 1999; Hirst and Thompson,
1999; Bordo, 1993; Zevin, 1992; Neal, 1992; Eichengreen, 1985). Migration played a significant role in
creating the 19th -century transatlantic economy and is playing now an as significant role in the SouthNorth relations (Strickwerda, 1999; O’Rourke and Williamson, 1999; Aghion and Williamson, 1998;
Wood, 1994). The second, data availability permitting for the 19th -century regime, would consider, as
growth theory suggests, the components of government spending—e.g., investment, welfare, and
military—as well as taxation. The third would include additional variables, whic h loom large in political
economy research, to enhance explanations of economic performance and social protection. The real
wage would shed light on the supply side of the economy and on issues of social inequality (Aghion and
Williamson, 1999; Bairoch, 1993). Investment is crucial to better understand for economic growth (Barro
25
and Sala -i-Martin. 1995). 29 The fourth would investigate other countries in each regime as they can differ
significantly from those of the hegemons due to distinct political institutions sanctioning the power
relations between governments, labor unions and business. Such differences inform the rich political
economy research on post-World War II embedded liberalism (Swank, 2002; Pierson, 2001; Huber and
Stephens, 2001; Garrett, 1998; Keohane and Milner, 1996). They also inform the incipient research on
19th -century laissez-faire (Cornwall and Cornwall, 2001; Aghion and Williamson, 1999; Verdier, 1994).
Contributions. The analyses of the two regimes contribute to several theoretical and methodological
debates in political economy. One set of debates concerns the specific hypotheses investigated in the fourdimensional models, which are now cast in terms of long-term cointegrated dynamics. First, analyses lend
support to the positive trade-growth relation—trade openness is associated with long-term growth—in
both regimes (Franklel and Romer, 1999). Second, the trade-unemployment relation—trade openness
associated with long-term increases in unemployment—finds support only for post-World War II
embedded liberalism. In 19th -century Britain, unemployment fluctuates, as in international business
cycles, with the booms and busts of trade. This crucial difference in the dynamics linking the international
and the domestic dimensions ought to be investigated. Third, the negative GDP-unemployment relation—
improving economic conditions associated with lower unemployment—also finds support only for
embedded liberalism. No such link appears in 19th-century Britain, where the dynamics of unemployment
depends solely on trade shocks. The link of unemployment and GDP on trade supports the hypothesis of
the greater dependence of the domestic economy from globalization (Ruggie, 1982; Keohane, 1984a).
Fourth, Wagner’s hypothesis—spending increases with income—finds support in both regimes. Similarly,
welfare effects support the hypothesis that social protection imperatives shape the long-run growth of the
public sector in both regimes. The growth of the public sector is a fundamental characteristic of capitalist
development (Flora and Heidenheimer, 1981). Finally, the efficiency of the spending-growth relation in
embedded liberalism supports new growth theories: spending is not inimical to long-term growth.
A second set of debates concerns the long-term stability and viability of embedded liberalism. The
long-run dynamics support the hypothesis that the weakening of embedded liberalism thus far involves
26
changes in objectives and instruments of state intervention but not, more profoundly, its normative
structure (Ruggie, 1998, 1982; Keohane, 1984). The equilibrium relations unfolding around the common
stochastic trend span the entire post-World War II era and therefore do not suggest a rupture in the
normative structure. Instead, the breaks at the onset of the 1980s suggest changes in objectives and
strategies: the shifts in the unemployment (objective) and spending (means) relations have contributed to
disembed labor markets and decommodify social life. Related, the persistence of the equilibrium relations
coupled with the co-breaking of the unemployment and spending relations in the early 1980s indicate that,
as yet, both “retrenchment” and “new politics” of the welfare state concern objectives and strategies of
intervention but not the normative structure of embedded liberalism (Pierson, 2001, 1996, 1994). Finally,
the analyses contribute to debates over the fear of a backlash leading to the implosion of globalization
(Bhagwati, 2002; Dollar and Kraay, 2002; Williamson, 1998a; Rodrik, 1997). At least for the U.S., the
conflict between the efficiency requirements for growth and the imperatives of social protection appears
to be unfounded. The interaction of market and state in embedded liberalism appears to generate superior
economic growth and social protection and may best preempt feared backlashes against globalization.
A third set of debates concerns the significance of cointegration for the investigation of historical
dynamics. The analyses of the two regimes lend strong support to recent critiques concerning the
disjunction between theoretical claims about persistent dynamics and methodologies that at best capture
temporary fluctuations (Juselius, 1999; Granger, 1997). The framework of cointegration in VECM form
best accomplishes comparisons of the long-run evolution of the two regimes. It better captures the
complexity of persistent historical dynamics—stochastic trends, equilibrium relations, and adjustment
mechanisms—stemming from feedbacks. More broadly, the cointegration framework contributes to the
emergent rich research, which, in the contexts of historical institutionalism and evolutionary theories,
investigates historical time, not the a-historical stationary time that inform neoclassical approaches
(Büthe, 2002; Abbott, 2001; Cederman, 2001; Pierson, 2000; Hodgson, 1996; Arthur, 1995; Nelson,
1995). Specifically, it helps investigate the macro-historical dynamics of the rich family of nonstationary,
yet historically coevolving, processes that appear to be so common in political economy.
27
Appendix 1: Properties of stationary and nonstationary series
Persistence hinges on the concepts of stationary and nonstationary series (Box and Jenkins, 1994).
Formally, the properties of a series, zt , are described by an autoregressive process of order one, or AR(1):
zt = c + ρ1 zt-1 + εt .
c is a constant; ρ1, the autoregressive parameter, describes lagged patterns of historical inheritance; εt is a
random disturbance term. The table below summarizes the basic statistical properties—mean (µ), variance
(σ2 ), autocovariance (γs) and the autoregressions (ρ1 )—of stationary and nonstationary series:
Table 5.1: Properties of time series processes
Stationary
Nonstationary
Drift-driven
Drift-less
Mean (µ)
µ = c/(1-ρ 1 )
µ = z0 + c0 t
µ = z0
Variance (σ2 )
σ2 /(1-ρ 2 )
tσ2
tσ2
2
Autocovariance (γt-s )
γs
(t-s)σ
(t-s)σ2
AR(1) (ρ 1 )
|ρ 1 | < 1
ρ1 = 1
ρ1 = 1
Notes. µ: mean. σ2 : variance. γs : autocovariance. ρ 1 : first autocorrelation. z0 : origin of series. t : time. t-s: lags.
zt is stationary if it converges quickly and systematically toward an inter-temporal equilibrium. The time
independence of its mean, variance, and autocovariances ensures stationarity. The mean, µ = c/1-ρ1 , describes
the long-run equilibrium. Given finite variance (σ2 /(1-ρ2 )) and quickly decaying autocovariances (γs ) and
autocorrelations (ρs), past shocks (εi) converge toward the stable inter-temporal equilibrium. Formally, |ρ1 |<1
captures the stationarity, or stability, condition for an AR(1) process.
zt is a nonstationary random walk with drift if it does not have inter-temporal equilibrium to which to
converge. The mean (µ = z0 + c0 t) is time-varying: the drift c0 t describes cumulating patterns of growth/decay
starting from historical origins (z0 ). Moreover, as the variance (tσ2 ) tends toward infinity and the covariances
((t-s)σ2 ) and autoregressions (ρ1 =1) do not decay, past shocks, ε i, integrate historically in the memory of
processes and contribute to the persistent dynamics of growth and decay.
zt is a random walk without a drift if c=0. The mean µ = z0 is time invariant and corresponds to its origin
z0 . However, given time-dependence of variances and covariances, stochastic shocks εi also have persistent
effects and zt unfolds with long, sticky, stochastic waves around z0 . Given the stochastic properties of waves,
the series has no meaningful inter-temporal equilibrium to which it converges systematically and quickly.
28
Appendix 2: Properties of cointegrated processes
Hypothesis of cointegration. Cointegration assumes stationarity of a set of nonstationary variables
in zt by linear combination. The hypothesis of cointegration is formulated as a reduced rank of the Πmatrix, such as Η1 (r): Π = αβ′, where α and β are p × r matrices of full rank. The hypothesis implies that
∆zt is stationary, zt is nonstationary, but β′zt is stationary (Johansen, 1991). The β′zt components are
interpreted as stationary I(0) relations among nonstationary I(1) variables that unfold around one or more
common stochastic trends. Eigenvalue tests indicate the number of common trend driving the system.
Equilibrium relations: β′zt-1. Two conditions ensure long-run stationary equilibria to which
nonstationary variables converge over time. First, there exist linear combinations of nonstationary
variables that are stationary (Engle and Granger, 1987). The matrix β′zt-1 represents up to (n-1)
equilibrium relations linking the evolution of such varia bles—n being the number of variables in zt .
Second, cointegrated variables share common stochastic trends that drive their joint long-run evolution
(Stock and Watson, 1988). The series share a history because they evolve around such trends. Long-term
equilibrium is at β′zt-1 =0 (Johansen, 1991).
Adjustment dynamics: α. The equilibrium relations in β′zt-1 represent long-run steady states, or
attractors toward which the system adjusts when shocks push it away from equilibrium. The common
trends impose limits as to how far the jointly endogenous processes may wander from one another.
Deviations of any variable from long-run equilibrium, given by β′zt-1=0, disrupt the steady states.
Disequilibrium emerges in the next period if β′zt≠0 because one or more variables grow or decay
inconsistently with long-run equilibrium. To close the gap, and reestablish equilibrium, some variables
must respond to disequilibrium. The α matrix describes both the direction and the speed of adjustment of
how variables in zt adjust to disequilibrium. Larger α ij indicate faster adjustments. If αij =0, then the
variables are weakly exogenous: they are unresponsive to disequilibrium and do not adjust.
Short-run dynamics: Γ. They capture temporary fluctuations that meander around the long-run
dynamics. The matrix Γ k = − (I − A1 − … − Ak ) describes the short-run fluctuations in ∆zt-k .
29
Appendix 3: Goodness of fit of initial VAR.
UK: 1865-1913.
Three characteristics of the preliminary cointegration VAR (Vector
AutoRegressive) insure vector white noise residuals: (i) an unrestricted constant and a linear trend (tr)
restricted in the cointegrated space to allow for non-zero drifts; (ii) a step-dummy, which describes the
hump of the 1890-93 Boer war (War), entered restricted to capture a deterministic shock; (iii) one lag for
model reduction. The table below summarizes the diagnostic tests of the goodness of fit for the VAR:
Diagnostics: vector system goodness of fit for 19th-century UK
Portmanteau
AR 1-2
Normality
Heteroskedasticity
Model reduction (lag 1)
Lag(6)
Fv ar(32,115)
χ2v (8)
Fv het (120,169)
107.794
1.3584 [0.1224]
5.7212 [0.6784]
0.55342 [0.9997]
0.81220 [0.6723]
Note. Portmanteau: autocorrelations for 6 lags; Fvar : serial correlation for the first two lags;
χ 2v: normality. Fvhet: heteroskedacity (Hendry and Mizon, 1993, 1998).
Tests fail to reject the null of serially correlated, non-normal, and heteroskedastic residuals. In
recursive estimation of the system, 1-step and break-point Chow tests indicate temporal stability.
US: 1955-1999. Tests cover the 1955-1999 period to skip the confounding effects of the Korean
War. Three characteristics insure vector white noise residuals: (i) an unrestricted constant and a restricted
linear trend (tr); (ii) a step dummy, entered restricted in the cointegrating space, to capture the structural
break linked to the Reagan-Volcker ‘regime’ at the onset of the 1980s (S82); (iii) two lags for model
reduction. The table below summarizes the diagnostic tests of the goodness of fit for the VAR:
Diagnostics: vector system goodness of fit for Post-World War II U.S.
Portmanteau
AR 1-2
Normality
Heteroskedasticity
Model reduction (lag 2)
Lag(6)
Fv ar(32,86)
χ2v (8)
Fv het (180,73)
80.4316
0.91947 [0.7328]
10.572 [0.2272]
0.57456 [0.9984]
0.81220 [0.6723]
Tests fail to reject the null hypotheses of serially correlated, non-normal, and heteroskedastic
residuals. Both 1-step and break-point Chow tests from recursive estimation establish constancy.
30
Figure 1. Time series
U.K.
60
25
Trade
U.S.
Trade
20
55
15
50
10
1870
100
1880
1890
1900
1910
1960
10000
GDP
1970
1980
1990
2000
1970
1980
1990
2000
1970
1980
1990
2000
1970
1980
1990
2000
GDP
7500
75
5000
50
2500
1870
10
1880
1890
1900
1910
1960
10.0
Unemployment
Unemployment
7.5
5
5.0
1870
10
1880
1890
1900
1910
Expenditures
1960
30
8
Expenditures
25
6
1870
1880
1890
1900
1910
1960
31
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NOTES
1
The concepts of laissez-faire and embedded liberalism rely on Ruggie’s theory of regimes (Ruggie,
1997, 1982). The concepts have gained wider application in non-academic writings as well as in
economic and policy analyses (Ruggie, 1998; Rodrik, 1997; Garrett, 1995).
2
Neointerventionists form a heterogeneous group: e.g., (i) self-professed neoclassical economists who
now believe that capitalism is subject to structural political conflicts over the requirements of
international competitiveness and the imperatives of social protection (Rodrik, 1997); (ii) new
Keynesians who, beyond instabilities triggered by political conflicts, hold that structural changes leads
to periodic yet persistent breakdowns in economic performance (Cornwall and Cornwall, 2001); (iii)
Third-Way social philosophers and political activists (Gray, 1998; Giddens, 1998; Reich, 1992); (iv)
disillusioned liberals (Soros, 1998; Friedman, 1999); (v) communitarians who also blame globalization
for destroying national independence and democratic self-rule and therefore advocate return to a world
of self-sufficient closed communities (Klein, 2002; Sandel, 1996; Etzioni, 1994); and (vi) populists who
blame globalization, especially of trade and labor, for its negative effects on long-term unemployment,
increasing labor market inequalities, and social protection for the exposed strata of the population, and
ultimately support protectionism (Mény and Surel, 2002; Buchanan, 1998; Lemert, 1996).
3
The diachronic comparisons only focus on the properties of globalization as economic phenomenon:
e.g., (i) 19th -century globalization is as an encompassing as in the post-World War II era (Vasquez,
2000; Sacks and Warner, 1995; Zevin, 1992); (ii) post-World War II globalization is more
encompassing (Bordo, et al., 1998; Bordo et al., 1999; Lawrence et al., 1996); (iii) quantitative
comparisons of the two globalization waves are unreliable because trade and financial aggregates
conceal features that render comparisons misleading (Krugman, 1995).
4
For the problems of such disjunction in economics see Juselius (1999). Section 4 discusses
nonstationarity, by which historical processes exhibit persistent, or long-memory, drifts and waves.
44
5
A rich literature has recently retraced these interwar debates (Allen, 1996; Cochran and Glahe, 1999;
Shearmur, 1996; Hayek and Caldwell, 1995; Mankiw, 1990). However, the roots of these debates
extend well into the 19th -century, especially in the context of British liberalism: classical liberals—
Bentham, Mill, Smith, Malthus Ricardo—shared a faith in the economic and social efficiency of
unfettered markets as well as the rejection that the state could ameliorate socioeconomic dislocations;
social liberals—Green, Hobhouse, Hobson and Bonsaquet—advocated legislation that provided social
protection against market dislocations (Richardson, 2001; Coats, 1971).
6
In economics, the ‘end of the business cycle’ captured the success (Okun, 1975). Yet, Hayekean ideas
continued to inform academic and popular writings (Friedman and Schwartz, 1963; Friedman, 1962).
7
Three critiques are central: (i) new classical theories challenging the efficiency and effectiveness of
Keynesian policies (Sargent and Wallace, 1975; Friedman, 1968); (ii) neo-conservative social theories
of malignant interests group formation resulting in inefficient public sectors (Alesina and Perotti, 1998;
Olson, 1982; Crozier et al., 1974); and (iii) public choice theories of responsive but irresponsible
governments (Buchanan, 1977; Alt and Shepsle, 1990).
8
For Hayekean evolutionary principles see Hayek (1996), and Birner and Van Zijp (1994).
9
The research on “post-industrialism” provides a second criticism to the hyper-globalization thesis: not
globalization, but post-industrial processes—demographic shifts in population ageing, family structure,
female labor participation, and skill-biased unemployment—explain state intervention in embedded
liberalism (Pierson, 2001, 1998, Iversen, 2001). This paper does not address this debate.
10
The metaphor ‘to go back to the future’ is borrowed from Bordo et al. (1999).
11
Realism focuses on how power relations among states shape the prospects for the emergence of regimes
(Grieco, 1990; Gilpin, 1987, 1981; Krasner, 1983; Kindleberger, 1981; Waltz, 1978). In its formulation
of hegemonic stability, which is crucial in this research, the hegemonic power takes the lead in
establishing and maintaining the regime in which it has a stake. Neoliberal institutionalism focuses on
how regimes help states realize common interests (Keohane, 1993, 1989, 1984; Ruggie, 1998, 1982).
45
Cognitivism, in its “constructivist” form, focus on the social character of international relations, and on
how inter-subjective social knowledge constitutes states and regimes (Wendt, 1994, 1992).
12
Political economy research on the Post-World War II era focuses on these four processes (Garrett,
1998; Boix, 1998; Swank, 2001; Iversen, 2001). So does the political economy research on the 19th century (Craft, 1997, O’Rourke and Williamson, 1999; Williamson, 1998b). However, models rely on
single-equations, which fail to capture interrelations and feedback (Midtbø, 1999). As is standard, trade
is treated as exogenous since the objective is to investigate its effects on the domestic economy. Trade
can be made endogenous to other variables: e.g., technological innovation (O’Rourke, 1999); inter-state
competition resulting in different choice of trade policies (O’Rourke, 2000; Pahre, 1998; Frieden and
Rogowski, 1996; Rogoswski, 1989); the evolution of international markets (Clark, 1997).
13
For trade openness, its operationalization and measurement remains controversial (Edwards, 1998).
This paper focuses on the most widely used measure: the trade-to-GDP ratio.
14
Several hypotheses have linked trade openness to the expansion of the public sector via risk-mitigating
social expenditures): modernization (Cameron, 1978); post-war compromise of embedded liberalism
(Ruggie, 1982); adaptive responses of small but highly open economies (Katzenstein, 1985);
deindustrialization (Iversen 2001; Rodrik, 1998; Wood, 1994).
15
The literature on the growth-openness connection has posited positive effects of trade on growth
(Bhagwati and Srinivasan, 1985). Recent theories of growth, pioneered by Romer (1986) and Lucas
(1988), focus on trade-induced positive effects of R&D, increasing returns to scale, and technological
spillovers (Grossman and Helpman, 1991; Romer, 1990; Krugman, 1990). In empirical research, the
growth-openness connection remains unsettled. Most of the research for the post-World War II era
supports the hypothesis of positive impact (Frankel and Romer, 1999; Edwards, 1998; Barro and Sala -iMartin, 1995; Sachs and Warner, 1995). However, recent studies question the validity of evidence from
growth regressions (Rodriguez and Rodrik, 1999; Sala -i-Martin, 1997). Evidence is ambiguous for the
second half of the 19th century (O’Rourke, 2000; Bairoch, 1993).
46
16
The research on the trade-unemployment relation has long posited short-run negative effects on
unemployment but long-run positive effects (Greenaway and Nelson, 2001; Aghion and Williamson,
1998; Krugman, 1995; Wood, 1994). Competition with low-wage economies weakens demand of the
less skilled resulting in wage deterioration and unemployment. Research on skill-biased unemployment
challenges the hypothesis (Iversen, 2001).
17
For neorealist theories of hegemonic stability see Gilpin (1987, 1981), Kindleberger (1981) and Waltz
(1978). For liberal institutionalism see Keohane (1993, 1989, 1984) and Ruggie (1998, 1982). For
constructivism see Wendt (1994, 1989).
18
Three pieces of legislation institutionalised the principles of laissez faire: (i) the Poor Law Amendment
Act of 1834 facilitated the flexibility of labor markets (Taylor, 1972); (ii) the Peel’s Bank Act of 1844
launched the Gold Standard monetary regime (Eichengreen, 1985); (iii) the Anti-Corn Law Bill of 1846
and the Cobden-Chevalier treaty of 1860 set in motion international trade (Cit.).
19
As Gilpin notes, “If the United States does not resume its leadership role, the Second Great Age of
Capitalis m, like the first, is likely to disappear.” (Gilpin, 2000, p.357).
20
For Britain, data are for the 1865-1913 period. The onset at 1865 eliminates the confounding effects of
the Crimean War while capturing the free trade drives of the 1860s. Trade and government expenditures
are from Mitchell (1998); real GDP, from Backus and Kehoe (1992); unemployment, from the Office
for National Statistics (1999). For the U.S., data for 1955-1999 come from Economagic (2001). The
start at 1955 eliminates the effects of the Korean War. Trade is exports (expgs) plus imports (impgs) as a
ratio of nominal GDP (gdpn). Government spending is federal expenditures (afexpnd) net of federal
grants in aid to state and local governments (afgl) as a percentage of GDP. Real GDP is gdpc.
21
Phillips-Perron tests yield similar results (Phillips and Perron, 1988). Tests are performed in Eviews.
22
The validity of these tests is corroborated by established tests of persistence (Fatás, 2000; Gil-Alana
and Robinson, 1997; Cochrane, 1988; Nelson and Plosser, 1982). Unemployment (u t ), in the U.S. as
well as in Britain despite the higher frequency fluctuations, is a random walk (cuk=0).
47
23
Caution is required even with the means of stationary series, µ = c/(1-ρ1 ) as they vary significantly with
the values of ρ1 . Assume c=4: with ρ 1 =0.2, the mean of the series is 5; with ρ 1 =0.8, the mean is 20. Such
equilibrium is mathematically undefined: given ρ 1 = 1, µ = c/(1-ρ 1 ) yields µ = c/ 0. The logic can be
extended to drift-less random walks, the inter-temporal equilibrium of which is also undefined.
24
The argument holds for the equally fashionable correlations.
25
The dominance of the OLS is clear in the research on post-World War II embedded liberalism (Swank,
2002; Huber and Stephens, 2001; Rodriguez and Rodrik, 1999; Garrett, 1998; Boix, 1998; Rodrik,
1997). It is as clear in the research on 19th -century laissez-faire regimes (O’Rourke and Williamson,
1999; Craft, 1997; Williamson, 1996; Verdier, 1994; Rowe et al., 2002).
26
Two exemplary, yet unsatisfactory, strategies are identifiable (Freeman, 1998). The first models levels
but includes an AR(1) term to control for persistence (Swank, 2002; Garrett, 1998; Boix, 1998). This
strategy is noninformative about persistence and yields ‘spurious’ regressions. The second models
stationary first-differences that obliterate historical persistence (Alesina and Perotti, 1998; Midtbø,
1998). Research on the 19th century largely relies on OLS regressions. Scant cointegration approaches
remain confined to single -equation ECM modelling (Swank, 2002; Iversen, 2001).
27
As debates are about long-run dynamics, short-run fluctuations (Γ k ) are not examined in this paper.
28
Estimation is done in PcFiml 10.0 (Doornik and Hendry, 2000).
29
Increasing the dimensionality of the model would not change significantly findings.