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International Political Economy: Interests and Institutions in the Global Economy OATLEY, CHAPTER 1 International Political Economy (IPE) IPE studies life in the global economy Focuses on political battle between the winners and losers from economic exchange Economic gains are not equally distributed among individuals Although all societies benefit from participation in the global economy, these gains are not distributed evenly among individuals. Global economic exchange rates raises the income of some people and lowers the income of others. International Political Economy (IPE) The distributive consequences of global economic exchange generate political competition in national and international areas. The winners seek deeper links with the global economy in order to extend and consolidate their gains, whereas the losers try to erect barriers between the global and national economies in order to minimize or even reverse their losses. International political economy studies how the enduring political battle between the winners and losers from global economic exchange shapes the evolution of the global economy. What is IPE? IPE studies the battle between winners and losers from global economic exchange Example: the decision by the Bush administration to raise tariffs on imported steel in the spring of 2002. The decision to raise the steel tariff was prompted by lobbying by the owners of American steel firms and the United Steel Workers of America. Why? The steel industry lobbied for higher tariffs because they were losing from trade. Imported steel was capturing a large share of the American market, resulting in a large number of plant closings. Higher tariffs would protect steel producers and steel workers from this competition. What is IPE? The higher steel tariff had negative consequences for other groups in the society. The tariff hurt American industries that use steel to produce goods, such as auto manufacturers, because these firms had to pay more for steel. The tariff harmed foreign steel producers, who could sell less steel in the American market than before the tariff was raised. In response, the European Union and Japan threatened to retaliate by raising tariffs on goods that the United States exports to their markets. What is IPE? To understand the global economy we need to understand economic theory One way to simplify, for sake of understanding, is to break down the economy into issue areas Issue areas International trade system International monetary system Multinational corporations (MNCs) Economic development These fields are interrelated, yet in spite of these deep connections, the central characteristics of each area are sufficiently distinctive that one can study each in relative isolation from others. Trade WTO: created a nondiscriminatory international trade system. Each country gains access to all other WTO members’ market on equal terms. Check the list of members (currently 160 members). http://www.wto.org/english/thewto_e/whatis_e/tif_e /org6_e.htm Trade GATT (WTO’s predecessor) GATT and WTO have enabled governments to progressively eliminate tariffs and other barriers to the cross-border flow of goods and services. But Regional trading arrangements emerging to pose a potential challenge to the WTO-centered trade system. Example: NAFTA- trading blocs composed of small number of countries who offer each other preferential access to their markets. International monetary system Enables economic exchange and transactions across borders. People living in the US who want to buy goods produced in Japan must be able to price these Japanese goods in dollars. Americans earn dollars, but Japanese spend yen, so somehow dollars must be converted into yen for such purchases to occur. The international monetary system facilitates international exchange by performing these functions. MNCs Firms that control production facilities in at least two countries (e.g Ford Motor Company, General Electric, The United Nations). Managerial control across borders (corporate managers based in the United States, make decisions to affect economic decisions that affect economic conditions in Mexico and other Latin American countries, in Western Europe and in Asia. Economic Development Throughout the postwar period, developing country governments have adopted explicit development strategies that they believed would raise incomes by promoting industrialization. Success of these strategies has varied: Some succesful, some not. The Newly Industrializing Countries (NIC)s of East Asia (Taiwan, South Korea, Singapore and Hong Kong) have been so succesful in promoting industrialization and raising per capita incomes that they no longer can be considered developing countries. Others, especially in Latin America and Sub-Saharan Africa have been less succesful. Questions of consequence How does politics shape societal decisions on how to allocate available resources? What are the consequences of these decisions? The study of international political economy is the study of how the political battle between the winners and losers of global economic exchange shapes the decisions that societies make about how to allocate the resources they have available to them. Questions of consequence We must consider that all resources are finite, and that there will be disagreements on how to allocate limited resources Competing demands for limited resources One of the important goals of IPE as a field of study is to investigate how such competing demands are aggregated, reconciled, and transformed into foreign economic policies. How are such demands aggregated, reconciled, and transformed into policy? Consequences of policy decisions What are the consequences of the choices that societies make about resource allocation? These have two different consequences. Welfare consequences: they determine the level of societal well-being. Some choices will maximize social welfare- they will make society as a whole as well-off as possible given existing resources. Other choices will cause social welfare to fall below its potential, in which case different choices about how to resources would make society better off. Consequences of policy decisions Decisions about resource allocation also have distributional consequences- that is, they influence how income is distributed between groups within countries and between nations in the international system. Example: steel tariff also redistributes income. Because the tariff raises the price of steel in the United States, it redistributes income from the consumers of steel, such as American firms that use steel in the products they manufacture to the steel producers. 2 research traditions These two abstract questions (How exactly does politics shape the decisions that societies make about how to use the resources that are available to them? and What are the consequences of these decisions?) give rise to two very different research traditions within IPE: 2 Research Traditions Explanatory studies: relate to first question, are oriented toward explaining the foreign economic policy choices that governments make. Aims to answer “why” questions. Examples: Why does one government choose to lower tariffs and open its economy to trade, whereas another government continues to protect the domestic market from imports? Why did governments create WTO? In answering such questions we are concerned with explaining the policy choices that governments make and pay less attention to the welfare consequences of such policies. 2 Research Traditions Evaluative studies: related most closely to the second question, are oriented toward assessing policy outcomes, making judgement about them, and proposing alternatives when the judgement made about a particular policy is a negative one. Welfare evaluation: focuses on whether a particular policy choice raises or lowers social welfare. Example: Does a decision to liberalize trade raise or lower national economic welfare? Distributional evaluation Environmental evaluation, etc. Studying IPE 3 traditional schools of IPE Mercantilist school Liberal school Marxist school Contemporary IPE Developing theories to answer the two questions through moving beyond the confines of traditional theories The approach of the book and this course: foreign economic policies that governments adopt emerge from the interaction between societal actors’ interests and political institutions. Traditional schools of IPE Mercantilism Rooted in 17th and 18th century theories on the relationship between economic activity and state power National power and wealth are tightly connected; National power is derived from wealth; Wealth is required to accumulate power Trade provides one way to accumulate wealth, if there was a positive balance of trade Manufacturing activities should be encouraged; agriculture discouraged Mercantilism continued ‘Modern’ mercantilism Economic strength is a critical component of national power Trade is to be valued for exports, but governments should discourage imports whenever possible. Some forms of economic activity are more valuable than others Mercantilism State should be involved in economic activity Channel resources into those areas that promote and protect national interest The only way to ensure that society’s resources are used appropriately is to have the state play a large role in the economy. Liberalism Emerged in Britain during the 18th cc to challenge mercantilism in government circles. Smith, Ricardo – trade and comparative advantage Liberalism Attempted to draw a strong line between politics and economics (purpose is to enrich individuals, not enhance state power) States do not enrich themselves by running trade surpluses; states gain from trade regardless of trade balance Countries are not necessarily made wealthier by focusing on manufacturing over commodities. Instead, liberalism argued, countries are made wealthier by making products that they can produce at a relatively low cost at home and trading them for goods that can be produced at home only at a relatively high cost. Government efforts to allocate resources will only reduce national welfare Liberalism Market-based system of resource allocation The limited role of the state is in the establishing of clear rights of ownership of property and resources Judicial system must enforce rights, contracts of transfership Resolve market failures Marxism Critique of capitalism 2 central conditions of capitalism: Private ownership of the means of production (capital) Wage labor According to Marx, the value of manufactured goods was determined by the amount of labor used to produce them Against this, capitalists did not pay labor the full amount of the value they imparted to the goods they produced Capitalists paid workers a subsistence wage and retained the rest as profits for subsequent investment Ultimate revolution predicted Dynamics of revolution The first problem: concentration of capital. Capitalists operating under market forces are driven toward greater and greater efficiency in the production of goods and services. Competition and efficiency demand that capitalists reduce the cost of producing goods and services for markets. Inefficient and uncompetitive enterprises are driven out of market, which leads to oligopoly and monopoly and the accumulation of wealth in the hands of the few. Efficient production translates into reducing labour costs because labour accounts for the lion’s share of production costs. The masses are impoverished, owing to the resulting decline in wages and increased unemployment. Dynamics of revolution A second contradiction of capitalism is the tendency toward overproduction. According to Marx, capitalism is prone to overproduction because greater efficiency allows capitalists to make more of the same good for the same or lesser cost. Dynamics of revolution A third contradiction is the falling rate of profit, which leads to oversavings on the part of the capitalists. As capital accumulates, the rate of return on capital investments declines. Capitalists have less incentive to invest in productive enterprises and instead save their excess wealth. Capital accumulation leads to a decline in investment returns until, finally a point is reached when investment ceases. These contradictions lead to great disparities between rich and poor, the capitalists and the workers. The immiseration of the working class eventually leads to a socialist revolution. Marxism According to Marxists, it is not markets but capitalists that make decisions on the allocation of resources Because capitalist systems promote the concentration of capital, investment decisions are not typically driven by market-based competition. Instead, decisions about what to produce are made by few firms that control the necessary investment capital. The state plays no autonomous role in the capitalist system. Instead, state operates as an agent of the capitalist class. Answering our questions 3 schools have distinct answers to how politics shapes the allocation of societal resources Mercantilists: state guides allocation to maximize power Liberals: Market-based transactions Marxists: Decisions made by large capitalist enterprises Evaluative consequences Mercantilists: Enhance the nation’s power in the international system Liberals: Enhance aggregate social welfare Marxists: Promote an equitable distribution of wealth and income Images of the Central Dynamic of IPE See Table 1.1, p. 11 Mercantilism: State (actor); intervention (role of the state); conflictual (image of the international system); enhance power of the nation-state (proper objective of economic policy) Liberalism: Individuals; establish and enforce property rights to facilitate market-based exchange; harmonious; enhance aggregate social welfare Marxism: Class, particularly the Capitalist Class; State as instrument of capitalist class; exploitative; promote an equitable distribution of income and wealth Interests and Institutions in IPE (an alternative approach) In their place, the book will emphasize an analytical framework developed during the last 15 years that focuses on how the interaction between societal interests and political institutions determines the foreign economic policies that governments adopt. To understand IPE we need to: 1- Understand where the interests (economic policy preferences) of groups in society come from 2- Explain how political institutions aggregate, reconcile, and ultimately transform competing interests into foreign economic policies and a particular international economic system Interests Interests are the goals or policy objectives that the central actors in the political system and the economy – individuals, firms, labor unions, other interest groups, and governments – want to use foreign economic policy to achieve People have material interests that arise from their position in the global economy. (“Tell me where you work and I’ll tell you what your foreign economic preferences are). Interests Interests are also based on ideas. Ideas are mental models that provide a coherent set of beliefs about cause and effect relationships. In the context of economic policy, these mental models typically focus on the relationship between government policies and economic outcomes. Economic theories, by providing clear statements about cause and effect relationships, can create an interest in particular economic policy. e.g A government that believes in comparative advantage will be inclined to lower tariffs to realize welfare gains. Institutions In order to understand how interests are transformed into policies, we need to examine political institutions Political institutions establish the rules governing the political process. This enables groups within countries, and groups of countries in the international system, to reach and enforce collective decisions (democratic systems vs. authoritarian systems) How to answer our questions How exactly does politics shape the decisions that societies make about how to use the resources that are available to them? What are the consequences of these decisions? Through: A focus on interests and institutions Begin by investigating the source of competing societal demands for income and then explore how political institutions aggregate, reconcile, and ultimately transform these competing demands into foreign economic policies and a particular international economic system The Global Economy in Historical Context 19th century: ‘first wave’ of globalization Technological change and politics Steam engine and telegraph made it profitable to trade heavy commodities across long distances Political structures: bilateral agreements that reduced tariffs and a stable international monetary system Cobden-Chevalier Treaty:1860, Britain and France eliminated most tariffs on trade between them with this treaty. Apart from the US (remained protectionist until 30s), shift to free trade gained momentum. Gold-backed currencies: each government pledged to exchange its national currency for gold at a permanently fixed rate of exchange. International migration: as trade grew, so did migration. (one million people migrated per year in 1900-1910). Cross-border financial capital. Late 19th cc British residents invested almost 10 % of their incomes in foreign markets. But then… World War I Countries abandon gold standard in order to finance the war, they tightly controlled trade and financial flows in order to marshal resources for the war. Failure following the war to reconstruct the 19th century economy There was a power shift from Britain to rivals, US and Germany A new ‘hegemon’ was required US remained unwilling to assume new role, preferring traditional isolationist policy E.g. War debt question (France and Britain had borrowed from the US to finance part of their war expenditures, the US refused to forgive these debts). US also raised tariffs in 1922, making it more difficult for European countries to earn dollars in order to repay debt to US German reparation payments (France insisted that Germany pay for war damages by paying reparations to the Allied powers. The American refusal to forgive French debt encouraged France to demand more from Germany). Delay in German recovery led to delay in recovery throughout Europe Payment of financial obligations was made possible by private capital flows from the US to Europe But by 1928 US lenders were reluctant to continue financing European war-debt High interest rates and the stock market bubble in the US were more attractive investments than Europe This led to a flow of capital out of Europe and into the US. Persistent capital outflows pushed many European financial systems perilously close to crisis and many European economies into recession. The Great Depression US stock market crash of October 1929 Full blown crisis US investors had bought stock with borrowed money Borrowers defaulted Banks began to fail The financial collapse in turn depressed economic activity Consumer demand fell sharply Output fell Unemployment rose Great Depression US production fell by 30% between 1929 and 1933 Unemployment rose to 25% in the US and up to 44% in Germany States raised tariffs in response 1930 Smoot-Hawley Tariff Act-(raised U.S. tariffs on over 20,000 imported goods to record levels. The tariff level was the highest in the U.S. in 100 years). Colonial trade blocs 1933 Imperial Preference System- a zone of limited tariffs within the British Empire, but with high tariffs with the rest of the world. Germany establish bilateral trade relations in central Europe Consequences on policy US policy makers drew some lessons from the Great Depression and World War II Construction of a stable and liberal international economy would have to be the centerpiece of postWWII planning in order to establish a lasting peace US concluded that it had, alone, sufficient power to establish a stable global economy Early 1940s, US (working with British policymakers) designed international institutions to provide the infrastructure for the postwar global economy Bretton Woods system Bretton Woods, New Hampshire, 1944 WTO, IMF, and World Bank all have their origins in Bretton Woods Restoration of the 19th century system. But this new system was slightly different than 19th century in that government was more activist (less liberal), following the experiences of the early 20th century. Keynesianism Insulation between the domestic and the international economies Contemporary global economy Global trend toward deeper international economic integration We should be cautious when we hear that globalization is ‘inevitable’, based on the experience of the early 20th century (the end of the ‘first wave’ of globalization) This book explores evolution of the global economy Organization of the book 3 additional devices Divide the field of IPE into 4 issue areas Trade and production MNCs International monetary system Finance system Levels of analysis International politics of the global economy Domestic politics of foreign economic policy Politics in advanced industrialized countries and politics in the developing world